Conservative Hybrid Funds, formerly also popularly known as Monthly Income Plans, are a sub-category of hybrid mutual funds, which invest 10 – 25% of their assets in equity and equity related securities and the balance in debt securities. Unfortunately, conservative hybrid funds, as a product category is not very popular among retail investors in India. We in Advisorkhoj, find this a little perplexing because in our view retail investors in India are in general risk averse and conservative hybrid funds are ideal investment solutions for investors who want to limit downside risks.
Why are conservative hybrid funds ideal for moderately conservative investors?
With the help of simple arithmetic, we will try to show to you, why these funds limit downside risks to great extent. Assume a conservative hybrid fund has 80% allocation to debt and 20% to equity. Assuming debt gives a return of 7 - 8% irrespective of equity market conditions, the debt portion of the fund will generate returns of 5.6 – 6.4% for you. If the equity market falls by 15 - 20%, most equity funds will give negative returns, but the effect of 15 – 20% correction on a hybrid fund (with 20% equity allocation) will be only 3 – 4%. Since the debt portion generates around 6% returns for the scheme, you are likely to get positive returns even if stock market crashes 20%.
On the other hand, when market rallies, the equity portion of these funds will give a kicker to returns. We saw earlier that debt portion will contribute around 6% returns (assuming 7 – 8% returns from debt), if equity market rallies 20% (which implies 4% contribution to fund returns), you will get double digit returns from the scheme. Unlike traditional fixed income products which often fail to beat inflation on a post-tax basis, conservative hybrid funds can generate good inflation adjusted returns in the long term for investors since historical data shows that equity as an asset class is able to beat inflation.
The other big advantage which these funds enjoy over traditional fixed income products is beneficial tax treatment. While traditional fixed income products like Bank Fixed Deposits or Post Office Small Savings Schemes are taxed as per the income tax rate of the investors, capital gains (profits) in conservative hybrid funds made over a 3 years plus investment tenors are taxed at 20% after allowing for indexation benefits. Indexation benefits can reduce your tax obligation considerably. Let us understand this with the help of an example.
In the first instance, let us assume you got Rs 5 Lakh interest from your FD. In your Income Tax Returns, you will have to add Rs 5 Lakh to your income. If you are in the 30% tax bracket, then your tax obligation will be Rs 1.5 Lakhs. Please note that tax on Bank FD interest is payable as it is accrued. The bank will deduct TDS at a certain rate, but you will have to pay the full tax on accrued interest every year throughout the FD term.
In the second instance, let us now assume that you invested Rs 15 Lakhs in a conservative hybrid fund3 years back and now its value is Rs 20 Lakhs. In mutual funds, capital gains tax is payable only in realized gains, i.e. when you redeem. There is no tax on unrealized gains. If you redeem your units, you will make a profit of Rs 5 Lakhs. You are allowed to adjust your acquisition cost for increase in cost inflation index (CII). CII is notified by the Income Tax Department every year. The CII in the year of acquisition (FY 2015-16) was 254 and the CII in the year of redemption (FY 2018 -19) is 280. You can index your acquisition cost with CII, by simply multiplying you acquisition cost (Rs 15 Lakhs) with the ratio of CII in the year of redemption and CII in the year of acquisition.
Adjusted Acquisition Cost = 15 Lakhs X (280 ÷ 254) = Rs 16.53 Lakhs
Redemption Value = Rs 20 Lakhs
Capital Gains after Indexation = Rs 20 Lakhs - Rs 16.53 Lakhs = Rs 3.5 Lakhs.
Capital Gains Tax (@ 20%) = Rs 3.5 Lakhs X 20% = Rs 70,000.
Though the income / profit from both the investments, bank FD and the hybrid fund was same (Rs 5 Lakhs), your tax outgo for the hybrid fund was less than 50% of your tax outgo for the FD.
Indiabulls Savings Income Fund
Indiabulls Savings Income Fund was launched in December 2015. The scheme has Rs 34 Crores of Assets under Management (AUM). The expense ratio of the scheme is 1.58%.
Sumit Bhatnagar and Malay Shah are the fund managers of this scheme. The fund has given around 10% CAGR returns since inception beating the Conservative Hybrid Fund category. The chart below shows the NAV growth of the scheme since inception.
The monthly dividend option of the scheme has been paying regular monthly dividends since December 2017. Investors should note that while mutual fund dividends are tax free in the hands of the investors, the asset management company has to pay 28.8% dividend distribution tax (DDT) for conservative hybrid funds before paying dividends to investors.
Top Performer in both Lump Sum and SIP modes
Indiabulls Savings Income Fund has been a top performer in both lump sum and SIP modes. Please see our Top Performing Conservative Hybrid Funds (for lump sum investments). You will see that Indiabulls Savings Income Fund has been the best performer in the category in the last 1 year. It has also been the best performing Conservative Hybrid Fund in 2018 (YTD basis). The chart below shows the growth of Rs 10,000 lump sum investment in the scheme since inception.
You can see that the scheme was able to beat FD returns comfortably despite the difficult equity market conditions this year and also at the time of scheme’s launch.
Let us now see how the scheme performed in the SIP mode. Please see our Top Performing SIP in Conservative Hybrid Funds. Indiabulls Savings Income Fund is among the top 5 conservative hybrid funds in terms of SIP returns over the last 1 year and the best performing conservative hybrid funds in terms of SIP returns over the last two years. The chart below shows the growth of Rs 10,000 monthly SIP in the scheme since inception.
Indiabulls Savings Income Fund will complete 3 years since launch in December this year. Though the fund is still very young, it has delivered strong performance thus far. Conservative Hybrid Funds are excellent investment choices for investors who prefer portfolio stability, income and long term capital appreciation. You should have a long investment horizon, at least 3 years or more for Indiabulls Savings Income Fund. Investors should consult with their financial advisors if this scheme is suitable for their investment needs.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.