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Equity Hybrid Mutual Funds are prudent investment options in current market conditions

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Mutual Funds article in Advisorkhoj - Equity Hybrid Mutual Funds are prudent investment options in current market conditions
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After several rounds of volatility during 2018, the stock market stabilized towards the end of the year. However, near term risks remain, among which political risk will be the biggest worrying factor weighing on the market before the Lok Sabha election and possibly, even after (in the event of the absence of a clear mandate).

Among key macro risks, the Rupee depreciation is a concern due to widening current account deficit and rebound in crude prices. The global outlook is also uncertain due to industrial slowdown in China, Brexit, US China trade war and concerns regarding US economic slowdown. These various risk factors may cause the market to remain volatile in the near term. In volatile times investors should pay more attention to their asset allocation to limit downside risks.

Near term risks notwithstanding, the medium to long term outlook for Indian equity is positive. India is the fastest growing large economy and as per the UN's World Economic Situation and Prospects (WESP) 2019 report, will continue to remain the fastest growing large economy in 2019 and 2020. The beneficial effects of some of the structural reforms instituted by the current Government like GST, Insolvency and Bankruptcy Code (IBC), direct benefits transfer, further opening to FDI will be seen in the coming years. India has jumped 54 places in World Bank’s Ease of Doing Business Index in last 2 years and India will continue to attract foreign investor interest. Indian equity continues to be an attractive asset class for long term investors.

Aggressive Hybrid Funds or Equity Hybrid Funds enables investors to reap long term benefits of equity while balancing near term risks with prudent allocations to debt. In the current political and economic climate, these mutual fund schemes are excellent investment choices for investors with moderately aggressive risk appetites.

According to SEBI mandate, the minimum and maximum equity allocations in Equity Hybrid Funds should be 65% and 80% respectively. The minimum and maximum debt allocation should be 20% and 35% respectively. The fund manager has the flexibility to manage asset allocation within the ranges specified by SEBI based on his / her outlook. The equity portion has the potential to generate capital appreciation for investors in the long term, while the debt portion provides stability to the portfolio in the short term.

Benefits of Equity Hybrid Funds

  • Equity Hybrid Funds are less volatile than Equity Funds. In the last 1 year, Equity Hybrid Funds outperformed most diversified equity fund categories. As such, these funds are excellent investment options for new investors or investors who do not have high risk appetites.

  • Equity Hybrid Funds can give good, equity like returns in the long term. In the last 5 years, Equity Hybrid Funds as a category gave average 13% CAGR returns, while in the last 10 years, Equity Hybrid Funds as a category gave average 15% CAGR returns.

  • An important aspect of managing asset allocation is rebalancing. Since different asset classes give different rates of returns, the asset allocation in your portfolio gets more skewed over time in favor or against particular asset class, changing the risk profile. The unintended consequence of this skew is either more volatility or sub-optimal returns. Since Equity Hybrid Funds are mandated by SEBI to maintain allocation of different asset classes within specified ranges, investors get the benefit of auto rebalancing. When equity outperforms debt, then at a certain stage fund managers will have to sell stocks and invest in fixed income to maintain asset allocation within the specified range. Similarly, when equity underperforms debt, then fund managers will have to shift allocation from fixed income to stocks. Rebalancing will ensure that you are buying stocks low and selling them high, limiting downside risks and getting you better risk adjusted returns.

  • Since minimum asset allocation in Equity Hybrid Funds is 65%, these funds enjoy equity taxation. Equity assets enjoy significant tax advantage compared to fixed income. Short term (investments held for less than 12 months) capital gains are taxed at 15%. Long term (investments held for more than 12 months) capital gains of up to Rs 1 Lakh is tax free. Long term capital gains in excess of Rs 1 Lakh are taxed at 10%. Dividends paid by Equity Hybrid Funds are tax free in the hands of the investors but the fund house has to pay 10% dividend distribution tax (DDT) before paying dividends to investors.

  • For investors, who want regular cash-flows from their investments, Equity Hybrid Funds are excellent lump sum investment options for Systematic Withdrawal Plans. Unlike dividends, which are paid at the discretion of the fund manager / AMC, in SWP investors can draw any fixed amount on a regular basis (monthly, quarterly etc.). SWP generates fixed cash-flows for investors by redeeming required number of units of a scheme based on prevailing NAVs. For moderate rates of withdrawal, SWP can provide fixed cash-flows to investors as well as wealth creation over long investment periods. Long term capital appreciation potential, limited volatility in market corrections and long term capital gains tax benefits, work to the advantage of Equity Hybrid Funds as far as SWP is concerned.

About Indiabulls Equity Hybrid Fund

Indiabulls Equity Hybrid Fund was launched last month. In the short period of time since inception till date, this aggressive hybrid fund has already become one of the top performers in its category. It has given 1% return in just last 1 month. The good performance of the fund is attributable to prudent stock selection with cautious allocation of funds towards select large caps and overweight in defensives considering the volatility in the markets.

The fund is currently biased towards growth theme with a large cap orientation having increased exposure to defensives sectors like IT, Pharma & FMCG with well-known companies like ITC (5.43%), TCS (3.84%), Infosys (4.50%) and Dr. Reddy’s (1.81%), as on Jan 18th, 2019. In addition to the defensive play, the fund managers expect corporate banks like ICICI Bank, HDFC Bank & Axis Bank to make a strong turnaround in earnings trajectory going ahead. The fund managers are bullish about the banking sector with improvements on the NPA front as well as pickup in credit demand after the elections. The fund managers also expect positive improvement in CAD which will determine the fund’s fresh allocation towards cyclical sectors like auto, energy & metals etc.

Due to the near term risk factors discussed earlier, the fund managers have adopted a cautious stance, allocating most of their funds in NIFTY futures to identify the right opportunity and allocate funds through prudent stock selection. The fund managers are currently holding 35% in Cash (including futures)which shall be utilized in companies having good earnings growth, stable cash flows and a reasonably good opportunity to generate higher alpha. In our view the fund managers have a sensible approach to balancing risks and long term returns; we expect the fund to perform well in the medium to long term.

Check the complete details of Indiabulls Equity Hybrid Fund here.

Conclusion

In this blog post, we discussed about the near term risks facing the market and also the growth opportunities which lie ahead. Mutual Fund Equity Hybrid Funds are excellent investment choices in such conditions. These funds will provide stability to your portfolio in the short term and can give good risk adjusted returns in the long term. Indiabulls Equity Hybrid Fund is a new entrant in this category and is off to a good start. You should have a long investment horizon for this and other equity hybrid funds. Investors should consult with their financial advisors, if equity hybrid funds like Indiabulls Equity Hybrid Fund are suitable for their investment needs.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

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Advisorkhoj Research Team

Our research team has a combined experience of nearly 40 years in the financial services management and distribution, across the entire spectrum of product classes including mutual funds, insurance, equity broking and loan products. To contact our research leads, please see their contact information below.

Dwaipayan Bose: dwaipayan@advisorkhoj.com
Pradip Chakrabarty: pradip@advisorkhoj.com

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