For high equity exposure, investors should select aggressive hybrid funds

Choose separate equity and debt funds for greater control over asset allocation

Hybrid funds of the type that take relatively high exposure to equities have produced attractive returns over the past year. However, when selecting a sub-category within hybrid funds (of which there are six), do not be guided by past-year returns only. Understand the invest­ment mandate of the sub-category first.  

Most asset classes did well in 2020. Large-caps fared well (the Sensex’s one-year return is 14.5 per cent; BSE Midcap’s is 19.3 per cent, and the Smallcap’s is 32.6 per cent). On the debt side, longer-duration debt has performed well. Gold has given 27.6 per cent returns.

Investment mandate: Aggressive hybrid funds are allowed to take 65-80 per cent exposure to equities and 20-35 per cent to debt. Multi-asset allocation funds need to take 10 per cent exposure each to at least three asset classes (mostly equity, debt, and gold). 

Balanced advantage/ dynamic asset allocation funds have the freedom to move the equity and debt allocations between 0 and 100 per cent. Of the three, multi-asset allocation funds have performed the best over the past year. 

“These funds received a boost from the stellar performance of both equity and gold,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.

Aggressive hybrid funds have also done well because they maintain exposure of 65 per cent and above to equities. The balanced advantage/ dynamic asset allocation category has given the least return of the three because these funds reduce equity exposure as the markets rally, as is the case this year.

Who need hybrid funds? Investors who have decided on a strategic asset allocation and have the ability to rebalance should buy separate equity, fixed-income, and gold-based instruments. “Investors will have better control over their asset allocation by investing in separate funds. They can also ensure there is low risk in the debt part of the portfolio and can withdraw from it whenever they need liquidity,” says Prateek Mehta, co-founder and chief business officer, Scrip­box. Investors can change their asset allocation according to their proximity to goals, life stage, etc. If they opt for a hybrid fund, the asset allocation is controlled by the fund’s mandate or the fund manager.

Newer investors, who can’t decide on their asset allocation and do rebalancing, may opt for hybrid funds. “The NAVs of hybrid funds generally fall less than that of pure equity funds during a market crash. This provides comfort,” says Belapurkar.  

If you want a high exposure (65 per cent and above) to equities, go for an aggressive hybrid fund. While their long-term retu­rns will be higher than that of the other two categories, they will be quite volatile.

Multi-asset funds also maintain high exposure to equities (generally, 60-70 per cent). 

In addition, they provide exposure to gold. Before investing take a close look at the fund’s allocation. “Some funds in this category could have a 60 per cent or so exposure to debt, so understand what you are getting into,” says Arun Kumar, head of research, Fundsindia.com.

In balanced advantage funds, the fund manager changes the equity exposure depending on market valuations. Equity exposure is decided by an in-house model. By going anti-cyclical, these funds give a less volatile ride. This is the most conservative of the three and suited for novice investors.

Finally, check the quality of the debt portfolio. Avoid funds that have lower-rated instruments or where the fund manager has taken a high-duration risk in the past.  Also, avoid funds with high expense ratios. Think twice before going for the dividend option as it is now taxable in the investor’s hand.