Worth seeking a balance?

If it seems too good to be true, it probably is. Given the current scenario, wary investors are wont to link the adage with hybrid funds. After all, monthly income plans (MIPs) and balanced funds have delivered average returns of 16.5% and 34.4%, respectively, despite the volatility in the past one year. In fact, the top funds have shot up to 65%. This, at a time, when the BSE Sensex offered 49% returns. But damningly, the stupendous offerings appear to be an aberration when you consider the average returns of 9-14% over a fiveyear period. Conversely, many an investor has blindly bet on these funds tempted by the attractive figures. The truth lies somewhere between the bounding figures and the bleak wariness.

For the uninitiated, hybrid funds offer a combination of equity and debt instruments and, hence, are supposed to be a good hedging tool against market volatility. Typically, equity and debt have an inverse relationship. So you stand to gain even if one component is underperforming. Their track record over the past year certainly underscores this aspect. Take the HDFC Prudence Fund, which has returned 69% in the past one year compared to 45% returned by the Crisil Balanced Fund Index and 64% by the Birla Sun Life 95 Fund. Although it could mean that the portfolios of these funds have taken some aggressive calls, given the fact that 20-30% of their investment is in debt, they have managed to outperform the indices with lesser amount of risk.

The question that needs to be asked is whether these returns are sustainable over the long term. Pankaj Tibrewal, fund manager, Principal PNB AMC, is sceptical. In the past one year, the BSE Sensex has rallied by about 50% owing to a turnaround in global sentiment and, hence, the equity markets. Meanwhile, debt has returned 20% on an average, owing to a drastic fall in interest rates. “Considering the fact that these returns were primarily a function of the rally in the equity and debt markets, we could see rationalisation in returns going forward,” says Tibrewal.

The bottom line? The instruments that give consistently high returns, yet are completely insured against volatility are a myth. Hybrid funds are no exception. A lot depends on the fund’s equity-debt ratio. Traditionally, balanced funds have invested about 50% in debt instruments and the rest in equity. But to avail of the ‘equity status’ for tax exemptions, like nil long-term capital gains tax (LTCG) and taxfree dividend income, these funds are mandated to invest at least 65% in equities. “These funds typically maintain 75% in equities, 5% as cash, and the remaining 20% goes into debt, making them as good as equity funds,” says Gaurav Mashruwala, a certified financial planner. In other words, the risk factor could be almost as high as that for equity funds.

For a more conservative investment, one could look at MIPs, which are primarily debt-oriented funds offering steady, albeit lower, returns. These funds fall in two categories. In conservative plans, the equity component goes up to 15%, while the aggressive ones, typically known as MIP Plus, boast an equity component of up to 25%. Since the nomenclature may differ among fund houses, it would be prudent to check the offer document for the classification.

“Since a major component of these funds is invested in debt, these should typically be compared with a fixed income product,” says Tibrewal. In fact, the mandate of an MIP is to generate at least 2-3% higher returns compared with a fixed income fund, to compensate for the additional risk. So if we look at the Principal MIP fund over a three-year period, its MIP plan has generated 10% returns, and the MIP Plus fund, 11.8%, compared with a return of 8.5% from its fixed income fund. Ideally, investors with a longer time horizon should enter this category since the accrual in debt will come with a minimum holding period of a year. Moreover, equities may be volatile in shorter periods.

While hybrid funds are less risky than most funds since equity and debt markets do not tend to move in tandem with each other, it is crucial to remember that there are periods when both could either be negative or positive. Usually when there is a change in the market cycle, as in 2003, debt and equity are likely to give handsome returns. However, the reverse is also possible.

Tibrewal does not expect interest rates to shoot up in a hurry from the current levels, which makes them a relatively safe proposition at present. “Also, given the fact that the portfolios of these funds are managed actively, any sudden spurt in interest rates would be managed actively by fund managers,” he says. Simultaneously, equities are poised to grow over the long term with a stable economic growth and corporate earnings rising at 17-18%.

Having said that, it would be foolhardy to join the hybrid bandwagon following the herd mentality. “Invest in these funds only if they are needed from an asset allocation perspective,” says Mashruwala. Hybrid funds are ideal for you if you are looking at an automatic rebalancing of your portfolio without the hassle of rebalancing and the incidence of taxation on every transaction. Once the allocation is skewed to a particular asset class, the fund manager would rebalance it to maintain the original allocation. Adds Mashruwala: “Remember that you can also split your investment into dedicated debt and equity funds in the same fund house. This is more likely to outperform a hybrid fund, yet give you the desired asset allocation.” It may be wise to ascertain the tax implications on your investment before taking a decision.

In case a hybrid fund suits you, it’s advisable to take the SIP route. If there is a 5-10% correction in the market, consider a lump-sum investment.