In the previous post, we showed that a hybrid allocation, roughly 65% equity, 35% debt, gave up about 6.5% of annual return over five years compared to pure equity, that's the cost. In exchange, when COVID hit, it fell half as much. When the 2024–25 correction arrived, it barely blinked. The equity investor needed nerves of steel. The hybrid investor needed patience. One of those is easier to sustain.

As also discussed in detail in our previous post, April 2023 was pivotal in terms of taxation when debt mutual funds became significantly tax inefficient in comparison to equities. Gains are now taxed at your income slab, no indexation, no long-term advantage. If you're in the 30% bracket (and most of our readers are), that's a meaningful drag on compounding.

But here's the thing. You still need non-equity exposure. That hasn't changed. What's changed are the ways to get that exposure.

That is where hybrid funds come in.  Not all of them, we're talking about 4 specific categories from the broader hybrid universe, all of which share one structural shenanigan: they at most times maintain at least 65% gross equity exposure (sometimes through derivatives and arbitrage). This means they qualify for equity taxation, STCG at 20% and LTCG at 12.5% beyond 1.25 lakh gains, regardless of the fact that a chunk of the underlying portfolio isn't actually taking directional equity risk.

You can have a meaningful chunk of your money sitting in debt, arbitrage, or gold and still pay equity tax rates on the way out. That's not a loophole. That's how these categories are designed. Understanding what each one actually does under the hood, not just on the label is the point of this article.

The Four Categories at a Glance

Before we get into each one, here's the summary table. Think of this as your reference card, we'll spend the rest of the article unpacking what these numbers actually mean in practice.

(Note: These are typical ranges based on how most AMCs run these categories. Individual funds will vary. The gross number is what matters for your tax treatment.)

Now let's talk about each one.

1. Equity Savings Funds: The Closest Thing to a Debt Fund with Equity Taxation

If you're thinking which is the most conservative option in this list, this is it.

SEBI's rule says: minimum 65% gross exposure to equity, minimum 10% in debt, and as of the February 2026 categorization circular, a net equity exposure of 15% to 40% of total assets. That last bit is important. SEBI has now formally codified what was previously just disclosed in scheme documents. What this means in practice is that these funds typically hold 15–40% in unhedged equity, 10–35% in debt, and the rest in arbitrage. The arbitrage piece is key. It's what pushes the gross equity number above 65% while keeping the actual risk profile closer to a debt fund.

How does arbitrage work? In simple terms, the fund buys a stock in the cash market and simultaneously sells it in the futures market, locking in a small spread. There's no directional equity bet. The return from this piece behaves a lot like a liquid or ultra-short-term debt fund depending on the spreads available.

So the real risk-return driver is that 15–40% unhedged equity. The rest of the portfolio is essentially generating fixed-income-like returns.

Who is this for? Someone who needs a parking spot for money they'll use in 1–3 years. Think of it as an add-on to your parking vehicles like short-duration debt funds or even FDs, with comparatively better post-tax returns if you hold for more than a year. If you were putting money in a liquid fund or an ultra-short fund and your tax bracket is 30%, the post-tax return from an equity savings fund will likely be superior, with only marginally more volatility. The 15–40% net equity band also means SEBI has put guardrails on how aggressive (or conservative) these funds can get, so you know roughly what you're signing up for.

The catch? Returns won't excite you. In steady markets, expect something in the ~7–9% range. And when equity markets fall sharply, that 15–40% unhedged portion will show up in your NAV unlike a pure debt fund which would be unaffected. You're trading a small amount of additional volatility for a significant tax advantage.

2. Dynamic Asset Allocation Fund: The "I'll handle the Asset Allocation" Fund

The idea is straightforward: A fund that dynamically shifts between equity and debt based on some model, usually driven by market valuations and sometimes trend or momentum signals. When markets look expensive, the fund reduces net equity exposure, typically by hedging more. When markets look cheap, it increases unhedged equity.

