Select MF: 3 Hybrid Fund Categories You Should Know About

The Indian Mutual Fund industry saw a big transition in 2017; when Sebi defined the mutual fund categories to bring uniformity in funds across AMCs.  Out of these categories, three hybrid fund categories are extremely useful to investors if used in the right way. Aggressive Hybrid Funds, Equity Savings Funds, and Balanced Advantage Funds are three hybrid fund categories we will look in detail today.

Aggressive Hybrid Fund

Aggressive Hybrid funds (or Balanced Funds as they were known before) are funds with a mix of Equity and debt. As per the Sebi’s definition, Aggressive Hybrid Funds must invest 65%-80% of total assets in Equity and Equity related instruments and 20%-35% of total assets in Debt instruments.

Hence, considering this fund structure, these funds are equity funds with a small exposure in debt instruments. However, for equity exposure, the limits of market cap are not given. Hence, the fund manager can invest in stocks with any market cap based on their market view. Similarly, for the debt exposure, credit rating and interest rate limits are not defined, hence the fund manager can select debt securities at his discretion.

Factors to consider before selecting an Aggressive Hybrid Fund

Before selecting a fund from this category, you should look at two factors:

1. Market Capitalisation wise stock exposure – Exposure to large, mid, and small-cap stocks defines the risk for the fund. If the exposure towards mid and small caps is high then the risk would also be high and vice versa.
   
2. Interest rate and credit risk exposure – In the debt portion of the portfolio, credit quality needs to be spotless in order to reduce the risk. To analyze the interest rate risk, you can look at the modified duration of the fund. Higher the modified duration, higher the interest rate risk.

Suitability of Aggressive Hybrid Fund

If you are an investor with a moderate risk appetite who does not want exposure to 100% equity fund but wants to plan for a long term goal; then you can go for Aggressive Hybrid Fund. However, do note that with about 65% exposure to Equity, the fund will have significant volatility built in them. Hence you should invest in Aggressive Hybrid funds if your investment horizon is more than 5 years.

Equity Savings Fund

Equity Savings Fund is a category created by Sebi that has a minimum of 65% of total investment in Equity & Equity related instruments and a minimum of 10% in Debt instruments. 65% of equity includes hedged and unhedged exposure. In simple words, Equity savings funds have three types of exposures: Equity, Arbitrage, and Debt. In normal cases, exposure to all three is equally divided.

The arbitrage part of the portfolio generates steady returns without any risk. The debt portion gives stability to the portfolio provided the credit quality is good. And the Equity part gives growth to the portfolio.

Factors to consider before selecting an Equity Savings Fund

Similar to Aggressive Hybrid Fund, before selecting a fund from this category, you should look at three factors:

1. Market Capitalisation wise stock exposure – Exposure to large, mid, and small-cap stocks defines the risk for the fund.
   
2. Interest rate and credit risk exposure – Look at underlying credit quality and modified duration to understand credit and interest rate risk exposure
   
3. Portfolio breakup between Equity and Arbitrage – While a lot of funds do have almost equal breakup between Equity and Arbitrage, it is important to look at this exposure carefully. If the equity exposure is high, it may result in higher volatility.

Suitability of Equity Savings Fund

If you are an investor with a low-risk appetite, but still want to take marginal equity exposure without taking the high risk; then Equity Savings Fund is a way to go. Since the actual equity exposure is only about 1/3rd of the total portfolio, if the market falls, it does not result in an extreme fall in the fund. Equity Savings Funds are suitable for the investment horizon of 3-5 years.

Balanced Advantage Fund

In Balanced Advantage Fund or Dynamic Asset Allocation fund the equity and debt exposure are managed dynamically. That means, based on the fund manager’s view of the market, equity or debt exposure is increased or decreased. In theory, such funds should help the investor navigate the market volatility better. However, the success of this strategy lies in execution.

A lot of funds do not reduce equity exposure below 65% to comply with equity taxation rules. In these cases, the balanced advantage funds behave like Aggressive Hybrid Funds.

Factors to consider before selecting a Balanced Advantage Fund

Similar to Aggressive Hybrid Fund, before selecting a fund from this category, you should look at three factors:

1. Market Capitalisation wise stock exposure – Exposure to large, mid, and small-cap stocks defines the risk for the fund.
2. Interest rate and credit risk exposure – Look at underlying credit quality and modified duration to understand credit and interest rate risk exposure
3. The portfolio breakup between Equity and Debt – Fund Management style is of the essence in these funds. Hence, check whether the fund is actually dynamically managed by looking at exposures of equity and debt in the portfolio.

Suitability of Balanced Advantage Fund

As balanced advantage funds have the freedom to take exposure between equity and debt, these funds can help you limit the downside in the portfolio. However, this does not eliminate short term volatility. Hence, while investing in Balanced Advantage funds, your investment horizon should be at least 5 years.

If used correctly these three hybrid fund categories can help you fulfill your short term and long term goals. Mutual Funds have a solution to your every investment problem, But you should know whether to look for it.