Money Explainer: How Sebi's new category of passive hybrid funds helps investors

Per Sebi's proposal, debt-oriented passive funds will allocate their investments in a ratio of 75% debt to 25% equity. Equity-oriented funds will primarily focus on equity, with a 75% equity to 25% debt allocation. Balanced passive funds will split their investments evenly between equity and debt.

As passive funds, these investments will align their portfolios with an underlying index. Mint explains how this proposal could help investors in building their portfolios.

More clarity on fund allocation

A passive hybrid fund gives more clarity to investors in terms of portfolio structure, according to experts.

“As passive funds track an index with a defined investment universe and predetermined stock and bond selection criteria, investors can clearly see where the equity and debt portions of the fund are allocated," said Vidya Bala, co-founder of primeinvestor.in.

Anil Ghelani, head–passive investments and product, at DSP Mutual Fund, said an index fund or exchange-traded fund will be a low-cost option for investors to take both equity and debt exposure in one place.

Where will such funds invest?

Sebi has proposed aligning the equity component with broad-based indices derived from the top 250 companies by market capitalization.

The debt component will stick to constant duration indices.

For example, a five-year constant maturity portfolio aims to maintain an average portfolio maturity of five years at all times. It can do this by mixing government bonds of different maturities such that the portfolio’s maturity is maintained at around five years, or by holding government bonds of a five-year maturity.

How will index hybrid funds be taxed?

Index funds with a 75% equity allocation will benefit from equity taxation rules. If such funds are held for more than one year, long-term capital gains tax rates will apply. Gains up to ₹1 lakh will be tax-free, while higher gains will be taxed at 10%. Short-term capital gains are taxed at 15%.

Balanced index funds will also receive an indexation benefit. If such a fund is held for more than three years, the gains will be taxed at 20% with an indexation benefit.

Gains from debt-oriented index funds, where equity allocation will be capped at 25%, will be taxed at the income tax slab rate of the investor.

Should you opt for such funds?

As these are passive funds tracking indices, there is no risk of underperformance or outperformance due to a fund manager’s investment calls.

According to Arun Kumar, head of research at FundsIndia, it can be challenging for regular investors to discern whether a fund is underperforming due to an out-of-favour investment style or poor investment decisions by a fund manager. “Therefore, a passive hybrid fund can be a good alternative for those seeking straightforward asset allocation products," he says.

Also Read: How you can blend investment styles with mutual funds

“Passive hybrid funds would be suitable for investors who want to build a simple product portfolio with a limited number of funds. Such funds can meet the different asset allocation needs of the investor," says Nirav Karkera, head of research at Fisdom. 

If you prefer simple investment options with clear allocation and minimal performance risk, hybrid passive funds could be suitable for you. Once fund houses launch these products, these could be a valuable addition to your investment portfolio.

Also Read: Why the mutual fund industry is betting on duration funds