Markets are soaring; should you stick to hybrid funds?

This, according to some experts, can be a sign that investors are jittery. “The recent investment trends show that investors are nervous about markets as prices are at unreasonable valuations," said Kirtan Shah, chief financial planner at Sykes and Ray Equities (I) Ltd.

Hybrid funds are favoured by investors as they seek to find a balance between growth and income by investing in both equity and debt.

“The rally in the markets has attracted many conservative investors to enter the market, which is the reason for the consistent growth in the hybrid funds category since the beginning of the year. DAAFs (dynamic asset allocation funds) witnessed the maximum inflow in August with almost six times increase in the inflows compared with the previous month," Gautam Kalia, head - investment solutions, Sharekhan, wrote in a recent note on the Association of Mutual Funds in India (Amfi) data for August.

Further analysis of the data showed that the hybrid category of mutual fund schemes saw net inflows of ₹18,705.84 crore, with DAAFs/BAFs (balanced advantage funds) cornering the lion’s share at ₹16,570.97 crore, in August.

This could further be attributed to the SBI Mutual Fund receiving over ₹14,500 crore for its BAF during the new fund offer (NFO) period. The investment trend for the hybrid category has remained robust since the start of FY22.

A question now arises that with the equity markets hitting fresh all-time highs on a regular basis, how should investors be placed in the hybrid fund category?

According to Harshad Chetanwala, a Sebi-registered investment adviser and co-founder of MyWealthGrowth, two segments of investors can look at hybrid funds. “First, those who are not happy with the kind of returns debt funds have given over the past one-and-a-half years or so, should move into conservative hybrid funds, DAAFs or BAFs, rather than aggressive hybrid funds," he said.

Chetanwala believes aggressive hybrid funds continue to hold about 70-80% in equities.So if you are risk-averse investor, these funds are not suitable for you.

“The second type of investors could be those who are wary of markets at around 58,000 levels. If the idea is to reduce risk, these investors should also stay with non-aggressive hybrid funds such as DAAFs and BAFs," he added.

Experts say that with a minimum 60% allocation to equities, these funds are taxed like equities, which is more efficient in the short run.

However, investors should keep in mind that hybrid funds do have their drawbacks. “For someone looking at a little higher return than debt, hybrid is the place to be. However, for someone who is into equity investing, a systematic transfer plan (STP) over the next 12 months makes more sense," said Shah.

Under an STP, an investor can periodically switch or redeem a certain amount or certain units from one scheme, usually a debt fund, and invest in another scheme of the same mutual fund house.

“With the hybrid route, there are two problems. One is that investors will not be able to meet equity kind of returns. Second, if they think they can sell hybrid when the market falls and then come back into equity, then there are taxation angles and timing angles," Shah added.

Chetanwala added that with the markets hovering around all-time highs, it would be better for investors to focus on large-cap and flexi-cap funds, allowing the fund manager to take the call and continue with a staggered manner of investments.

If investors want to stick with the hybrid category, they should keep in mind that this category isn’t completely risk-free.

“Medium risk-takers can take some allocation into BAFs. The focus cannot be for the whole portfolio. History has shown that BAFs have seen double-digit negative returns. So, as long as one sticks to one’s time horizon, anywhere between three and five years (minimum), volatility should be waived to some extent," said Rushabh Desai, a Mumbai-based mutual fund distributor. Desai points out that the only way to mitigate risk is to venture into fixed income.

“Otherwise, one has to distinguish between conservative hybrids in the sense of debt and equity. This is because conservative hybrid funds have around 25% in equity and the constant 75% debt portfolio in these funds can act as a buffer in some way. The buffer in balanced advantage funds will depend on the debt allocation at the time of correction," Desai added. Remember that if the allocation is biased towards equities, you invariably take higher risks.

The best way to build a sustainable portfolio is to stick with the four pillars of investment strategy: know your goals, time horizon, risk capital and asset allocation.