The return profile of traditional fixed income products has been on a steady decline over the past few years. Experts suggest that this trend is unlikely to change in a jiffy. So, if you are an investor who is conservative and was opting for traditional investment options, then there is a possible alternative one can consider, especially if the investment is made with a 5 to 10-year framework in mind. The proposed solution is in the form of a hybrid mutual fund.
As the name indicates, a hybrid mutual fund invests in a combination of two different asset classes – debt and equity. The debt portion, aiming for stability, gets invested in fixed income instruments like government bonds, corporate bonds, debenture, etc., whereas the equity portion gets invested in shares of listed companies, which is volatile in nature but brings in high returns over long term. Such funds have been in existence for over a decade.
Depending on the proportion of equity and debt, they further get classified as Aggressive Hybrid Fund, Balanced Hybrid Fund, Conservative Hybrid Fund, Dynamic Asset Allocation (DAAF) or Balanced Advantage Fund (BAF), Multi Asset Allocation Fund, and Equity Savings Fund. Generally, the funds which invest more than 65 per cent of its money in equities are considered aggressive funds while funds which invest more than 65 per cent in debt instruments are considered conservative funds. Hybrid funds address an investor’s need of asset allocation and at the same time relieve them of the complexities related to it.
We all have been experiencing a southward moving interest income for almost a decade-and-a-half and the present scenario appears like a crisis for many. A crisis usually pushes our minds to be innovative, leading us to search for alternatives to earn better returns. It is often said that risk and return go hand in hand. Risk is something that is not known or understandable. We all have learnt it in the hard way that even traditional fixed-return products carry some risk – the risk of reducing interest rates. And when it comes to equity, it all hinges on how we react to the universal truth that equity markets are volatile. But then, is it possible to earn a higher return without taking higher risk?
The answer is both ‘Yes’ and ‘No’. It is essential to establish a balance between the risk we are willing to take (mentally/emotionally), risk we can afford (basis our overall financials), and risk that is required (to earn a higher return). Moreover, when we talk of risk in equity oriented mutual funds, we are mainly referring to the unpredictability of markets in the short to medium term. This is where DAAF or BAF comes in.
Unlike other hybrid funds, BAF dynamically rebalances the portfolio. For this rebalancing, some fund houses rely on a model-based approach. The model provides a signal to the fund manager to shift allocation depending on the movement of the asset classes involved. In simple terms, what it is trying to achieve is to reduce equity allocation when the equity market valuation is high, and vice versa. This “no-emotion mechanism”, many a times, tends to restrict the upside return potential, but it substantially reduces the impact of downside risk of the market, and this is the central point for investing in it.
An individual or institution should consider investing in DAAF or BAF if:
- The investment horizon for a goal is around 4 to 6 years
- The investment is for long term, but the risk-taking ability is low
- The return expectation is a little higher compared to other traditional investments for the regular inflows
For those who want a regular income for longer term, the Systematic Withdrawal Plan (SWP) from this fund can be strategically deployed. Data analysis shows that this strategy is not only tax efficient but has also aided in capital appreciation substantially over the long term. If you are a conservative investor, consider allocating a portion of your investments in this category and increase the allocation once you gain confidence. For better understanding of product suitability, it is best to approach a financial advisor.
Shreedhara R Bhat, Founder, Ara Financial Services Pvt Ltd