As per the proposed amendments in the Finance Bill, 2023, income from any mutual fund investing not more than 35% of its total proceeds in the equity shares of domestic companies, shall be treated as short term capital gains on after April 01, 2023.

Against this backdrop, investors can consider hybrid funds as feasible addition to the portfolio.

Why does investing in Hybrid Funds makes more sense in the Current Scenario?

An investor, who is willing to take additional risk, can consider adding hybrid funds (with a gross exposure of over 65% to equities) to his or her portfolio to get incremental exposure to debt on or after April 01, 2023. By investing in these funds, investors can benefit from tax-efficiency, as they will be taxed as equity-oriented funds.

As per The Income Tax Act, 1961, the taxation of capital gains for an equity-oriented fund, for an individual investor, in the short term (holding period less than equal to 12 months), the capital gains are taxed at 15% (plus applicable surcharge and cess). In the long term (holding period greater than 12 months), the capital gains are taxed at 10% (plus applicable surcharge and cess) for gains exceeding INR 1 lakh.

Since the tax levied on the capital gains will be at the investor’s personal income tax rate for investments in debt funds on or after April 01, 2023, getting incremental exposure in debt through hybrid funds can be a more tax-efficient route for an individual investor.

Why should an investor consider Asset Allocation?

In Hindustani Classical Music, an octave, also known as Saptak, comprises of the following 7 notes – Sa Re Ga Ma Pa Dha Ni. Interestingly, every song is created using a combination of all the 7 notes. By judiciously combining these notes, a composer makes listening to music, a stress-free experience.

Just like this combination equates to a stress-free experience, allocating to different asset classes helps in making an investor’s investment journey less stressful!

Why should an investor consider investing in Hybrid Funds?

When investing in hybrid funds, investors can allocate their assets to different asset classes. What does this mean? Primarily, an investor can consider allocating towards 3 asset classes, namely:

• Equity: Providing growth of capital
• Debt: Providing stability to capital
• Commodity: Hedge against inflation and uncertainties

While each asset class has a specific role to play, different asset classes perform differently under each market cycle. For example, while equity markets fell sharply during onset of COVID-19 pandemic, both debt and gold saw a modest rise during the same period.

As these asset classes have low or negative correlation amongst themselves, investment in multiple asset classes can help in reducing the volatility (measure of risk) of the overall portfolio during period of sharp movements in a single asset class. This non-linear relationship between the asset classes is the key reason for hybrid funds being a great addition to an investor’s portfolio.

For further clarity, let us have a look at the graphs below. Taking one scenario from Chart 2 – An investor’s portfolio has an allocation of 60% towards domestic equity, 30% towards debt and 10% towards gold. For this portfolio, in comparison to pure equity, while the gross compounded annualized returns over 20 years fell by a mere 1.7%, the volatility has reduced significantly – by 7.4%!

Source: www.niftyindices.com, World Gold Council. Data for last 25 fiscal years from April 2002 to February 2023. Returns are compounded annualized in nature. Data used for asset classes: Equity – NIFTY 50, Debt – NIFTY 10-year Benchmark GSec, Gold – Spot Rate INR/10 Grams. Monthly portfolio rebalancing assumed. Standard Deviation calculated using daily returns. HDFC Mutual Fund/AMC is not guaranteeing future returns of these asset classes. The above combinations are for illustrative purpose. Investors are requested to take professional advice while making investment decisions. *E: Equity, D: Debt, G: Gold

The selling of securities within a mutual fund portfolio is exempt from tax under Section 10(23D) of the Income Tax Act, 1961. As a result, the re-balancing of portfolio between asset classes within a hybrid fund also does not attract any tax. Hence, asset allocation through a hybrid fund is highly tax efficient as compared to investors doing the same on their own.

Consider investing from our Suite of Hybrid Funds

While there are multiple choices to opt from the suite of Hybrid Funds offered by HDFC Mutual Fund, it is important to assess risk tolerance level before choosing a hybrid fund. Based on the asset allocation, especially the exposure to equities, each hybrid fund differs from another. The net equity allocation ranges from minimum 15% to maximum 100%, and there are four different categories under hybrid funds to suit different investor segments from conservative to aggressive: