There are multiple fund categories in mutual funds and each category has its own USP. Hybrid funds are based mostly on different allocations to equity and debt, and sometimes to other asset categories such as gold or equity, cash & futures arbitrage. There is an old debate, whether focused allocation to equity and debt funds is better or hybrid funds are better.
Recently, another debate has emerged: between balanced advantage funds (BAF) and aggressive hybrid funds (AHF). Just to get the basics clear, a BAF has majority of the exposure to equity, at least more than 65 per cent of the portfolio, to be eligible for equity taxation. The balance is invested in debt. In the equity component, while there is ‘long’ exposure i.e. purchase of stocks in the portfolio, there is a ‘short’ exposure where some of the stocks have been sold in the stock futures segment.
The implication is equity price volatility, either favourable or unfavourable, gets cancelled out to the extent of short equity exposure. An AHF has 65-80 per cent of the portfolio in equity, and the rest in debt.
The context of the recent debate is AHF as a category has outperformed BAF over a longer time frame, say 10 years. In other words, in spite of the bearish phases in the equity market, when funds with a relatively higher equity exposure will underperform BAF, straightforward equity allocation works better when we look over a horizon of, say, 10 years.
The counter-argument is, volatility is lower in BAF, since with an effectively lower allocation to equity (due to short exposure), these funds lose less in bear phases. Hence, the investor experience is better. Since equity has given decent returns over longer periods of, say, 10 years in spite of the interim ups and downs, a fund with a relative higher equity exposure will deliver little higher returns.
Now let’s us look at some data. We are looking at the past 10 years’ performance, till June 10, 2021, in the regular plan i.e. non-direct plan. BAF has delivered 11.05 per cent annualised. This is an average of only nine funds. If we take shorter periods, we will have a higher number of funds. While 11.05 per cent is the category average, the better ones like ICICI Prudential Balanced Advantage Fund delivered 12.69 per cent, Nippon India Balanced Advantage Fund delivered 11.54 per cent and Edelweiss Balanced Advantage Fund yielded 11.28 per cent.
In the AHF category, the average annualised return over 10 years is 11.99 per cent, which is the crux of the debate i.e. 11.99 per cent is better than 11.05 per cent of BAF. This is the average of 21 funds. We have more funds in this category with a 10-year history than BAF; many AMCs had a product in this category, which were known as balanced funds earlier.
The top ones in this category included ICICI Prudential Equity & Debt Fund with 15.01 per cent annualised returns, SBI Equity Hybrid Fund with 14.17 per cent and Canara Robeco Equity Hybrid Fund with 13.93 per cent annualised returns. Net-net, the annualised difference between BAF and AHF over 10 years is approximately 1 per cent.
Now let us have another perspective to this debate. The effective equity exposure in BAF, though it is a function of the particular fund mandate and fund manager’s views, has been net of the short positions, somewhere around 40 per cent for quite some time. There is another fund category, conservative hybrid fund (CHF), where the equity exposure is in the range of 10-25 per cent of the portfolio.
Hence if we take an average of AHF (65-80 per cent equity exposure) and CHF (10-25 per cent equity exposure), we will get equity exposure somewhere around that of BAF’s net equity exposure. In CHF, the average return over last 10 years stood at 8.53 per cent annualised. Obviously, lower than the previous two categories mentioned, as the equity exposure is lower. This is the average of 20 funds, of which the top three included ICICI Prudential Regular Savings Fund with 10.34 per cent annualised returns,
Sun Life Regular Savings Fund with 10.21 per cent and Kotak Debt Hybrid Fund with 9.92 per cent.
Now, if we take the average of AHF and CHF over 10 years, (11.99 per cent and 8.53 per cent) which is 10.26 per cent. And that gives a different perspective: BAF with 11.05 per cent per year has outperformed the average of AHF and CHF, which is 10.26 per cent. In other words, an active fund manager’s call on the effective extent of equity exposure has proven productive.
Fund selection is a matter of risk appetite and horizon. If you have both, you can go for pureplay equity funds. If you are conservative, given the levels of equity market valuation, and want to go with the fund manager’s call on equity exposure, you can go for BAF. AHF as a concept is somewhere in between pureplay equity and BAF.