Best of Both Worlds

Tanvi Varma/Money Today | Print Edition: April 2012

Choosing between equity and debt is difficult in the best of times. To get over this problem, most investment advisers say that one must invest on the basis of one's age and market conditions.

However, if you are among those who do not want the hassle of investing in a basket of products that needs to be rebalanced at regular intervals, you can opt for hybrid funds.

"Hybrid funds allow you to invest in a combination of equity and debt," says A Balasubramanian, chief executive officer, Birla Sun Life Mutual Fund. The category includes funds with different mandates.

Equity hybrid funds, for instance, offer more than 65 per cent exposure to equity, and the rest to debt. Debt hybrid funds invest at least 75 per cent funds in debt and the rest in equity.

SPECIAL: Know more about Hybrid Funds

Based on their objectives and strategy, hybrid funds, also called balanced funds, come in three forms-monthly income plans (MIPs), asset allocation funds and capital protection funds.

The main objective of these funds is to offer you the best of both worlds-equity and debt.

Hybrid funds have given good returns in the last few years. For instance, balanced funds have returned 18 per cent in the last three years compared to 23 per cent returns given by the Bombay Stock Exchange Sensex.

Funds such as HDFC Prudence, Reliance Regular Savings Balanced, Birla Sun Life 95 and Tata Balanced have given more than 25 per cent annual returns in the period. In fact, in the last five years, these funds have performed better than the Sensex by returning more than 10 per cent compared to a modest 5 per cent rise in the benchmark index.

Balasubramanian says hybrid funds do well when stock markets are going through a difficult phase as they have a cushion of debt. So, they are better equipped to withstand shocks in falling markets. However, when stock markets are rising, they may not do as well as funds with 100 per cent equity component.

Rebalancing based on market conditions also works for these funds. Take a balanced fund with 70 per cent exposure to equity and 30 per cent to debt. If the stock market falls, the fund's equity exposure will drop to the extent of the fall, leaving the fund manager with no option but to buy more shares to maintain the 70 per cent equity level. Debt provides safety.

SPECIAL: How to choose the right Mutual Fund

Similarly, in a rising market, if the equity allocation moves up to 80 per cent, the fund manager will sell 10 per cent equity portfolio and buy debt, thus automatically booking profits. In fact, the debt component in balanced funds is managed in such a way that short-term debt funds, which are less volatile, comprise a big part of the portfolio. "The idea is to lower the risk," says Balasubramanian.

Even the fund managers for equity and debt are different. The equity part is managed actively with exposure to companies across sectors and market capitalisation categories. The debt part is managed more passively.

The other category within hybrid funds is debt-oriented MIPs, which allocate 5-25 per cent funds to equity and the rest to debt. Their performance over the last three years has been noteworthy, with many delivering more than 10 per cent returns.

Gaurav Mashruwala, a Certified Financial Planner, attributes the good performance of these funds to falling bond yields in the wake of the downward pressure on interest rates.

As bond prices and interest rates are inversely related, the net asset value, or NAV, of any fund's debt component rises when interest rates start falling and vice versa. Mashruwala says one can invest in MIPs for consistent returns, not capital appreciation.

"The idea of investing in these funds is that they give regular payouts. So, choose a fund with a consistent dividend record," he says.

Then there are capital protection funds, a new category of close-ended funds whose aim is to offer consistent returns and protect wealth in a volatile market and yet gain from the upside offered by the equity markets.

These funds invest up to 80 per cent in debt (usually with a lock-in of three years), which generates a fixed return and ensures that the principal remains safe. The balance, that is, up to 20 per cent, is invested in equity for wealth generation.

However, Mashruwala says these funds offer a psychological respite at a high cost.

"You can create your own capital protection plan by investing in a growth option of, say, an MIP, which has a similar composition of debt and equity, at a lower cost," he says. These funds have low liquidity and tradability.


The ideal investment is a fund that offers exposure to equity and gold considering they usually have a negative correlation.

Lalit Nambiar

Fund Manager and Research Head, UTI MF

"These are for those who want to invest in the equity market but wish to stay protected on the downside, that is, do not want to risk the principal amount," says Balasubramanian.

These funds don't have much of a performance history to boast of, unlike their counterparts. Also, they do not guarantee capital. It is something that is stated implicitly; capital protection is inherent in the way the portfolio is constructed.

"Although equity and debt are more or less known to share an inverse relationship, there have been times when they have been positively correlated, especially when market cycles are turning," says Mashruwala.

In 2003, when the cycle was turning, funds investing in government securities gave double-digit returns just like the equity markets. This went on till 2004. Similarly, after the 2008 global financial crisis, the stock markets picked up after early signs of recovery and debt, too, did well after the Reserve Bank of India cut interest rates to revive the economy.

18 per cent is the average return given by balanced funds in the last three years compared to 23 per cent rise in the Bombay Stock Exchange Sensex.

Lalit Nambiar, fund manager and head of research, UTI MF, says the purpose of investing in a hybrid fund is diversification, which can be achieved if both asset classes bear a low or negative correlation Nambiar says the ideal investment is a hybrid fund that offers exposure to equity and gold considering they usually have a negative correlation.

Gold's low or inverse correlation with other major asset classes like equity and debt can stabilise the fund's risk-return profile during periods of falling equity markets and challenging economic climate.

For instance, in the last one year, the domestic equity market has given a negative return of 1 per cent, short-term debt funds have returned 9 per cent, while gold has been an outperformer, delivering 35 per cent returns.

There are a number of debt-oriented hybrid funds that offer a combination of equity, debt and gold, such as Religare MIP Plus, Fidelity Children's Plan, Taurus MIP Advantage, Axis Triple Advantage, Canara Robeco Indigo Fund and UTI Wealth Builder, an equity oriented hybrid fund.

"Your choice should not be based on market conditions but your asset allocation strategy," says Mashruwala. You can also invest in two separate funds by different fund houses.

Tax Status:
Equity-oriented funds (more than 65 per cent into equities) qualify for the same tax treatment as equity funds, that is, short-term capital gains are taxed at 15 per cent, while there is no long-term capital gains tax.


The idea of investing in debt MIPs is that they give regular payouts. So, choose a fund with a consistent dividend record.

Gaurav Mashruwala

Certified Financial Planner

Funds that predominantly invest in fixed income instruments are taxed like debt mutual funds, where short-term capital gains are taxed according to the investor's tax slab while long-term capital gains tax is 10 per cent without indexation and 20 per cent with indexation.

Indexation is adjusting the purchase price with inflation. It reduces real capital gains and, hence, the tax liability.

Comparing and benchmarking:
Different types of hybrid funds follow different asset allocation strategies and returns depend on how their individual investments perform.

So, it is imperative to ensure you compare apples to apples and benchmark the fund's performance against the right index.

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