Don't go by history alone while picking hybrid fund, say analysts

These are for long-term wealth; dynamic funds protect downside risk better

Aggressive hybrid funds (AHFs) are currently outperforming dynamic asset allocation or balanced advantage funds (DAA/BAFs) across investment horizons (see table). This has sparked a debate on whether it is better to invest in a category where the asset allocation remains static, or one where it keeps changing.

Higher equity allocation drove performance

The equity markets have done well over the past year (the Sensex is up 54 per cent). Explaining the outperformance, Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India, says: “AHFs would have maintained their equity allocation of 65-80 per cent over the past year. DAA/BAFs, on the other hand, would have reduced it as equities got more expensive.” The massive 17.4 percentage point outperformance over the past year, he adds, has also contributed to the outperformance over longer time horizons.

A couple of other factors also work in AHFs’ favour. “In an AHF, the allocation is static. These funds are always fully invested in the equity market. Such funds will always do a better job of catching the upside in the market compared to those where the equity allocation keeps changing,” says Swarup Mohanty, chief executive officer, Mirae Asset Investment Managers.

Their debt allocation can range from 20 per cent to 35 per cent. “Since the allocation to debt is also fixed, the fund managers are able to invest more sensibly and often contribute well to overall returns by catching interest-rate cycles better,” adds Mohanty.

Fundamentally different

Some experts say these are two different categories that should not be compared at all.

An AHF maintains a consistently high equity allocation. The DAA/BAF category, on the other hand, cuts its equity exposure when the market is expensive, and vice-versa. “DAA/BAFs reduce volatility by using derivatives. Their overall equity exposure is usually around 65-70 per cent, but the net equity exposure is only around 40-50 per cent most of the time. The rest is in derivatives. While the use of derivatives reduces volatility, it also caps the upside,” says Vidya Bala, co-founder, Primeinvestor.in. According to her, a category with a much lower net equity exposure can’t compete against one where it is higher.

Horses for courses

Don’t be guided by past returns alone when choosing between these two categories. Understand their underlying asset allocation and select the one that suits you. “DAA/BAFs are meant to provide conservative long-term investors better risk-adjusted returns by buying low and selling high. AHFs, on the other hand, fulfil the needs of investors with a relatively higher risk profile,” says Chintan Haria, head-product and strategy, ICICI Prudential Mutual Fund.   

DAA/BAFs aim to curtail volatility. “They are likely to do a better job of containing downside risk than AHFs,” says Bala. Investors who have an aggressive portfolio may add them to reduce overall volatility. Those with a horizon of just two-three years, who want better returns than they would get from debt funds, and desire equity-like tax treatment, may also invest in them.

Investors building longer-term portfolios for wealth creation may opt for AHFs (or separate equity and debt funds), provided they have a horizon of at least five years. New investors, who don’t have sufficient funds to buy separate equity and debt funds, may also buy them for their long-term portfolios.