Aggressive hybrid funds: Cope with mkt volatility, benefit from rate cuts

Volatility in the capital markets continues to pose a challenge to equity investors. At the same time, the possibility of interest rate cuts, following a prolonged wait, is becoming more likely. In such an environment, taking a balanced approach to investment through aggressive hybrid schemes of mutual funds may offer a prudent path forward.

 

“Aggressive hybrid funds are well-suited for the current market environment as equity markets are volatile due to global economic uncertainties, inflationary pressures, and shifting interest rate expectations. Their balanced asset allocation allows these funds to navigate such challenges more effectively,” says Nirav R. Karkera, head of research, Fisdom.

 

 

“Hybrid funds are all-season funds and best for new investors in equity markets as they help build confidence in the asset class,” says Fatema Pacha, senior equity fund manager, Mahindra Manulife Mutual Fund.

 

Cushion against volatility

 

Aggressive hybrid funds are designed to allocate 65-80 per cent of their assets to equities, with the remainder invested in bonds. Most of these funds employ a large-cap-heavy strategy for their equity portfolios. This helps to reduce volatility compared to portfolios with significant exposure to mid- and small-cap stocks.

 

If interest rates decline, the bond component of these portfolios could generate capital gains. Conversely, rising interest rates may cause short-term losses.

 

“At present, the category has over 70 per cent of equity allocation to large-cap stocks, which offer stability and are less susceptible to market fluctuations compared to midcaps and smallcaps. With only 5-7 per cent exposure to smallcaps and the remainder in midcaps, these funds’ equity portfolios reduce the risks associated with midcaps and smallcaps, which are trading at premium valuations. The debt component provides further stability,” says Karkera.

 

Largecap stocks are also better positioned to withstand economic slowdowns and subdued corporate earnings compared to their mid and smallcap counterparts.

 

“Hybrid funds tend to underperform pure equity funds in a trending market like that of FY24. However, over longer periods, they tend to deliver better risk-adjusted returns as markets generally move in cycles. The year 2025 could be a volatile year after the past two years of spectacular returns for equity markets. Hybrid funds generally outperform during these times. Also, we expect the Reserve Bank of India (RBI) to cut rates this year, helping debt funds to generate higher returns as bond prices could rally,” says Pacha.

 

Who should invest?

 

Aggressive hybrid schemes may appeal to investors seeking equity exposure with relatively lower volatility.

 

“These funds are ideal for moderate risk-takers who seek exposure to equities with reduced volatility due to the debt component. They are also suitable for new investors looking for a relatively safer entry into equities and those with medium-term financial goals,” says Karkera.

 

Points to consider

 

Investors should assess the underlying portfolio and choose a scheme aligned with their risk tolerance. They should also evaluate the fund’s historical performance. While these schemes offer a smoother ride, occasional bouts of volatility are inevitable. Investors should enter with a minimum investment horizon of five years.

 

A Systematic Investment Plan (SIP) is widely regarded as the most effective method of investing in these funds. “An ideal holding period for aggressive hybrid funds is three to five years, allowing them to navigate market cycles and deliver balanced returns,” says Karkera.

 

He suggests that these funds can constitute 15-25 per cent of the portfolios of moderate risk-takers, while conservative investors may limit exposure to 10-15 per cent.