Debt funds vs Hybrid funds. All you need to know
As an investor, you may have heard about three broad types of funds
- equity funds
- hybrid funds
- debt funds
In this article, we will be trying to put out a comparison between debt funds and hybrid funds. We will try to differentiate them based on risks-returns and tax assessment.
Difference between Debt funds and Hybrid funds
A debt fund is a mutual fund, an exchange-traded fund (ETF), or any other pooled investment instrument that invests primarily in fixed-income assets. Debt funds have lower fees than equity funds due to lower management costs. Investors in debt funds can choose between passive and aggressive solutions.
Credit funds and fixed-income funds are common names for debt funds. These funds are popular among investors looking to preserve their capital, along with the generation of low-risk income.
Debt funds invest in a wide range of securities, each with its own set of risks. Companies with a steady outlook and high credit quality issue investment-grade debt. High-yield debt is usually issued by low-credit-quality businesses with good growth potential and has a larger risk-return profile.
Debt funds are appropriate for people with short to medium-term investment horizons, where “short-term” refers to 3 months to one year, and “medium-term” refers to a period of 3 to 5 years.
A hybrid fund is a mutual fund scheme that invests in a mix of equity and debt instruments to create a balance between risk and returns of the instruments mentioned above.
The risk of investing in a hybrid fund is dependent on the allocation of funds between equity and debt.
Hybrid funds obtain their returns effectively in two parts:
- From the risk-free debt instrument
- The risky and high-delivering equity segment is volatile as well.
A comparative analysis of debt and hybrid funds
Comparison of the risk-return scale
Without a second thought, hybrid funds are riskier than debt funds because of equity components.
The riskiest ones within hybrid funds are those with more than 65% of equity exposure; among debt funds, the fund with low credit quality and high growth prospects carry a riskier profile.
Returns are dependent on the risk you take so returns will vary depending upon your separate exposure to equity and debt, though debt funds are categorically safer than a hybrid.
Comparison of the funds on the taxation scale
These funds are subject to taxation on capital gains and dividend distribution tax. Funds are categorized into equity (if equity exposure is >65%) and non-equity.
Equity funds are subject to STCG of 15% if held for less than one year and LTCG of 10% if held for more than a year. On the other hand, non-equity funds (debt funds and hybrid funds with <65% equity) are taxable according to your income-tax slab.
If held for less than three years, LTCG is payable at 15% with indexation benefit. Equity and non-equity funds attract Dividend distribution tax (DDT) of 10% and 25%, respectively.
So, while choosing the fund you wish to invest in, you have to account for your risk-return equation before deciding.