SEBI classifies these as "Dynamic Asset Allocation" funds. There's no fixed equity-debt band, the fund can theoretically go from 0% to 100% equity. In practice, most of these funds maintain 65%+ gross equity for the tax benefit, and the net unhedged equity typically ranges between 30% and 80%.

The new SEBI categorization circular (February 2026) makes one thing explicit: Dynamic Asset Allocation funds can invest in debt and equity instruments only. No gold, no REITs, no commodities in the core allocation. If you want those, you need a Multi Asset fund. This is a cleaner line than what existed before, and it matters when you're comparing a Dynamic Asset Allocation Fund to a Multi Asset fund. They're solving different problems.

Here's what's happening under the hood in a typical Dynamic Asset Allocation Fund with, say, Rs 100 of AUM:

• Equity holdings: Rs 75 (gross)
• Short/hedge positions: Rs 30 (via futures)
• Net equity exposure: Rs 45
• Debt: Rs 25

So on paper, it's a 75/25 equity-debt fund. In practice, the net equity risk is 45%,much more conservative than it looks.

Who is this for? Someone who wants to outsource the hardest part of investing, deciding how much to hold in equity versus not-equity, and adjusting that over time. You don't have to panic-sell in a crash or figure out when to add equity. The fund does it for you. (Whether the fund does it well is a different question, and one you should evaluate fund-by-fund.)

The catch? Two things. First, in a sustained bull market, Dynamic Asset Allocation Funds will underperform pure equity because the hedging and debt allocation act as a drag. You're paying for downside protection with upside participation. Second, different AMCs run their models very differently. ICICI's fund and HDFC's fund might both be classified under the ‘Dynamic Asset Allocation Fund’ but they can have meaningfully different net equity exposures at the same point in time. Look at the actual portfolio, not just the category name.

3. Multi Asset Allocation Funds: The Diversifier

SEBI's mandate here is clear: invest in at least three distinct asset classes, with a minimum of 10% in each. Typically, that's equity, debt, and a third asset usually gold, sometimes silver, or other commodities.

This is the category that gives you structural diversification beyond just equity and debt. Gold doesn't always move along with equities, sure there could be times like those too (consider the move it has had since the last one year which should tell you something about both its potential and the danger of extrapolating recent performance). 

Most multi asset funds maintain 50–65% net equity exposure, 15–25% in debt, and the remainder spread across gold, silver, and other commodities. 

This is the category that saw the most explosive growth in 2025. A lot of that is gold doing the heavy lifting on recent returns, but the underlying structural argument is sound, if you want one fund to give you equity, fixed income, and a commodity hedge, this is the only SEBI category designed to do exactly that.

Who is this for? Investors who want true multi-asset diversification without managing multiple funds and dealing with the rebalancing headache (and tax event) that comes with it. Also good for people who believe in holding gold as a strategic allocation but don't want to buy it separately.

The catch? The fund manager has wide discretion on how much to put where (beyond the 10% minimums). Two multi asset funds can look very different from each other. And when one asset class (like gold recently) drives most of the returns, it can create a misleading picture of what the fund "normally" delivers. Multi asset allocation is a process argument, not a returns argument.

4. Aggressive Hybrid Funds: Exactly What the Name Suggests

This is the most straightforward category of the four. SEBI says: 65–80% in equity, 20–35% in debt. No arbitrage tricks, no dynamic models, no gold. Just equity and debt, in a fixed band, rebalanced by the fund manager.

The equity portion is typically run like a diversified equity fund, large and mid cap stocks, across sectors. The debt portion is usually high-quality (AAA/AA rated), short-to-medium duration. The fund manager can move within the 65–80% band based on their market view, dialing up equity when they're bullish, pulling back towards 65% when they're cautious, but the range is much narrower than a Dynamic Asset Fund.

