All You Need To Know About Hybrid Funds!

There are different types of investors. Some investors believe in taking risks and, as a result, they prefer investing in equities. Their reasoning is that the more the risk you take, the more returns you get and hence, equity becomes their first choice. Another type of investor is someone who believes more in safety of capital, rather than in higher returns. These investors usually invest in safer instruments and try to lower the risk as much as possible.



Generally, they invest in debt instruments. However, some people are often confused as they are afraid of losses in equities and do not appreciate the stable returns provided by the debt instruments. Here step in the hybrid funds that invest in both equity as well as debt. Historically, there was no categorisation of hybrid funds. The fund houses used to create hybrid funds of their choice by tweaking the proportion of both the asset classes as they deem fit. However, the situation changed when Securities and Exchange Board of India (SEBI) came up with its circular for rationalisation and recategorisation of mutual funds. SEBI created five broad categories of funds, of which hybrid fund is one. Hybrid funds are further categorised and each sub-category of hybrid funds is defined. We will understand these sub-categories in a while.



In the last two months or so, hybrid funds are gaining much acceptance among investors. This can be seen by the AUMs (Assets Under Management) data from AMFI. If we look at the above graph, then we can say that AUM for hybrid fund have picked up from April 2019 onwards, when it rose almost 44 per cent when compared with March 2019. However, it is to be noted that this AUM is the aggregate of all the sub-categories of hybrid funds. However, if we look at the sub-categories, then in one month i.e. from May 2019 to June 2019, the arbitrage funds witnessed an increase in AUM by 6.22 per cent, followed by dynamic asset allocation or balanced advantage funds and multi-asset allocation funds whose AUMs increased by 2.29 per cent and 1.57 per cent, respectively. On the other hand, equity savings funds witnessed a drop in AUM by 4.88 per cent, followed by conservative hybrid funds and balanced hybrid funds or aggressive hybrid funds, whose AUMs dropped by 2.54 per cent and 0.48 per cent, respectively.

Types Of Hybrid Funds

There are in all 7 types of hybrid funds as defined by the SEBI.

Conservative hybrid funds : These funds invest 10 per cent to 25 per cent of the total assets in equity and equity-related instruments and remaining 75 per cent to 90 per cent of total assets in debt instruments.

Balanced hybrid funds : These funds invest 40 per cent to 60 per cent of the total assets in equity and equity-related instruments and remaining 40 per cent to 60 per cent of total assets in debt instruments. Arbitrage is not permitted in this scheme.

Aggressive hybrid funds : These funds invest 65 per cent to 80 per cent of the total assets in equity and equity-related instruments and remaining 20 per cent to 35 per cent of total assets in debt instruments. Fund houses can either have balanced hybrid funds or aggressive hybrid funds. They cannot have both the funds on offer.

Dynamic asset allocation or balanced advantage funds : These funds can invest in equity and equity-related instruments and debt instruments and manage it in a dynamic way. Here, the fund at its own discretion can change the asset allocation as it may deem fit.

Multi-asset allocation funds : These funds invest in minimum three asset classes, where each asset class must have minimum of 10 per cent allocation of the total assets. Here foreign securities cannot be considered as a separate asset class.

Arbitrage funds : These funds invest minimum 65 per cent of total assets in equity and equity-related instruments. The main objective of these funds is to seek arbitrage opportunities.

Equity savings funds : These funds invest a minimum of 65 per cent of total assets in equity and equity-related instruments and minimum 10 per cent of the total assets in debt instruments. The minimum hedged and unhedged is stated in the Scheme Information Document (SID). Here, the fund can invest in equity, debt and can also seek arbitrage opportunities.

Performance

Whatever the type of fund, after all everything comes down to performance. So, let us look at the performance of these funds. For understanding the same, we have carried out a study wherein we have compared the performance of the hybrid sub-categories with that of Sensex and 10-year sovereign bonds. The period of study is from June 2008 to June 2019. The performance of the aggressive hybrid funds and balanced advantage funds are compared with Sensex, where 65 per cent or more of the assets is in equity and the remaining is in debt. The conservative hybrid funds are compared with 10-year sovereign bonds. The funds that had no NAV history from June 2008 have been excluded from the study. 



If we look at the 1-year average rolling returns, then a maximum number of times the aggressive hybrid funds and dynamic asset allocation or balanced advantage funds match the performance of Sensex. Even the conservative hybrid funds managed to beat the 10-Year sovereign bond. However, if we look at the period from May 2010 to October 2010, August 2011 to August 2012, July 2014 to June 2016, aggressive hybrid funds and dynamic asset allocation funds were able to beat the Sensex. 



From the below table, we can see that in terms of average 1-year rolling returns, aggressive hybrid funds and balanced advantage fund were able to match the performance of Sensex. In fact, they have beaten the performance of the Sensex by a slight margin. The conservative hybrid funds were able to beat the performance of the 10-year sovereign bond. If we look at the risk, which is measured by the standard deviation, then aggressive hybrid and dynamic asset allocation funds have the same standard deviation, which is less than that of the Sensex. Arbitrage funds are least in terms of risk, followed by equity savings funds and conservative hybrid funds. Since their risk is low, the returns generated by them are also low. 



