A passive hybrid fund combines the long-term growth potential of equities with the relative stability of government securities (Gsecs). “Equities act as the primary return driver while Gsecs help cushion market volatility,” says Bhavesh Jain, president and co-head, factor investing, Edelweiss Mutual Fund.
The debt allocation can make the investment journey less volatile than that of a pure-equity portfolio. “The structure provides a smoother investment experience and improved risk-adjusted outcomes,” says Jain.
The allocation to Gsecs can control the risk arising from the credit quality of instruments in the debt portfolio.
Disciplined asset allocation
Passive hybrid funds follow a rule-based approach to investing. “Investors can be reasonably confident that the fund will follow its stated strategy,” says Raghaw.
These funds follow a defined approach to rebalancing. “Automatic rebalancing creates discipline in asset allocation,” says Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors.
“They also offer a low-cost approach to hybrid investing,” says Siddharth Srivastava, head – ETF product and fund manager, Mirae Asset Mutual Fund.
Rebalancing takes place within the fund. Investors do not have to sell one asset class and buy another to restore the prescribed allocation. “Internal rebalancing does not create a tax liability for the investor. This makes a combined product more tax-efficient than maintaining the same equity-debt allocation independently,” says Deepesh Raghaw, Securities and Exchange Board of India (Sebi)-registered investment adviser (RIA).
Investors can choose index combinations that suit their risk profile. “They can select the equity and debt indices that provide exposure to particular market-cap segments and investment strategies that suit their investment objectives,” says Srivastava.
The debt allocation reduces the proportion invested in equities. Consequently, investors may not fully participate in an equity market rally.
Investors must understand the scheme’s tax classification. “A hybrid fund with equity exposure below 65 per cent would be subject to non-equity taxation, which would reduce its post-tax return,” says Dhawan.
Don’t rely blindly on back-test results
Passive hybrid index funds and ETFs are new products. Any long track record they display is based on back-tested data rather than live performance.
The fund’s returns may vary from those shown in back-tested results. “Performance can change significantly once real money begins tracking the index,” says Raghaw.
Investors may use back-tested results as one input in their decision-making, but should not regard them as being predictors of future performance.
First-time equity investors may consider passive hybrid funds, which can offer them a less volatile experience than a pure-equity fund. Conservative investors may also find them suitable.
“Investors seeking a hassle-free, tax-efficient asset-allocation solution may consider these funds,” says Jain.
These funds may also suit investors who want the prescribed asset allocation and do not intend to make frequent tactical changes. Existing equity investors seeking to reduce portfolio volatility may also consider them.
Investors seeking high equity exposure may not find these funds suitable. “Aggressive investors may find the equity allocation restrictive,” says Dhawan.
Those who prefer to actively manage their asset allocation or make tactical shifts between asset classes may also find the structure limiting.
Investors working with an adviser may prefer a customised asset allocation. “Such investors may prefer separate funds,” says Dhawan. Asset allocation at the portfolio level becomes easier to control with separate funds.
An investor opting for a passive hybrid fund must understand the underlying equity and debt indices. “Those who find the structure too complex should avoid these funds,” says Raghaw.
Indices’ risk-return profile
• Large-cap stocks can provide stable returns
• Mid-caps can improve long-term returns
• Large-caps may offer lower upside than mid-caps
• Mid-caps come with greater volatility
• Can capture upside strongly in favourable equity markets
• Can see sharp drawdowns 8-13-year Gsec index
• Gsecs may offset equity drawdowns
• Do not carry credit risk
• But have long duration, can fall considerably when interest rates rise