Hybrid Funds to withstand market volatility

Equity market remained highly volatile in the first half of the 2022. As seen in the below chart, key equity indices across the globe fell sharply following aggressive interest rate hike by the US Federal Reserve, Russia-Ukraine war, rising crude oil prices, bond yields and spike in inflation. The road ahead looks bumpy as monetary tightening will continue to combat inflation and there are mounting fears of global recession.

Source: Financial website; Note returns are calculated for the period Jan 2022 till June 2022

Such sharp market swings obviously make investors, nervous and pessimistic about the way ahead.  Often to limit the losses investors either tend to seller the winners (stocks or equity funds) or stop the systematic investment plan (SIP).  But key to survive in volatile markets:

• To remain invested across all market cycle
• Diversify investment across asset classes to reduce the risk associated with single asset class
• To remain focussed on intrinsic value of the equity which as an asset class has the ability to give better returns in the long run despite intermittent volatility

While the recent dismal performance of the stocks and pure equity-oriented funds such as large, mid and small cap funds could be disheartening but investors always find the balance and diversify to mitigate the losses. One of the easiest ways to do so is consider investing in hybrid funds – a mix of debt and equity. In a highly volatile scenario, hybrid funds are able ally as the debt portion of these funds can cushion against market swings plus investors get the perks of hassle-free rebalancing.

Hybrid funds strikes balance between returns and risks by diversifying between equity and debt

In the Indian mutual fund space, investors have the option to choose from wide range of hybrid funds. Below is asset allocation pattern each of these fund’s variant.   

Source: SEBI;

Note: Mutual Funds will be permitted to offer either an Aggressive Hybrid fund or Balanced hybrid fund.  A balanced hybrid fund will invest 40 to 60% in equity, 40 to 60% in debt and no arbitrage is permitted

Investors with lower risk appetite aiming for relatively stable returns can consider investing in conservative hybrid funds as these funds have large portion allocated to debt.  On the flipside, investors with higher risk appetite can consider investing in aggressive hybrid funds having greater exposure to equities.

With the sharp fluctuations in the equity market in the recent times, the balanced advantage fund (BAF) or dynamic asset allocation funds are in spotlight as these funds aims to limit the downside and reward during upside by dynamically allocating asset to equity and debt. BAFs helps to control emotional biases of greed and fear since when the equity market is overvalued these funds reduce their equity exposure and increase allocation to debt and vice versa. Multi asset allocation funds help to diversify across different asset classes which holds key in the volatile markets.

Investors looking for low risk option for their short-term goals can consider arbitrage funds which aims to generate profit by buying and selling the same underlying security in different market segments. As arbitrage funds are categorised as equity funds, individuals in the higher tax bracket of 30% can benefit from the favourable tax treatment compared to liquid funds. Short term gains for the period of one year in arbitrage funds is taxed at 15% where in case of liquid funds gains for the short term are taxed as per income tax slab which could be 30%. Lastly investors with moderate risk appetite and aiming for capital appreciation and equity fund taxation can consider equity savings fund which invest 65% in equity (including derivatives) and minimum 10% in debt. Hybrid funds taxation angle is summarized in the below table:

Summing up

Hybrid funds are relatively safe compared to pure equity funds but riskier than debt funds. New investors with moderate risk profile can consider investing in these funds in line with their goals and risk tolerance ability. Evaluation of the portfolio attributes, performance across market cycle, cost involved and fund managers experience is crucial before investing. While investors can opt for lump sum but in current volatile times it will be wise to opt for systematic mode of investing wherein a fixed sum is invested in hybrid funds on regular basis. This will help to keep away fears of market volatility and remain invested in the equity market.