Enter debt-oriented hybrid funds with a minimum horizon of three years

Invest via the SIP route to benefit from the volatility expected in the near term

Owing to low returns from pure fixed-income instruments, many financial advisers had asked their clients to invest in debt-oriented hybrid funds. Since these funds take some exposure to equities, they are expected to offer slightly higher returns than pure debt funds. Over the past month, however, returns of many funds in these categories have turned negative.

Sliver of equity exposure

Conservative hybrid funds invest 15 to 25 per cent of their portfolio in equities and the rest in bonds. Equity-savings schemes invest in a mix of stocks and spot-futures arbitrage in such a way that these two components together constitute minimum 65 per cent of the corpus. The rest is invested in bonds. The pure equity allocation ranges from 15 to 35 per cent.  

“In debt-oriented hybrid funds, the bulk of the portfolio is accrual based, so they are more stable than pure equity funds. The equity component provides the market upside over a slightly longer horizon,” says Joydeep Sen, corporate trainer (debt markets) and author.

Investors also get the benefit of asset allocation to both equity and debt. “It is the fund manager’s responsibility to maintain an asset allocation in keeping with the fund’s mandate,” adds Sen.

Prepare for near-term volatility

Returns of many conservative hybrid schemes and equity savings schemes have turned negative over the past month. This has come as an unpleasant surprise to investors with moderate risk appetite, who typically invest in these funds.

Remember that both these scheme categories allocate some money to stocks. Some also hold long-term bonds to augment returns. The past month’s correction in the stock market has caused the equity portion of the portfolio to bleed. Longer-duration bonds have also witnessed mark-to-market losses due to hardening of interest rates. These developments have together tipped the NAVs of these funds into the red.

Interest rates are set to rise globally this year, including in India. If they move up fast, both global and Indian stock markets could remain volatile. Conservative hybrid funds and equity savings schemes may also bear the brunt in the short term.

“The market is at a peculiar juncture. Central banks all over the world are about to reduce liquidity. They will also normalise (read hike) interest rates. These developments are not good, at least in the short term, for either equity or bond markets. Hence both the segments may remain volatile this year,” says Sen.

Remember, however, that these categories may decline less than aggressive hybrid funds and pure equity funds.    

Who should invest?

Despite the current bout of volatility, debt-oriented hybrid funds remain well suited for risk-averse investors looking to beat debt market returns by taking a small amount of risk. “These funds are also a good option for first-time investors in mutual funds. Risk-averse investors who desire slightly higher returns than are being offered by conventional debt funds like gilt funds, PSU and banking funds, and shorter-duration fund may also go for them,” says Vikram Dalal, managing director, Synergee Capital Services.

Examine the portfolio

Study the portfolio before investing. “Look at the quality of debt papers and the equity category they have invested in. Poor-quality debt papers could affect both liquidity and return. Exposure to large-cap stocks will provide greater stability during a volatile phase in the markets,” says S Sridharan, founder and principal officer, Wealth Ladder Direct.

Check the expense ratios of these schemes. Since these schemes offer only slightly higher returns than debt funds, avoid those with high expense ratios.

Finally, take a longer-term view and wait for the volatile phase to pass. “Invest with at least a three-year timeframe in conservative hybrid funds,” says Sen. Investing via the systematic investment plan (SIP) route will also help you benefit from volatility.