In the last 3 years hybrid fund categories of mutual funds have been the cynosure of all eyes and have been pulling many investors towards them like a Giant Magnet. This more specifically has happened due to the emergence of dynamic asset allocation funds which have arguably become the best FD plus solution in terms of return expectations. This category, due to its high compatibility to various market climates has become a natural part of most portfolios.
The dynamic asset allocation funds basically increase their exposure to equities when market valuations are favourable and reduce the equity exposure when valuations are expensive. The last 3 years in which the equity markets have seen a roller coaster ride starting from the pandemic impacted fall in 2020 , to a faster and higher than expected recovery, to the uncertainties due to the Russia-Ukraine war, to the current concerns of recession have by itself has made the dynamic asset allocation funds a natural choice.
READ MORE: Why should you choose hybrid funds when markets are unpredictable?
The following numbers explain the meteoric rise of the overall Hybrid funds category. As per the data of AMFI, the overall category had an AUM of just ₹39,146 cr in March 2016 which almost doubled in each of the next 2 years to 84,763 cr in March 17 and 1,72,151 cr in Mar-18 which was very significantly higher than the overall AUM growth of the industry.
This continued growing at a great pace with reasons fuelled by the pandemic steered uncertainties, growing to a size of 4,81,748 cr as on 31 Sep '22 which is an AUM growth of 12 times in the last 6.5 years. It’s not just the AUM of this category which saw such skyrocketing growth, this also reflected in the percentage share of the hybrid categories to the overall AUM, which has spiked to over 12% from just a meagre 3% in 2016.
The last 2 decades have not seen any mutual fund category witnessing such a staggering growth. The data given here is excluding the arbitrage fund category which has been left out as this category is only suitable for short term parking and not long-term investing.
Along with this massive increase in AUM , this category now throws up a variety of choices for investors in various spectrums of risk and for different market conditions. The most encouraging and progressive aspect of the evolution of this category is that many risk averse investors who do not have the appetite to embrace equity fully but would like to have a soft touch of it yet refraining from the interim shocks it can give now have options meeting that objective in the form of hybrid funds.
READ MORE: Conservative Hybrid Funds: The definitive guide you must read before you invest
With the list of hybrid fund categories expanding, it's important for one to pick the suitable category and right set of schemes within the category. Following are the various hybrid fund categories and suggestions on how to choose from them.
Hybrid Funds (Conservative) – This category takes 10 to 25% net exposure to equity and the rest of the investments goes into debt instruments. The category falls under debt taxation. The suggested investment period is more than 3 years. This fund is suitable for those who are looking at 1 to 2% more than bank FD rate over a 3 year period.
Equity Savings Funds – This category has 15 to 50% net equity exposure and the rest is held in debt instruments and arbitrage opportunities. The investments in this fund qualify for equity taxation and the suggested investment period is more than 2 years. Investors who look at 2 to 3% more than bank FD returns and cannot afford much of a depreciation in capital can consider this category.
Multi Asset Funds – This category has 10 to 80% net equity exposure and the rest of the investments is in debt instruments, commodities and arbitrage opportunities. Taxation is of Equity except the schemes which follow Fund of Funds(FOFs) style which fall under debt Taxation .Suggested holding period is 3 years and above for FOFs and 2 years and above for the others. Investors who would like to have a blend of debt, equity and commodities and aim for 3 to 4% more than a bank FD can look at this category.
Asset Allocator Funds –This category takes the highest swing in net equity exposure from 0-100% and the residual investments are in debt, commodities and arbitrage opportunities. The investments in this category are deployed in various mutual fund schemes and so fall under the debt taxation applicable for FOFs. The recommended holding period is 3 years and above. Investors who look at active churn of the portfolio across various mutual fund schemes to adapt to changing market conditions with expectation of 10 to 12% annualised returns can consider this category.
Balanced Advantage Funds – This is the most important and popular category in the spectrum of hybrid funds. The category takes 30 to 80% net exposure to equity while the rest is held in debt instruments and arbitrage opportunities. Schemes of some fund houses take more than 50% exposure to equity at all times which are ideal to be held for more than 3 years while the others can be held for about 2 years or above. Taxation applicable is of equities. This category is for investors who look at capitalising the return opportunities of equities but do not want to have high equity exposure when valuations are expensive and have annualised return expectation of about 10 to 12%.
Hybrid funds (Aggressive) – As the name suggests this category is the most aggressive in terms of the net equity exposure it takes which is 65 to 80% and the rest is held in debt instruments. It falls under equity taxation and the ideal holding period is 3 years and above. Investors who wish to take equity exposure to the level of minimum of 65% with the fusion of debt can consider this category and return expectation over the long term can be slightly upwards of 12%
Note: The returns given here are only the indicative and not fixed or assured returns.
READ MORE: Why should you have an aggressive hybrid fund in your portfolio
The funds which fall under Equity taxation have the Short Term Capital Gains (STCG) realised in less than 1 year taxed at 15% and Long Term Capital Gains (LTCG) generated above 1 year are taxed at 10%. Long Term Capital Gains up to 1 lakh withdrawn in a financial year is exempted from tax. The funds which fall under Debt taxation, have the Short Term Capital Gains , which is gains realised below 3 years taxed at applicable nominal income tax slab and Long Term Capital Gains is taxed at 20% with indexation.
The long-term annualised returns of these categories can potentially range between 9 to 12% or slightly more based on equity exposure they take and the returns delivered by the other asset classes they are exposed to during the investment period. Due to the equity exposure the funds can see a drop in capital during market corrections proportionate to the equity weightage and investors should stay put without reacting during such situations holding long term to reap the benefits of these categories. These funds also deliver better tax efficient returns as compared to fixed deposits and other traditional investments.
Apart from the sub categories of hybrid funds mentioned above there are also solution-oriented hybrid funds targeting financial needs of children and retirement corpus creation which are structured differently by different fund houses and have a longer holding and lock-in period.
Retail investors who have aversion to equities, which is the critical asset class in wealth creation, can test the equity waters through these hybrid fund categories and slowly increase their exposure to equities as their risk appetite enhances.
V Krishna Dassan, Director - Wealth Management, Dhanavruksha Financial Services Pvt. Ltd.