Simple, very simple

The cover story of 'Mutual Fund Insight' December 2023 issue is about hybrid funds, which investors of a certain age and above still tend to call 'balanced funds'. While 'hybrid' is a technically more correct term for these funds, I must confess that 'balanced' is more descriptive. The reason is that the name itself incorporates the concept of asset rebalancing. Automatic asset allocation and asset rebalancing are the main reasons hybrid funds make sense for investors, so we might as well have the name reflect this.

This brings me to another point about hybrid funds that seasoned investors, fund professionals and analysts often do not appreciate. The logic of hybrid funds is harder to imbibe for new investors even though these funds are more suitable. There exists a knowledge barrier to investing in hybrid funds.

Equity funds or debt funds by themselves are much simpler ideas. Conceptually, they have a single purpose. Equity funds help to generate high returns, while debt funds are for safety. In the mind of a new investor, one can optimise the choice of either type of fund by optimising for these two characteristics. That's an oversimplification but broadly correct.

Hybrid funds are not like that. They are a little bit of this and a little bit of that. Their returns are never as good as equity funds, and their safety (protection from falls) is never as good as debt funds. And since they never have the best returns or the highest safety, they are a hard thing to choose. Yet, they make sense for more people, most of the time. It's something that takes a bit of effort to appreciate. As a class, equity funds have the best returns, debt funds have the best safety and hybrid funds have the best compromise. However, it takes a certain amount of mental sophistication about investing to appreciate that a compromise is often the superior option.

The real-world practicality of hybrid funds becomes apparent when considering the average investor's constraints — time, knowledge and the ability to withstand volatility. For these individuals, hybrid funds offer a 'set-and-forget' strategy requiring less daily thought. It's an investment tool that simplifies the investor's engagement with the market and reduces the stress associated with equity investments.

As you'll read in the cover story, one of the triggers for doing it was our recent study of portfolio sizes, wherein we found that most people had invested in too many funds. When we looked at the patterns of aggregate data of several Indian mutual fund investors, it turned out that most had more than ten funds, 20-30 were not uncommon and more than 50 were unusual but not rare. Most investors who had less than ten or so funds have been investing only for a few years. No doubt, as time passes, their collection will also grow more impressive.

Why do people invest in so many funds? Their polite reason is diversification, but the real one is sales pressure. The underlying cause of investors holding an excessive number of funds is often due to the influence of salespeople who profit from commissions. Lacking a clear understanding of adequate diversification, investors fall into the trap of believing that holding more funds equates to a better investment strategy.

Hybrid funds are the perfect antidote to investing in too many funds. One single (type of) fund can serve practically all investor needs. Once your tax-saving needs are taken care of, the best thing to do is to choose a suitable sub-type of the hybrid fund after imbibing our cover story, then select a set of actual funds within that sub-type, then start a systematic investment plan (SIP) and then stick to it for a long time to come.

By understanding the unique value of hybrid funds, the principles of asset allocation and the rebalancing they offer, investors can streamline their portfolios. By selecting a well-suited hybrid fund, setting up an SIP and committing to it over the long haul, investors can mitigate the risks of unnecessary complexity and focus on building a resilient and growth-oriented portfolio.

The key takeaway is clear: simplicity, coupled with strategic fund selection and patience, is often a winning formula for sustained investment success.

Also read: Keep calm and invest on