Hybrid funds Strategy - Newspaper Summary

 The sources provide a detailed discussion of Hybrid Mutual Funds (MFs), also referred to as a "Blended Strategy," emphasizing their role in balancing risk and return, diversifying portfolios, and offering structured solutions within the dynamic financial market environment. The discussion covers the specific categories defined by regulatory bodies, their investment mandates, performance characteristics, and crucial taxation implications.

I. Role of Hybrid Mutual Funds in Investment Dynamics

Hybrid mutual funds are positioned as a "practical solution" for investors seeking to blend multiple asset classes to balance growth potential with stability. They are crucial at times when single asset classes, like Indian equities, have delivered "negligible returns" over the past year, prompting investors to realize that "relying solely on equities can derail portfolio growth and delay financial goals". Hybrid funds address investor fear of suffering extreme losses (50-90% capital loss), which can happen due to worsening fundamentals or collapsed valuations from hype in bull markets.

II. Categories, Portfolios, and Performance

The Securities and Exchange Board of India (SEBI) has defined six sub-categories within the hybrid space, each with distinct asset allocation rules, performance profiles, and suitability requirements.

1. Aggressive Hybrid Funds (AHFs)

• Investment Approach: AHFs are one of the oldest categories, blending equity's growth potential with debt's stability.
• Portfolio Mix: They are mandated to hold 65–80 per cent in equities, with the remainder in fixed income. Management styles vary, with some consistently holding equity closer to the upper limit (75–80 per cent), while others actively shift within the 65–80 per cent band. Some funds allocate towards mid- and small-caps for potentially higher returns, and debt strategies involve duration calls versus accrual focus.
• Performance: Due to high equity exposure, AHFs often mirror diversified equity funds and have historically matched or beaten large-cap funds and benchmarks over long periods. For instance, top schemes showed a 5-year rolling return CAGR of 23–24 per cent over seven years, significantly outperforming the Nifty 100 TRI's 18 per cent and active large-cap funds' 17 per cent.
• Suitability: They suit investors with moderate to high risk appetite seeking long-term growth with lower volatility than pure equity, and are appropriate for first-time investors or those nearing retirement.

2. Balanced Advantage Funds (BAFs) / Dynamic Asset Allocation Funds

• Investment Approach: BAFs are the largest hybrid category by assets (about ₹3.05 lakh crore), appealing due to their flexibility. They dynamically allocate between fully equity and fully debt based on models analyzing market conditions, valuations, and interest rates, aiming to contain downside risk during volatile phases.
• Portfolio Mix: While net equity exposure is typically managed based on proprietary models, most BAFs maintain over 65 per cent gross equity allocation through derivatives and arbitrage to secure favorable tax treatment while lowering net equity risk.
• Performance: Their key strength is downside protection; during the 2020 Covid crash, BAFs cushioned drawdowns better than large-cap equity funds. In the year prior to the publication, the category corrected only 0.8 per cent compared to the Nifty 100 TRI’s 4 per cent fall. However, returns often trail pure equity funds during strong bull runs because the models cap equity exposure.
• Suitability: BAFs suit investors desiring smoother equity participation with lower volatility, and are suitable for first-time investors, retirees, and long-term savers (recommended horizon of three years or more).

3. Multi Asset Allocation Funds (MAAFs)

• Investment Approach: MAAFs provide diversification within a single product by spreading investments across several asset classes. SEBI mandates holding at least three asset classes with a minimum 10 per cent allocation to each.
• Portfolio Mix: Assets include unhedged equities, debt, arbitrage, gold, silver, exchange-traded commodity derivatives, overseas equities, and real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). Strategies vary greatly; some are equity-heavy (over 65 per cent equity) while others are debt-heavy (eschewing unhedged equity for arbitrage, commodities, and fixed income).
• Performance: Since many funds are new, long-term performance across full market cycles is unclear, and returns differ sharply based on the allocation mix. Funds tilted toward gold, silver, and overseas equities performed well in the recent past, delivering up to 14 per cent.
• Suitability: They suit moderate-risk investors seeking easy diversification without managing multiple products, requiring a five-year horizon, and are appropriate for retirees, first-timers, and salaried professionals.

4. Equity Savings Funds

• Investment Approach: These funds appeal to conservative investors seeking returns slightly above fixed income without incurring heavy market risk.
• Portfolio Mix: They achieve equity taxation (gross exposure > 65 per cent) by holding 30–35 per cent in net equity (mostly large-caps) and 30–45 per cent in arbitrage positions (which are near risk-free). The remainder is in debt, usually with low-to-moderate duration.
• Taxation: They qualify for equity taxation due to the gross equity exposure exceeding 65 per cent.
• Suitability: Suitable for cautious investors, retirees, and those looking to park surplus funds for two to four years while benefiting from equity tax treatment.

5. Conservative Hybrid Funds (CHFs)

• Investment Approach: CHFs aim for stability with a modest equity kicker, primarily catering to risk-averse investors.
• Portfolio Mix: They are debt-oriented, with 75–90 per cent allocation to debt and only 10–25 per cent in equities. Debt investments typically prioritize AAA-rated securities to avoid credit risk, while equity exposure focuses on large-cap, dividend-paying, or stable companies to maintain low volatility.
• Performance: Over seven years, the average 5-year rolling return was 9 per cent, consistently outpacing bank deposits, albeit with slightly higher risk.
• Suitability and Taxation Impact: While still suitable for risk-averse investors and conservative savers with a 3–5 year horizon, their attractiveness has been affected by regulatory changes. Post the 2023 Budget, tax concessions and indexation benefits were withdrawn for funds with equity below 35 per cent, meaning CHFs are now taxed at slab rates, similar to bank deposits.

6. Arbitrage Funds

• Investment Approach: These are low-risk hybrid options focused on exploiting short-term price gaps between the cash (spot) and derivatives (futures) markets, rather than taking directional market bets.
• Portfolio Mix: They must maintain at least 65 per cent equity exposure, but this exposure is fully hedged through opposite futures positions, rendering the fund structurally low-risk. The rest of the portfolio is invested in short-term debt and money market instruments.
• Performance: The strategy captures the spread when futures trade at a premium, which is more common in volatile or rising rate environments. Over the last five years, the average one-year rolling return was 5.8 per cent.
• Taxation and Suitability: Because their gross equity exposure exceeds 65 per cent, they enjoy equity taxation. They are suitable for large investors seeking to park money for 6–18 months with higher post-tax returns than traditional fixed deposits.

III. General Market Context

The attractiveness of hybrid funds is underpinned by the general performance of market segments, where assets beyond equity, such as debt, gold, silver, and international markets, have outperformed Indian equities over the past year, proving that "Diversification is the only free lunch in investing". The sources emphasize the stability offered by debt instruments, juxtaposed against the diminishing returns and "adverse taxation and removal of indexation" that have made traditional debt or fixed income investments less attractive in recent years.