Hybrids, Debts and Equity Funds: Know The Real Difference

ByDavid Adamson

Hybrids, Debts and Equity Funds: Know The Real Difference

During the past several years, the traditional Investment Management (IM) industry has seen rapid changes with the appearance of well-funded fintech companies, the digital tsunami and the shifting of demographics. DCI is one such upcoming finance preferred ecosystem that leverages the digital capabilities in order to provide excellent investment opportunity for the private, retail, and institutional investors. DCI uses advanced technologies like AI, machine learning, and Robo-advisory to offer a complete 360-degree view of the private and institutional portfolio to the users of the ecosystem.

Coming back to traditional investment methods in the IM industry, it is observed that the traditional investment methods like mutual funds and hedge funds do not guarantee an excellent return to investors due to limited investment opportunities and larger capital requirements. In the recent past, investing in mutual funds has also been considered as expensive by IM industry experts that is largely considered as an anachronistic ETF.

In the cryptocurrency space too, the investors are looking to invest in digital crypto funds that offer high returns with minimum market risk. In order to help investors, modern fintech players, such as DCI (Digital Crypto Invest), are planning to provide active portfolio management capabilities in a ready turn-key ecosystem featured by modern technologies such as Artificial Intelligence (A.I)/Robotics.

Despite rapid changes in the IM industry, it is important for the investors (i.e. private, retail and institutional) to obtain proper knowledge regarding the difference between types of funds in terms of risk, return, tax treatment, and investment opportunity.

Here are the category-wise differences between three major funds, which include equity funds, hybrid fund, and debt funds.

Investment Risk

When it comes to investment risk, the equity funds come on top with a high-risk rating in comparison to debt and hybrid funds. Equity funds are the ones that primarily invest in stocks. In equity funds also, the risk varies in sub-categories. For instance, mid-cap and small-cap are riskier than the diversified large-cap funds.

The lowest risk credit in the equity category goes to index funds, which passively tracks the index. On the other hand, in the debt category, the risk rating is mainly determined by maturity and credit quality. Debt funds primarily invest in different securities like Treasury bills. High maturity generally incurs high risk in debt funds. Lastly, in the hybrid category (debt and equity both), the riskiest category is the balanced funds as it has a greater than 50% exposure to equity.

Return Scale

In obvious terms, it can be simply stated that the returns expected on each type of fund are generally proportional to the risk taken by the investor. One thing that affects this relationship between risk and return is Total Expense Ratio (TER). TER, in simple terms, can be defined as the total cost that incurs to the investor for managing and operating any fund like a mutual fund.

The level of TER varies with active management of funds by the investor. Talking about three different funds, the closely ended and liquid funds have a low TER in debt category, whereas in the equity category, diversified and sectoral funds have high TER and high expense ratio. In the hybrid category, arbitrage funds are largely passive in nature, hence have low TER, whereas the balanced funds have high TER close of 2.5 percent.

Apart from TER, the choice between regular and direct plan also affects the NAV to investors, and as a result, overall return also gets affected.

Keeping this in mind low TER would be the best choice for investors to have a high return in the alpha markets.

Taxation Scale

Talking about taxation, there are broadly two categories, dividends and capital gains, on which taxation scheme of things gets imposed. In the case of dividends, the capital earned is tax-free and is directly handed to investors in case of debt, equity, and balanced funds. However, the Dividend Distribution Tax (DDT) generally varies in each category. For equity, DDT is 10%, whereas the debt category has a much higher DDT of 25%.

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