Capital Markets: Challenges and Developments

What are Hybrid Funds?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Hybrid funds

Mains level : Not Much

This newscard is an excerpt from an originally FAQ published in TH.

Try this PYQ:

Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

Hybrid Fund

  • A hybrid fund is one that invests in both equity and bonds. So, such funds ought to help investors with their asset allocation decision.
  • This refers to how you allocate your annual savings between equity and bond investments.
  • Suppose you are unsure of the proportion of equity and bond investments to have in your portfolio.
  • By investing in a hybrid fund, you could outsource your asset allocation decision to the manager of the fund, so the argument goes.
  • The issue is that each goal you pursue requires different asset allocation. For instance, the asset allocation for your child’s education portfolio must be different from your retirement portfolio.
  • Hybrid funds cannot consider your individual goal requirement as it is a collective investment vehicle.

Tax efficiency of the fund

  • Based on current tax laws, a hybrid fund that holds 65% or more in equity is considered as an equity fund.
  • So, if you redeem your units in such hybrid funds after a holding period of more than 12 months, you have to pay long-term capital gains tax of 10%.
  • If a hybrid fund holds less than 65% in equity, you have to pay 20% capital gains tax with indexation if you sell your units after a holding period of more than 36 months.

Back2Basics: Stocks vs. Bonds vs. Equity

  • A stock represents a collection of shares in a company which is entitled to receive a fixed amount of dividend at the end of the relevant financial year which are mostly called Equity of the company.
  • Bonds term is associated with debt raised by the company from outsiders which carry a fixed ratio of return each year and can be earned as they are generally for a fixed period of time.
  • Bonds are actually loans that are secured by a specific physical asset.
  • It highlights the amount of debt taken with a promise to pay the principal amount in the future and periodically offering them the yields at a pre-decided percentage.
  • Equity is ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of an asset.
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