Why retirees should opt for savings scheme, and not aggressive hybrid funds

If you were mis-sold this product with the promise of regular dividend, you should exit it

Aggressive hybrid funds, popularly known as balanced funds, which have an equity allocation of above 65 per cent in their portfolio, have seen large outflows in recent month. The assets under management of this category declined by Rs 1,931 crore in December and Rs 4,071 crore in November 2019.

One reason why the category is seeing redemption is mis-selling. A lot of people, including those who are retired or are about to retire, were sold these funds with the promise that they would offer regular monthly dividends of 11-12 per cent a month.

From 2016 to the start of 2018, there was a rally in mid- and small-cap stocks. Without taking into consideration the relatively conservative profile of the customers they cater to, many balanced fund managers entered these stocks in a big way. Some had as much as 50 per cent exposure to mid- and small-cap stocks in the equity portion of their portfolio. The downturn in these stocks from the start of 2018 and the narrowness of the market rally in the recent past has led to these funds underperforming.  

Many of these funds have stopped paying dividend, which has upset retirees who had entered those expecting regular payouts. Some funds are still paying a dividend, but at a reduced rate. They are making these payouts from their accumulated profits. But this is leading to erosion in the value of the fund portfolio, which many conservative investors are miffed about.  

However, the aggressive hybrid category does have merits. It has the ability to offer almost equity-like returns with much lower volatility. “When we ran the numbers, we found that these funds are able to capture about 85 per cent of the returns of equity funds with much lower standard deviation,” says Shridatta Bhanwaldar, fund manager-equities, Canara Robeco Mutual Fund.  

 

A balanced fund manager has the option to switch between equity and debt. In an equity fund, he can only move from equity to cash. The latter does not generate any return. “When the markets turn volatile, balanced funds reduce their equity exposure from 75-80 per cent to around 65 per cent. They invest 35 per cent of their portfolio in debt where it earns some return. This provides stability to the returns of these funds during volatile phases in the market,” says Sousthav Chakrabarty, co-founder and chief executive officer, Capital Quotient. Since these funds maintain minimum 65 per cent allocation to equities, they enjoy the more favourable equity-like tax treatment.

Being hybrid funds, they also offer investors the benefits of asset allocation and rebalancing. Most retail investors who invest in separate equity and debt funds fail to rebalance. Here, the fund manager performs this task on their behalf.

Retirees who were mis-sold this product, or misunderstood it, should exit. “A 65-75 per cent allocation to equities may not suit many retirees,” says Chakrabarty. Those who are dependent on their investments to meet their regular expenses, or want safety of capital, will be better off going into fixed-income products like Senior Citizens Savings Scheme that make a quarterly payout at the rate of 8.6 per cent.

People who were earlier investing only in fixed-income products but now want a taste of equities with lower volatility (than in pure equity funds) may enter or stay invested in balanced funds.  
 

When selecting a fund from this category, make sure the fund manager does not take high exposure to mid- and small-cap stocks when they are rallying. Around 30 per cent should be the upper limit. The debt portion of these portfolios should also be run conservatively, with the fund manager avoiding too much credit or duration risk. Enter with at least a five-year horizon and be prepared for some volatility.