scorecardresearchMutual fund investing: Should you go for aggressive hybrid funds or dynamic asset allocation funds?

Mutual fund investing: Should you go for aggressive hybrid funds or dynamic asset allocation funds?

Updated: 25 May 2023, 08:57 AM IST
TL;DR.
Aggressive hybrid funds must maintain a 65-80% allocation to equities at all times, while dynamic asset allocation funds may vary their equity exposure to between 30-80%, depending on the fund managers' strategies.
Dynamic asset allocation mutual funds invest in equity, real estate, stocks and bonds and tweak their allocation with changing circumstances.

Dynamic asset allocation mutual funds invest in equity, real estate, stocks and bonds and tweak their allocation with changing circumstances.

Both these funds, i.e. the aggressive hybrid funds and the dynamic asset allocation funds come under the hybrid funds’ umbrella. And to many, there might not be much of a difference between the two as both invest in equity and debt asset classes. In reality, there is a significant difference though.

The major difference lies in how both these funds go about choosing asset allocation and the frequency of making the changes.

The aggressive hybrid funds need to have 65-80% in equities at all times. The remaining 20-35% should be in debt instruments. If the allocation changes, then it has to be rebalanced by the AMCs periodically. As per the rules, it is not allowed to have an unbalanced portfolio which is not in line with the mandate of the hybrid funds.

The dynamic asset allocation funds, on the other hand, have the freedom to be more dynamic about their asset allocation strategy. Theoretically, it is within the rules for the fund manager to have the freedom to change equity allocation from 0 to 100% or vice versa.

Practically it varies between 30-80% equities. The choice of actual allocation will depend on the fund manager’s view or the strategy being followed. Many AMCs use qualitative factors (like PE, PB, etc.) while many managers might use additional quantitative factors as well.

So each dynamic asset allocation fund uses a different strategy to general returns and balances the volatility. And it is for this reason that comparison between funds in this category can get tricky as it’s not really a like-to-like comparison.

To understand how both funds operate, suppose there is an aggressive hybrid fund that has a 65% equity allocation and a dynamic asset allocation fund that has 75% equity currently. Now if the market rises by 10%, the equity allocation may increase to (say) 69% for aggressive hybrid funds and (say) 84% for dynamic allocation funds.

Now here is where the difference in approach gets highlighted. The aggressive hybrid fund, being statically managed, will bring back the equity allocation to 65%. But the dynamic funds may not necessarily bring back the allocation to the original 75%.

If the fund manager’s strategy is such that it sees equity markets getting dangerously overpriced, it may decide to bring the allocation down to even 45%. Or if they are still convinced that the market will rise further, it may leave the allocation at 84% itself.

So, this is how the 2 categories compare when it comes to portfolio handling.

The fundamental basis for both categories is simple - balance return and volatility. But both categories follow different paths to achieving this balance as we saw earlier.

While both funds have their own fan followings, there is no way to be sure which category will outperform the other in the short term. So, there will be different winners amongst the two each year. But in general, and over the long term, both categories are expected to have similar risk-return outcomes though volatility experienced may vary for both in the short term.

Here are a few points to consider if deciding between the two:

  • First things first, both funds will have significant equity allocation most of the time and hence, are suitable only for long-term investing.
  • If an investor wants to have a sufficiently large equity allocation at all times, then better to opt for aggressive hybrid funds. These will always have a minimum of 60-65% equity allocation which is regularly rebalanced. It won’t go below that.
  • If an investor wants to be a little more tactical and is open to varying asset allocation based on the fund manager’s market view, then dynamic allocation funds are better. But since each dynamic allocation fund will follow a different strategy, the risk level of each of them may be very different. So, pick accordingly.
  • What if you want to have both funds in your mutual fund portfolio? You can but it may not help much as there can be considerable overlap within the equity portfolio of both funds. So, one needs to look under the hood of both funds to know what is overlapping and what is unique.
  • Given the recent adverse changes in debt funds, some people are looking at these two categories as alternatives. That is not the right view. These are equity-heavy categories and cannot be compared or considered as alternatives to pure debt funds just because of better taxation.

Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.
 

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First Published: 25 May 2023, 08:57 AM IST

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