Worried about market? Invest in hybrid mutual funds (2024)

Many investors are worried about the current markets. They are apprehensive about investing in a pure equity fund. Such investors can take a defensive investment through hybrid funds, with graded exposure to equity. A Balanced Advantage Funds (BAF) is one where the fund manager decides the effective allocation to equity. In Aggressive Hybrid Funds (AHF), the extent of allocation to equity is between 65% to 80% of the portfolio. Then there are Equity Savings Funds where the net equity exposure is, say, 30% of the portfolio, usually in a range of 20% to 40%, as defined by the fund investment objectives. The balance corpus in Equity Savings Funds is invested in hedged equity and debt.

The advantages of allocation through hybrid funds are as follows:

Discipline: in a portfolio, allocation to equity and debt is done as per the investment objectives. Since market movement is not uniform, this ratio gets distorted. If there is a rally in the equity market (which has happened since March 2020), the initially decided ratio becomes skewed in favour of equity. A significant change calls for review and rebalancing, otherwise, the portfolio does not meet the investment objectives. In a hybrid fund, since there is a parameter to be followed as per the fund investment objectives, fund manager does the rebalancing periodically.

Flexibility: in pure-play equity fund categories, apart from Flexi Cap funds, there is a binding on the fund manager. In Large Cap funds it is limited to top 100 stocks, in Multi Cap category it is 25% to each of large, mid and small cap categories, etc. In debt funds, there are parameters on portfolio maturity, credit rating of instruments, etc. In hybrid funds, there is flexibility to the fund manager.

Taxation: taxation is more efficient in equity funds as it becomes long term after a holding period of one year against three years for debt funds. Moreover, long term capital gains up to Rs 1 lakh is exempt for equity funds. There are six categories in hybrid, of which AHF, BAF, and Equity Savings category funds usually offer equity taxation as they maintain apparent equity exposure of more than 65%. In the process, the debt component of the fund also is taxed as equity. If you are doing it through pure equity or debt funds, there may be a tax implication on your rebalancing, as a redemption is a taxation point.

Coming to performance, funds with effectively higher equity exposure have given relatively higher returns, as equity outperforms debt. This also gives you a perspective on the risk, as funds with higher equity exposure can be more volatile as well. Over the 5 years till 10 December 2021, AHFs on an average delivered 13.4% annualized (regular option, source AMFI website, number of funds 25). For a perspective, though not a fair comparison due to the differential equity exposure, BAFs delivered 10% annualized over 5 years till 10 Dec 2021 (regular option, source AMFI website, number of funds 13, includes the earlier version of some of the funds before repositioning as BAF). The volatility was lower in BAFs than AHFs, as the fund manager was tuning the effective equity exposure. On the same parameters, Equity Savings category delivered 8.2% annualized returns (regular option, source AMFI website, number of funds 15).

Conclusion
There are various categories offering you various degrees of equity exposure. Pure play equity funds have 100% equity, barring a bit of cash component for meeting redemptions or as a fund manager call. As discussed earlier, AHFs have 65% to 80% equity exposure and if you want a more graded or defensive exposure, it is BAFs where the effective equity exposure is a fund manager call. Moving more towards defensiveness i.e. lower effective equity exposure, we have Equity Savings Funds where it is approx. one-third of the fund. To the extent you intend to make your portfolio defensive and reduce the equity exposure, you may consider these funds, either for fresh deployments or rebalancing.

(The writer is a corporate trainer and author.)

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