Bucketed based on the asset class allocation and risk-factor, each type of hybrid fund has a different investment style and purpose. Assess each type to pick the right one for your portfolio
By Raghav Iyengar
A hybrid fund is a type of mutual fund that invests in a mix of asset classes within the same fund. Depending on the type of fund, it can be a combination of two or more asset classes that include equity, debt, gold and also international equities in varying proportions. There is little to no correlation between these asset classes, which can enable an investor to artfully balance risk and return at all times through flexible rebalancing.
Understanding the broad contours of a hybrid fund makes it easy to see their relevance in an investor’s portfolio. At the same time, it is not a one-size fits all approach. This Rs 3,711-billion category (as on May 31, 2021) is divided into six sub-categories. Bucketed based on the asset class allocation and risk-factor, each has a different investment style and purpose. In order to pick the right fund for your portfolio, remember to first understand and assess each type.
Here are the six key categories of hybrid funds:
Conservative hybrid fund: A conservative hybrid fund invests only about 10-25% of its total assets in stock markets, i.e., equities. The remaining portion is invested in debt instruments that include corporate and government bonds and non-convertible debentures. While the debt investment aims to provide regular and stable income from coupon payments, the equity portfolio has the potential to generate better returns through capital appreciation and dividends over time. If you are a risk-averse investor with moderate returns expectation, then this category of hybrid funds is likely to suit your investment style
Aggressive hybrid fund: This category of hybrid funds is at the other end of the spectrum compared to a conservative hybrid fund and is good for investors who have a higher (equity like) risk appetite. The mandate is to allocate 65-80% to equity across market capitalisations (large-cap, mid-cap and small-cap) and the remaining to debt and other asset classes. The category is ideal for investors who are looking for equity-like return (as 65%-80% is invested in equity) but with lower volatility (balance 20%-35% is invested in fixed income). But as the underlying is heavily tilted towards equities, investors should consider this product for a period of more than five years.
Dynamic asset allocation fund: A balanced advantage fund or a dynamic asset allocation fund are hybrid mutual funds which increase / decrease allocation between equity and fixed income based on certain pre-defined valuation parameters. An investor can invest in balanced advantage funds if they want to avoid timing the market levels. The fund balances between equity and fixed income instruments depending on market conditions to earn reasonable returns with low volatility as compared to pure equity funds.
Arbitrage fund: Arbitrage funds take advantage of the price differential of a stock either on two different exchanges or between two different markets (the cash and derivative market). By creating an arbitrage position, the fund manager ensures that the spread between the two markets is captured and this translates into returns for the investor. With the advantage of equity taxation, an arbitrage fund can be an investor’s choice for parking short term surplus liquidity and earning decent returns.
Multi asset allocation fund: Going one step beyond your traditional hybrid funds, the multi asset fund invests in at least three different classes with a minimum of 10% allocated to each. A mix of three asset classes can help the investor attain the goal of asset allocation via a single product. Since every asset class behaves differently, diversification safeguards the portfolio against downside emerging in a single asset class. A mix of asset classes which have low correlation amongst them is a good way to generate decent returns with low levels of volatility.
Equity savings fund: The equity savings fund is another way of diversifying the portfolio as the fund is a prudent mix of equity, debt and arbitrage. An equity savings fund does just that, by allocating a minimum of 65% in equity and arbitrage positions and the balance in fixed income instruments. The arbitrage positions create a hedge in the portfolio and the focus is to generate regular income, whereas the allocation to equity focuses on capital appreciation.
Because of this, the fund’s equity exposure is partially hedged and the volatility is reduced as compared to the completely unhedged equity exposure in aggressive hybrid fund. The fund also offers equity taxation.
Each type of hybrid fund has a unique investment style. Investors must compare these plans vis-à-vis their investment needs and pick the ones that best address them.
The writer is CBO, Axis AMC