How To Make Best Use Of The Hybrid Funds?

The new tax laws allow to be placed under the capital gains taxation of 12.5 per cent if units/investment held for two or more years with a portfolio composition of 35 per cent or in non-debt i.e., it could be a mix of equity, gold or other assets

Investing requires dynamism as the markets remain volatile and this volatility is not a bug but a feature of markets where markets could be debt, equity, commodity, etc. Despite the underlying asset, markets respond to the direct supply-demand equation, possible forecast of the changes in either side of the equation and the sentiment i.e., the psychology of the market participants. The changes to equation could happen due to the macro factors like geo-political situations, economic conditions, crisis, etc.

To maneuver this nature of the market, one needs to be nimble and responsive to the changing conditions. While in the long run, one could afford to remain passive, investors tend to react and hence hedge their risk emanating from the market. The risk mitigation could be achieved through diversification, asset allocation and portfolio construction. This needs a deeper understanding of oneself i.e., their risk appetite, risk tolerance and timelines or/and goals.

For mutual fund (MF) investors, who predominantly have exposure to equity MF could allocate towards various hybrid funds to not just reduce their risk but also generate long-term returns at a better risk-adjusted rate. Hybrid funds as the name suggests, have more than one asset class in their portfolio to generate returns. The predominance of the asset class in the fund portfolio defines their risk, reward, also their tax treatment.

Asset allocator funds expose their capital to various funds across the spectrum depending upon the investment philosophy. If it’s an aggressive fund, it could have a higher allocation to equity through investing various equity funds and if it’s a conservative fund, it explores higher allocation to debt through investing in various debt funds. Among the many hybrid funds, asset allocator funds (which are fund or funds) have now turned attractive due to their tax treatment. The new tax laws allow to be placed under the capital gains taxation of 12.5 per cent if units/investment held for two or more years with a portfolio composition of 35 per cent or in non-debt i.e., it could be a mix of equity, gold or other assets.

The allocation could be pre-defined by a model suiting to the fund philosophy. For instance, the ICICI Pru Asset Allocator fund uses an in-house model which allows it to “buy low and sell high” while keeping the human emotions aside. They have an equity valuation index which is calculated by assigning equal weights to Price to Earnings (P/E), Price to Book (P/B), G-Sec PE and Market Cap to Gross Domestic Product (GDP).

This metric allows the fund house to identify if the time is ripe for partial profit booking on one extreme to other of aggressively invest in equities. The fund has delivered an annual return of 12.9 per cent since March 2010 till end-Oct ‘24. For context, during the same period, the NIFTY 50 TRI has given 12.8 per cent and Crisil hybrid 50+50 Moderate Index, the benchmark of this fund has generated 10.8 per cent in returns. The average allocation to equity being 41 per cent in the fund during the above period.

Within this hybrid category, the offerings are in both active and passive fund strategies. The above example being active, one could consider passive approach where the fund invests through multiple different funds of Index funds and ETFs (Exchange Traded Funds). Motilal Oswal Asset Allocation Passive FoF is an aggressive fund in this category. With an equity allocation over 70 per cent in equity, about 16 per cent in bonds. The fund invests across the world through funds tracking multiple global indices like S&P 500, other than investing G-Secs and in gold through ETFs.

Despite the diverse exposure, the expense ratios are capped making them relatively equally expensive as their pure equity counterparts. These funds could underperform relative to equity funds in a bull phase of market as they can’t participate completely. Also, doesn’t infer that they don’t completely nullify the volatility but they could be comparatively better off than pure equity funds. In the very example, we’ve considered, the ICICI Prudential offering had a maximum drawdown of negative 19.26 per cent though the Calander year returns turned positive.

The choice of these funds should be in accordance with the investor’s risk tolerance and timelines while they could certainly be utilised as a good diversification tool.

(The author is a co-founder of “Wealocity”, a wealth management and could be reached at [email protected])