Now if we look at the average 3-year rolling returns, then we can see that for a maximum number of times the aggressive hybrid funds and dynamic asset allocation managed to beat Sensex performance. Among both these funds, the aggressive hybrid funds turn out to be better than dynamic asset allocation funds. Both these funds underperformed the Sensex only for the period from August 2018 to June 2019. On the other hand, the conservative hybrid funds have been in line with the 10-year sovereign bonds most of the time. 



From the above table, we can see that in terms of average 3-year rolling returns, the aggressive hybrid funds and balanced advantage funds were able to beat the performance of Sensex. In fact, aggressive hybrid funds have even beaten the performance of the balanced advantage funds. The conservative hybrid funds were able to beat the performance of the 10-year sovereign bond. If we look at the risk, then the aggressive hybrid funds and Sensex have the same standard deviation. The balanced advantage funds have lesser standard deviation when compared with aggressive hybrid funds and Sensex. The arbitrage funds and equity savings funds are the least in terms of risk, followed by the multi-asset allocation funds and conservative hybrid funds. Since these are low in terms of risk, the returns generated by them are also low, except for multiasset allocation funds. The interesting thing here is that even by taking three times lesser risk than Sensex it has managed to beat the Sensex by a slight margin. Even when we look at the minimum returns, the multi-asset allocation funds have positive 4.38 per cent returns, whereas the Sensex has negative return of 1.54 per cent. This shows the importance of asset diversification.



Looking at the average 5-year rolling returns, we can see that for a maximum number of period, the aggressive hybrid funds and balanced advantage funds have consistently beaten the Sensex. The aggressive hybrid funds have even beaten the balanced advantage funds. The conservative hybrid funds have consistently outperformed 10-year sovereign bonds. The aggressive hybrid funds and dynamic asset allocation funds have underperformed Sensex for the period from October 2013 to May 2014. 



From the above table, we can see that in terms of average 5-year rolling returns, the aggressive hybrid funds and balanced advantage funds were able to beat the performance of Sensex. The aggressive hybrid funds have even beaten the performance of the balanced advantage funds. The conservative hybrid funds were able to beat the performance of the 10-year sovereign bond by a good margin. If we look at the risk, then the aggressive hybrid funds and balanced advantage funds have the same standard deviation. The Sensex has higher standard deviation when compared with aggressive hybrid funds and balanced advantage funds. The arbitrage funds and equity savings funds are the least in terms of risk, followed by conservative hybrid funds and multi-asset allocation funds. Since these funds are low in terms of risk, the returns generated by them are also low, except for multi-asset allocation funds. Even in average 5-year rolling returns, the multi-asset allocation funds take three times less risk than the Sensex but have managed to give performance in line with the Sensex. Even when we look at the minimum returns, the multi-asset allocation funds have the highest minimum returns of 7.42 per cent, whereas the Sensex has 3.31 per cent.

Conclusion

In hybrid funds, exposure is not restricted to only equity or debt. It is in fact a combination of equity and debt and also other asset classes. However, who should invest in them is a question that investors should decide themselves. To arrive at the decision, there are various factors like investment horizon, risk profile and financial goals that need to considered. In hybrid funds, even the aggressive hybrid funds and balanced advantage funds, which are equity-oriented in nature, have debt allocation. So, these funds are for those who want to experience investing in mutual funds and also wish to take some exposure to equity or someone having conservative to moderately conservative risk profile. Arbitrage is something that benefits when the markets are volatile, so these funds can be used by people adopting tactical allocation and when the markets get volatile, they allocate assets to these funds. These funds even enjoy the tax status of equity. Investors having very conservative risk profile can take exposure to conservative hybrid funds as these funds majorly invests in debt instruments and also have a little exposure to equity, which would help you to get somewhat better returns than being in a pure debt portfolio. Nevertheless, investors with moderate to aggressive risk profile should avoid hybrid funds. They would be better off creating their mutual fund portfolio consisting of equity and debt which can be changed based on their investment tenure and risk profile. Even you can have equity and debt proportions are per your requirements. This helps in managing mutual funds at the micro level and rebalance the overall portfolio accordingly.

Further, SEBI has not bifurcated the equity and debt portion of hybrid funds by its sub-asset classes. But when you create a portfolio, you have great deal of flexibility to move your portfolio according to your needs. In hybrid funds, if a fund manager feels that there is opportunity in small-cap and mid-cap space, then he may have high exposure to the same, which will not be suitable for conservative to moderate risk takers. However, this is not the case if you have your individual portfolio of equity and debt mutual funds. Hybrid funds, though, are good investment options for the first time investors, as the risk taken by them is less as compared to equity mutual funds.