Think of this as a flexicap fund with a built-in 20–35% debt cushion. The debt allocation dampens volatility on the way down and slightly reduces returns on the way up. 

Who is this for? Investors who want majority equity exposure but with guardrails. First-time equity investors who find 100% equity too nerve-wracking. People who want both equity and debt but don't want to deal with rebalancing between equity and debt funds. Also, anyone who recognises that 20–35% in debt, inside an equity-taxed wrapper, is a better deal than holding a separate debt fund taxed at slab.

The catch? This is still a high-equity product. In a serious market correction (think March 2020 or the 2022 drawdown), an aggressive hybrid fund will fall, less than a pure equity fund, but it will still hurt. Don't mistake the word "hybrid" for "safe." Also, unlike Dynamic Asset Funds, the allocation here doesn't dynamically respond to market conditions. If the market drops 30%, the fund doesn't automatically increase its debt allocation. It stays within its 65–80% equity band.

The Net Equity Spectrum (or, the Thing that Actually Matters)

Forget the category names for a moment. What you really care about is, how much directional equity risk am I taking?

Here's how the four categories roughly stack up on net equity exposure:

The range across these four categories from ~25% net equity to ~75%  is enormous. That's the whole point. These aren't four versions of the same thing. They're four distinct positions on the risk spectrum, all sharing the same tax treatment.

And that tax treatment is the structural advantage. In the post-2023 world where debt fund returns are taxed at slab, getting 30–50% non-equity exposure inside an equity-taxed structure is a genuine edge on post-tax compounding.

To Add a Little More Insight

To see how these categories actually behave, not in theory, but in practice. We built a simple equal-weighted portfolio for each category, including every active fund in that category at any given point in time from 2017 to 2025.

Here's what the data shows: Aggressive Hybrid and Multi Asset funds have delivered the highest returns, Dynamic Asset Allocation sits in the middle on returns, volatility, and drawdowns, which is kind of the point. And Equity Savings comes in with the lowest volatility and drawdowns, behaving almost like a fixed-income product with a bit of equity seasoning.No surprises, but it's useful to see the numbers confirm the intuition. 

The max drawdown column is where things get interesting. Even the most aggressive category here, Aggressive Hybrid has a max draw down of about 29%, compared to 35–40% that a pure equity fund would have suffered in the same period. That 20–35% debt allocation isn't just a regulatory requirement, it's a real cushion when things go wrong.

The drawdown chart makes this even more vivid. Look at March 2020, that's where you see the full spectrum at work. Aggressive Hybrid and Multi Asset funds dropped nearly 25–30%, tracking equity pretty closely on the way down. Dynamic Asset Funds held up noticeably better, and Equity Savings barely flinched in comparison. But here's the more interesting part, look at the post-2020 period. The drawdowns across 2022 and late 2024 are shallower for every category, but the gap between them stays consistent. Equity Savings rarely dips below ~5%, Dynamic Asset and Multi Asset hovered in the ~5% to ~10% range. Aggressive Hybrid touched ~10% to ~15% a few times.

This is what the net equity spectrum looks like when the market actually tests it. The categories don't just differ in returns,  they differ in how much pain they ask you to sit through. 

What Comes Next?

There’s a lot more to unpack now that we have touched upon "what are these things and what do they do." In our next article, we’ll explore more about:

• Which specific funds are good within each category (that's a fund selection question, not a category question)
• How much to allocate to each category?
• Is there any value in having all 4 in your portfolio?

For now, the takeaway is this—post the 2023 debt tax change, hybrid mutual funds are the most tax-efficient way to get non-equity exposure in your portfolio. They each do it differently, for different risk profiles, and understanding those differences is the first step to using them well.

 

This is the second of three articles ahead of the launch of Anchor, our new hybrid basket in PMS. The first article explains why asset allocation matters in the first place while the third explains how Anchor is built. This one explains the hybrid category and answers the question “what does that buffer actually look like?”.