Should you take debt exposure via hybrid funds? Pros and disadvantages you need to know | Mint

Long -term debt funds have been enjoying a cozy place in the portfolios of conservative Indian investors for years. Thanks to tax arbitrage benefits, especially for those in higher tax heels, it was an attractive alternative to traditional fixed deposits (FDs). Until April 1, 2023, debt funds had a clear tax benefit: Long -term capital gains (LTCG) held for more than three years qualified for indexing benefits and were taxed at 20%. On the other hand, interest of FDs is taxed at the appropriate tax page, which was as high as 30%. But long -term debt funds have become like an endangered species in investment portfolios over the past few years. With the rising interest rate scenario, the interest rates offered by fixed deposits reached a peak to 8%, making debt funds look irrelevant. Taxarbitrage, so from April 1, 2023, is also short and long -term debt funds, regardless of whether the holding period, according to the investor’s revenue plate. The move effectively killed the tax arbitrise that made FDS more attractive than debt funds. As FD tariffs in the rising rate cycle reached almost 8%, investors embraced FDs who left the cold in the cold. The predictable returns, safety and simplicity of FDS have made them a no-brainer for those who chase stability over the complexity, especially if the YTM (returns to expiration) of debt funds is chased due to rising interest rate scenario. Hybrid Funds: The stop gap solution in response to debt funds that shed the favorable tax has begun many investors to use hybrid funds to obtain tax privilege debt exposure. Shares-Oriented Hybrid Funds (with 65%+ stock allocation) Enjoy the favorable share tax regime: Short-term Capital Gains (STCG) -20% (if held < 1 year) Long-Term Capital Gains (LTCG): 12.5% beyond ₹1.25 lakhs (if held > 1 year) Conservative hybrid funds (with 35% -65% equity) have also become a popular route, with long -term tax at 12.5% ​​after 2 years and short -term gains taxed by the appropriate income tax page. But that’s not all: Basteren funds fade the lines of asset allocation, while these hybrids offered tax benefits, they also jeopardized risk -insulation. With exposure to equity, they could not provide the capital conservation with pure debt instruments. Volatility crept in, especially during the stock market exchange – to cover the purpose of a debt award. Most investors assume that the “debt portion” of a hybrid fund is stable/fixed. It is not. Fund managers often take opportunistic calls – to draw up or reduce debt exposure based on market views. What can be a 35% debt award at the time of the investment can shrink up to 20% if valuations are expensive or shot during periods of market optimism/attractive valuation, without any direct communication to investors. This undermines the purpose of taking a specific weight that matches the ideal asset allocation that fits the risk profile. As the markets fall, investors can rely on such hybrid funds as sharper withdrawals than expected, and convert what was supposed to be a low-risk core entry into a source of volatility. In a bear market, debt tax in a hybrid fund would shake the psychological confidence. If the exposure to debt is only through hybrid funds, if the markets are low, all schemes in the portfolio may be in the red due to the shares. But if the exposure to debt was through pure debt funds, those schemes would remain resilient with positive returns, giving some psychological tranquility. Arbitrage + debt funds: A low-risk middle road to stop a better balance, AMCS has launched hybrid funds without any active stocks and investors have started investing in these funds. There are 2 sub-categories below with no open stock positions. i) Equity Arbitrage + Debt ii) Shares Arbitrage + Commodity Arbitrage (Gold and Silver) + Debt This combinations provide stability with a very limited disadvantage, and is aimed at 7.1% –7.2% pre -tax returns, or 6.2% –6.3% after tax for those in higher tax pages, as the capital gains tax is increased. But even this approach has restrictions in the benefit of the full potential of debt possession. As interest rates are expected to fall within the near term, the YTM of the long -term debt funds will rise above 9%, creating a strong case for pure debt funds to perform better than arbitrage plus debt funds, especially for investors under the 30% tax. Union Budget 2025: A quiet victory for investors in debt funds The latest union budget has brought a lesser known but powerful tax loss. Under the new regime, capital gain of up to £ 12 lakhs in a financial year out of debt-to-do funds (investments made on April 1, 2023 or later) can be completely tax-free if the investor has no other income, thanks to the Article 87A. While in the case of stock-oriented funds, capital gains become taxable if total revenue is more than £ 4 lakhs. For pensioners, home makers and low-income investors, it offers a significant benefit and gives you a new look at debt funds. Why is it time to recalibrate your debt strategy? Several factors now suggest that it is time to reconsider debt allocations. Falling interest rates will benefit the prices of bonds, leading to higher yields in long -duration debt funds. YTM of quality debt funds are on an upward trend, especially in dynamic and corporate bond categories. Hybrid funds dilute risk protection by interfering with shares, regardless of tax benefits. Article 87A creates a zero tax window for the capital gains of debt funds in the case of low income groups. For conservative investors and those who are not in the highest tax rate, debt funds can provide after tax returns that beat hybrid replacements at lower risk, volatility and greater predictability. Conclusion: Strategy on structure in a world to tax arbitrise is the message clear: debt funds develop, not disappear. With the interest rate cycle shift, budget benefits kicking in, and the hidden risks of hybrid strategies that come to light, investors must re -evaluate their debt allocations, not only from a return perspective, but through the lens of risk management, portfolio tables and tax efficiency. As the markets recalibrate, your strategy should be too. V.Krishna Dassan, Director, Dhanavruksha Financial Services Pvt. Ltd. First Published: 10 Apr 2025, 03:22 PM IST