Mutual Fund Unlocked: Conservative Hybrid Mutual Funds

In our country, for a majority of investors, even today, bank fixed deposits and government saving schemes are the way to go. This is because technically these investment options provide a risk-free rate of return. Though this is true, one must look at the bigger picture. What these investments are providing is the nominal rate of return and not the real rate of return.

The real rate of return is the inflation-adjusted rate of return. The nominal rate of return is what the bank fixed deposits or government saving schemes have promised.

To make this clear, let us take an example. The prevailing bank fixed deposit rate is around 6.5 to 7.0 per cent. These are fully-taxable as per the income tax slabs of the investor. So, for the investor in the highest tax bracket, post-tax returns would come to around 4.97 to 5.35 per cent. The CPI (Consumer Price Index), i.e. inflation in 2018 is 4.6 per cent. So, the real rate of return would be around mere 0.37 to 0.75 per cent.

If in the future, the inflation goes up, then the fixed deposits would generate a negative real rate of return, though technically they are risk-free investments, they do possess inflation risk.

Even though mutual funds are subject to market risks, they generate potentially higher inflation-adjusted returns. Mutual funds have a wide variety of choices for investors to choose from which would match the investor's risk appetite. One such category of funds is Conservative Hybrid Category which is a good option for people with low-risk appetite.

Hybrid Conservative Mutual Fund invests in both debt and equity-asset classes wherein these are more inclined towards investment in debt and money market securities. As per the recent SEBI guideline, Hybrid Conservative Mutual Funds must at least have 75 to 90 per cent investments in debt and money market securities. Equity and equity-related investments must be in a range of 25 to 10 per cent. So, with kind of asset allocation structure, these funds are less volatile than other equity or hybrid category of funds.

For the debt portion of these funds, fund managers generally deploy accrual strategy. In this strategy, investments are generally held until maturity and the interest on such investments are accrued. Due to this, changes in interest rates do not impact returns over the tenure of the securities held. This asset allocation strategy aids to reduce the downside risk and give reasonable risk-adjusted returns over the long period.

Long-term investment in Hybrid Conservative Category of Funds proves to be more tax-efficient than that of bank fixed deposits and government saving schemes. There is no TDS (Tax Deducted at Source in Mutual Funds unlike bank fixed deposits. If the investments in Hybrid Conservative Category Mutual Fund is held for more than three years, then as per Income Tax laws it is considered as Long-Term Capital Gain and would be taxed at 20 per cent with indexation benefit. On the contrary, if the investments are held for less than three years then it is considered as Short-Term Capital Gain and would be taxed as per the investor’s income tax slabs.

So, for investors with higher tax brackets i.e. 20 or 30 per cent, in long-term Conservative Hybrid Funds may prove to be more tax efficient than bank fixed deposits and government saving schemes. In a nutshell, Conservative Hybrid Funds can be considered for investment for investors with low-risk appetite.