Hybrid offerings perform well on risk-adjusted basis, say experts

With equity markets seeing a phenomenal rise in the past two years, returns generated by hybrid schemes have lagged pure-play equity schemes. Such funds invest in a mix of equity and debt and change the allocation dynamically as they look to align themselves with market conditions.

Though there are over half-a-dozen categories of hybrid funds, two are popular. One is the balanced advantage or BAF (also called dynamic asset allocation) category, whose March 2022 average asset under management (AUM) stood at Rs 1.76 trillion. The other is the aggressive hybrid category, which has an average AUM of Rs 1.45 trillion. Together, these two account for almost two-thirds of the hybrid category AUM of Rs 4.8 trillion.

BAFs have delivered an annualised category average return of 23.1 per cent in the past two years. During the same period, the Nifty50 total return index (TRI) delivered an annualised return of 44 per cent. Over three- and five-year spans (ended March 31, 2022), these funds have given annualised returns of 10.7 per cent and 9 per cent, respectively.

Aggressive hybrid funds, which have a greater equity skew, have performed slightly better. In the past two years, these funds gave a category average return of 32.5 per cent. Over the three- and five-year spans (ending March 31, 2022) these funds have given annualised returns of 13.4 per cent and 11.1 per cent, respectively.

The two-year returns for hybrid funds may have lagged equity schemes, but Gautam Kalia, head–investment solutions, Sharekhan by BNP Paribas, says they have fared better on a risk-adjusted returns basis. He expects such funds to continue to attract investors.

“Dynamic equity allocation along with equity-like tax treatment will help BAF remain a preferred category among retail investors,” he says.

Kalia adds that in the current environment of global uncertainty, elevated crude oil prices, and high inflation, investors with a medium-term tenure who want a flavour of equity in their portfolio, but desire less volatility than in a pure equity fund, should opt for this category.

Typically, hybrid funds use a pre-defined methodology — based on valuation metrics such as price-to-earnings (P/E) ratio, price-to-book value (P/BV), or dividend yield — to decide equity allocation.

To illustrate: Let’s consider ICICI Prudential BAF, the second-largest fund in the category with an AUM of Rs 39,479 crore. In March 2020, the fund had a 73.7 per cent allocation to equities. By the time the market peaked in October 2021, equity allocation had been reduced to 35.5 per cent.

“When the pandemic led to a sharp correction, the model indicated it was time to be invested in equities. Consequently, the fund was close to fully invested. As the markets recovered, the fund red­uced its equity allocation,” explains Ihab Dalwai, fund manager, ICICI Prudential Mutual Fund.

During an upturn in the equity market, the returns of aggressive hybrid funds tend to be better than BAF, but they also tend to be volatile.

Shridatta Bhandwaldar, head of equities, Canara Robeco Mutual Fund, says the 32.5 per cent two-year annualised returns delivered by aggressive hybrid funds is quite “respectable”.

“While these funds protected the downside between March 2020 and May 2020, investors got to participate in the equity run up that happened thereafter,” he says.

Over the next two- or three-year period, investors can expect a double-digit or close to double-digit return from this category.

“The equity side will capture 70-75 per cent of the return from a flexi-cap equity portfolio. However, with interest rates set to harden, the debt side of the portfolio will only contribute accrual return, not capital gains,” says Bhandwaldar.

When selecting a fund from these categories, investors should be wary of those that take credit risk on the debt side of the portfolio. On the equity side, the fund should not take very high exposure (above 30-35 per cent) to mid- and small-cap stocks as doing so can make the fund volatile.