Hybrid Funds: Catering To All Requirements

Updated: Nov 16 2003, 05:30am hrs
With a sharp spurt in equities and some decent bond market rallies through 2003, hybrid funds have gained from both asset classes. The category is up 43.11 per cent this year as on October 31, 2003. And surprisingly all equity-oriented hybrid funds have beaten the VR Balanced Index, which is up 23.6 per cent. After 1999, this is the highest return posted by the hybrid funds category in the first ten months of any calendar year.

The worst performer in the category is up 29.65 per cent, which wasnt the case even in the 1999 bull market when the least gainer was up 15.4 per cent. Dont these facts make hybrid funds interesting

Apart from the recent performance, there is something sweet about hybrid funds. First, they make picking easy: when you cant decide whether an equity or a bond fund is better for you, hybrid funds fit the bill perfectly by offering both fund types wrapped up in one convenient package. Second, a hybrid fund acts as a risk diversification tool and fulfills your dream of making money without taking too much risk.

While bonds give it a sense of stability and an attractive flow of income, equities provide the extra boost. Equities have proved to be the best long-term asset class and hence the best hedge against inflation. Third, hybrid funds provide smooth sailing in the market (read low volatility). For instance, the standard deviation of the average hybrid fund was 5.17 as on October 31, 2003 compared to 7.41 for diversified equity funds.

Performance in the first four months of 2003 was dull for the equity market. Initially, it was the impact of US-Iraq war and the spread of SARS, which influenced the markets. Later, Infosyss poor revenue guidance dampened market sentiment. This was also the period when debt markets went through one of the most volatile times in recent history.

The yield on the 10-year benchmark government security, after touching a low of 5.86 per cent shot up to 6.76 per cent within a short span. Thus, till April-end, the category of hybrid funds was down 2.8 per cent. Only three funds- HDFC Prudence, GIC Balanced and DSPML Balanced managed to remain in black. A low exposure to technology stocks helped all the three funds escape the tech turmoil of April. On the other hand, SUN F&C Balanced, ING Balanced Portfolio and Canganga were the worst losers - down over 7 per cent each.

All three had higher equity exposure with the first two having a high tech allocation. ING Balanced also had the highest gilt allocation (average 29 per cent) during the period, which further added to its volatility.The real boost came after April 2003, when both equity and debt markets showed signs of recovery. Healthy FII inflows and good monsoon have turned the table for equity markets since May. The reduction in interest rates and abundant liquidity have propelled bond prices upwards.

Thus, in the subsequent six months, hybrid funds gained a robust 47.22 per cent as on October 31, 2003. Magnum Balanced gained the most. SUN F&C Balanceds high equity exposure, which didnt work in its favour initially, proved rewarding in the recent rally-it was among the biggest gainers in the category. HDFC Prudence and Tata Balanced closely followed it.

While HDFC Prudence gained on the back of higher exposure to the then hot favourites financial services and healthcare stocks, the mid-cap orientation in Tata Balanced worked in its favour. The CNX Mid-cap 200 Index gained 86.5 per cent during May-October 2003. That apart, Alliance 95, Magnum Balanced and K Balance have also tasted mid-caps during the period but for a shorter time period.

Over the whole cycle, HDFC Prudence turned out to be the best performing hybrid fund. Its year-to-date return of 68 per cent as on October 31, 2003 was 13 per cent higher than the second best fund in the category. More surprisingly, it has beaten half of the diversified equity funds. Its initial gain of 7 per cent in the bear phase and the subsequent higher return has helped it top the category.

Normally, equity-oriented hybrid funds keep a 60-40 stock-bond weight and debt-oriented hybrid funds have 40-60 stock-bond allocation.

However, plus/minus 5 per cent is accepted. Through 2003 till date, most hybrid funds have stuck to this allocation, but few like Canganga, SUN F&C Balanced and Alliance 95 have gone overboard on equity in the past - with an average equity exposure of over 70 per cent.

In contrast, there are few cautious ones like JM Balanced-G and K Balance that have confined their equity allocation to 55 per cent.

While selecting the right hybrid fund, one should decide upon the risk-taking ability and the equity-bond mix of your overall portfolio.

One should go in for a diversified yet actively managed hybrid fund, which is dynamic and has shown some ability in reallocating its portfolio on a regular basis. Low expenses are always an advantage and the fund managers track record also helps.

If you are not comfortable with the 60-40 asset mix, there are fixed asset allocation funds, which have options with different asset mixes. Then there are variable or dynamic asset allocation funds too, where the allocation varies based on some parameter or on the fund managers discretion. A hybrid fund is ideally a sample of what everyones portfolio should look like.

My picks among equity-oriented hybrid funds include HDFC Prudence, FT India Balanced, Sundaram Balanced,

Prudential ICICI Balanced and DSPML


Value Research