Widely read:
So, let's begin this conversation with, first of all, why hybrid funds? Why not equity?
It is a big question. Most investors know that there are equity funds and fixed-income funds, and they are the dominant fund category. But the point is, the case for hybrid is that they help you balance. Most people get carried away by a roaring market; when the going is good, everybody thinks there is no risk, and everybody is chasing recent past performance. In bad times, people just run away from the market; they think it is way too risky. These hybrid funds not only help you navigate this, but they also provide you stability and growth with reasonable stability, which is the objective of your long-term investment. They also help you capitalise on this madness of the market, which creates an opportunity. Every time the market goes down, ideally, you should invest more in equity, but it is very hard to do. The way to systematically do this is hybrid because these hybrid funds decide on an asset allocation between equity and debt, and then they rebalance it so you don't have to worry about it. So, they are a great vehicle for most investors because they're simple, provide you greater stability, and are tax efficient.
Now, there are seven different categories of hybrids. Let's focus today's discussion on balanced advantage funds, aggressive hybrids, and multi-asset funds. Can you draw a comparative analysis of these? How are they different?
Aggressive hybrids are almost like an equity fund—75 per cent equity. That is why they're almost like an equity fund, and 25 per cent into fixed income. The advantage of this is that the frozen asset allocation forces them to rebalance. Equity goes up, and they take profits, or, they realign it downwards. So, they are booking profits continually, and it's a very tax-efficient vehicle. So, think of it like if an investor is not used to equity, for them, it's a very suited vehicle because you are participating in equity, and it does not give you the massive blow, which is very unnerving for any investor who is getting started.
The second one is a balanced advantage; I would like to give you some background about why it was created, what the advantage was, and how it has, today, become a different animal altogether. Our tax laws have been evolving, and initially, a balanced fund was 50 per cent equity and 50 per cent debt. Then our tax laws said that it should be dominantly equity. So, it was 51 per cent equity and 49 per cent debt, which was fine. Then, our tax laws were revised to 65 per cent equity so that it could qualify as an equity fund. And that is when some of these balanced funds or the Balanced Fund investors wanted 50/50. But how to have 50/50 while actually taking the equity pleasure of 65 per cent technically? And that is when this balanced advantage came about. Many of the funds were created because they started having something like arbitrage positions to the extent of 15-20 per cent. So, they will have 50 per cent equity, 30 per cent debt, and 20 per cent into arbitrage with the character of fixed income, but from a tax point of view, it will be treated as equity. So, it was able to alter a 20 per cent allocation to a fixed-income kind of thing into equity, and that is how balanced advantage was created. Depending on the circumstances, they can move more into equity, less into debt, or more into debt and less into equity. So, this is basically taking a call on an allocation based on the outlook of the various components of the market.
I have my doubt about a fund manager's continued ability to perfectly time his allocation to a certain thing to a certain asset class because it requires making a judgement about equity unlikely to do well in the near future, and that is why I should reduce it, and there is no evidence that many funds are able to do it consistently. Sometimes, they do it, but they don't do it often or consistently. But I have great belief in a disciplined strategy, and disciplined allocation itself creates a great deal of opportunity and alpha for you.
Now, multi-asset funds are a third category that includes equity and debt as well as precious metals or commodities. Because gold has done very well and has become a fairly mainstream category, it has been able to provide reasonable returns or decent returns with great stability in the last five or seven years, and that is how this multi-asset category came into being.
When it comes to diversification and risk management, which of these hybrids score better than the rest?
They are somewhat similar, but I would look at it in terms of hierarchy: the aggressive hybrid funds, which are 75 per cent equity and 25 per cent debt, are meant for investors who are first-time investors, or are not very comfortable with the big swings of the equity market. So, I like it for its simplicity, it gets you great diversification, it gets you the fixed-income allocation, it gets you rebalancing, and it could be a long-term vehicle, and you're not deprived of any great opportunity by investing in a relatively stable fund, which does not scare you out of the market when the going gets tough. So, it should be looked upon as a quasi-equity fund vehicle or a relatively steady equity vehicle.
Balanced advantage funds have been around for a while, but still, I would say that it is heavily dependent on the fund manager taking a call and being right as well. Just taking a call is not good enough, because he has to be right, and sometimes it could be a little disappointing, but I would look at it as a relatively steadier vehicle because of its very design; it tends not to be 75 per cent into equity mostly, and that is why I would think that if you want an even more stable vehicle, go for it.
Multi-asset funds still have to shape up, and they are heavily dependent on gold's performance and allocation to gold. Have your fixed income allocation, have your equity allocation, and have a little bit of gold, but not through multi-asset, simply because you will be frozen and will not have the flexibility to decide on your own.
How are each one of them taxed?
Equity aggressive is taxed as an equity fund, so long-term gains are taxed at 10 per cent, and short-term gains are taxed at 15 per cent. Simple: they are treated like equity funds.
Balanced advantage funds depend on asset allocation. Generally, a balanced advantage fund endeavours to be treated like an equity fund because that is how it came into being. So, mostly, balanced advantage funds are treated as equity funds.
Multi-asset funds depend on the average asset allocation, the average allocation to equity through the year; if it is more than 65 per cent, then it is treated as equity, else fixed income. Things are pretty straightforward: equity or debt, depending on the allocation. Mostly balanced advantage and definitely aggressive hybrid funds are treated as equity.
Under such circumstances, when the markets are volatile, which is most suitable for investors?
Somebody who understands and appreciates the risk of the equity market and still wants to start, he should start with aggressive hybrid funds. If you have some sizable money and you want to invest and many times people accumulate their savings in their account, and then they want to invest Rs 4-5 lakh, with that mindset, for them, balanced advantage and a medium-term investment balance advantage could be the vehicle. So, it depends entirely on your risk tolerance and your comfort. Many people are fine with a 50 per cent decline, and they are able to stick around and see through it; for them, a flexi-cap fund is good enough. But for somebody who's a little fearful and gets upset, then aggressive hybrid funds are better. For medium-term investment and those who are a little fearful, balanced advantage. I think these two funds actually fulfil the needs of most investors' aspirations.
Viewer's question
Preeti Kadam says she's got Rs 3 crore of insurance money after her husband passed. She wants to invest that money in flexi-cap, mid-cap, and small-cap funds. So is it okay to park that money in liquid funds and do an STP from there, or should she park this money in a balanced advantage fund and plan a systematic withdrawal?
I would say she needs a slightly more complicated plan. She should estimate what her monthly requirement is and whatever she needs in the next three years. If you need a lakh of rupees every month, then that means Rs 36 lakh. Put that into a liquid fund, and you are taken care of and sorted for the next three years. Every month, you will keep getting your Rs 1 lakh. For the rest of the money, put it in a short-term debt fund or an ultra-short-term debt fund, dividing that money over the next 36 months into a flexi-cap fund and maybe two to three flexi-cap funds over the next three years. This is the longest time period over which you should invest in equity. And that is how you will eliminate the possibility of catching a market high—you will not get upset. Once you keep doing it, after three years, you will get an opportunity; so many of your equity investments will be more than one year old. Then, you have to see how much money you need over the next year, and depending on the appreciation that you've witnessed, you can revise your withdrawal rate.
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