Home / Money / Personal Finance /  Hybrid Schemes fell out of flavour in FY20: Here’s why

Hybrid mutual funds are mutual fund schemes that invest in both equity and debt. They are meant to offer some of the benefits of equity with less risk than pure equity schemes. Taxation of some hybrid schemes as equity funds, lends an edge. In times of volatility, investors are supposed to turn towards these funds in preference to pure equity schemes. But this does not seem to have happened on the ground, as AMFI data shows. In this piece we look at why and what the case for them looks like.

Hybrid schemes contain a vast array of sub-categories. They go from conservative hybrid which have a roughly 25:75 equity debt allocation to aggressive hybrid with a roughly 75:25 allocation. Other sub-categories sit somewhere between. One particular sub-category Dynamic Asset Allocation Funds (DAAFs) has been strongly promoted by the mutual fund industry over the past year because of its wide flexibility to move between equity and debt.

Industry body AMFI reports Assets under Management (AUM) for all these sub-categories put together each month and we have examined this data. An important point to note is the treatment of arbitrage funds. AMFI includes arbitrage funds in the hybrid category for technical reasons. However these funds do not seek to generate returns by shifting between equity and debt. Instead they simply buy stocks and short their futures, giving returns more or less in tune with short term interest rates in the economy. Stripping these funds from the data, gives a more accurate picture of hybrid funds in India.

Hybrid Schemes, stripped of arbitrage funds saw net outflows of 2,383 crore in April 2020 repeating a story that has played out for practically every month in the last 12 months. Assets under Management (AUM) for the category have dipped from 3.36 lakh crore in April 2019 to 2.84 lakh crore in April 2020 down 15.4%. The percentage fall steepens if you take out arbitrage funds, to 21.5%. Many would argue that AUM also includes market movements and this due to the Covid 19 correction. However pure equity schemes which are far more exposed to the stock market saw only a 6% drop in assets under management. Even as the mutual fund industry has raised the pitch of its ‘asset allocation is important’ slogan, it seems that MF investors do not quite trust fund managers to do it.

Vishal Dhawan, founder, Plan Ahead Investment Advisors laid out three reasons why investors have turned away from hybrid funds. First, he pointed to the previous mis-selling of such schemes on the promise of regular dividends. When equity markets were in an upswing, these funds would declare dividends in a way that allowed some distributors to compare them to FD returns. This positioning was shattered, when dividends evaporated in the weak equity markets after September 2018. Second, Dhawan noted that the introduction of the Long Term Capital Gains Tax (LTCG) in the February 2018 budget hit the investment case for these funds. LTCG of 10% for capital gains in equity funds (many hybrid funds are taxed as equity) above 1 lakh per year was introduced in 2018. “Earlier, for short term investors, it was a choice between paying 30% tax on debt (for people in the highest bracket) and nothing on the debt component of a hybrid fund. Now it is a choice between 30% on pure debt and 10% on hybrid," he said. Third, he said that many old and large hybrid funds have delivered poor performance for several years.

Mutual Fund investors essentially have a choice. They can either put money in hybrid funds and let fund managers choose their asset allocation (equity v debt) or they can do this themselves by splitting their money between pure equity and pure debt funds. This latter course will get investors funds that are more aligned with the risk appetite and goals, argues Prateek Pant, Co-founder and Head Products and Solutions at Sanctum Wealth Management. Picking individual equity schemes can help you choose large, mid or small cap funds. In case of debt funds, you can choose schemes which take low exposure to credit risk, an aspect that has grown prominent after the freeze in 6 schemes of Franklin Templeton last month. You can also choose the sensitivity of your debt fund to interest rates. However Pant carves out an exception for small ticket investors who are new to mutual funds. “Such investors will have a better experience in hybrid funds due to their lower volatility than pure equity," he adds. Mutual Fund investors with good financial planning ability or an advisor who can choose asset allocation may be better off in pure equity or debt schemes.

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