How hybrid funds can be used to tweak asset allocation

There are two ways you need to tweak your asset allocation. You may be overexposed to equity and you may be looking to cut down on your equity exposure. Alternatively, you may under-exposed to equity despite having the capacity for a bigger equity allocation.

Jun 21, 2021 09:06 IST India Infoline News Service

Hybrid funds typically represent a rule-based combination of equity and debt. They have been in existence for a long time and in the month of May-21, hybrid funds saw net inflows of Rs6,217cr. What is more important is that hybrid funds have an average AUM of Rs372,623cr accounting for 11.3% of the total mutual fund AUM. 

Data Source: AMFI

Of the above funds, arbitrage while being classified as a hybrid fund, is actually a mirror of a short-term liquid funds. Broadly, hybrid funds combine equities and debt in different proportion. For example, aggressive hybrid funds could have about 80-85% exposure to equities and the  balance to debt. On the other hand, the conservative hybrid funds can go as low as 15% on equities.

How hybrid funds fit into your investment plan?

Investors often remonstrate that in investing, you either run with the hares or hunt with the hounds. Once your allocation is decided, all you need to do is to fill the gaps with equity funds and debt funds. However, hybrid funds have a role to play.

a) There are many conservative investors looking to take equity exposure but want to do it gradually. For them, hybrid funds can be the answer. If they opt for a conservative fund, they are still predominantly in debt, but the small equity component gives the alpha.

b) The second justification for hybrid funds is where investors do not have the time and expertise to track allocation and lets the hybrid funds do the job for them.

c) Finally, there is the all-important purpose of tweaking your asset allocation, which can be done in a more systematic manner using hybrid funds. That will be our focus.

How to use hybrid funds to tweak your asset allocation?

There are two ways you need to tweak your asset allocation. You may be overexposed to equity and you may be looking to cut down on your equity exposure. Alternatively, you may under-exposed to equity despite having the capacity for a bigger equity allocation. Here again, hybrids can fill the gap. Let us look at both the scenarios separately.

Scenario 1: Increasing your equity exposure through aggressive hybrid funds

Starting Amount – Rs.20,00,000 Addition of Rs.5,00,000 aggressive hybrids in the Ratio of 80:20
Asset Class Current Mix Amount (Rs) Addition Amount (Rs) New Allocation
Equity 20% 4,00,000 4,00,000 8,00,000 32.00%
Debt 60% 12,00,000 1,00,000 13,00,000 52.00%
Liquids 5% 1,00,000 1,00,000 4.00%
Gold 15% 3,00,000 3,00,000 12.00%
20,00,000 25,00,000

The above table is a classic illustration of how to use an aggressive hybrid fund to increase your equity exposure. For example, by using an aggressive hybrid fund to tweak the asset allocation, the investor is not taking on too much of absolute risk. By investing the additional amount of Rs500,000 in an aggressive hybrid fund with equity / debt ratio of 80:20, the new portfolio has been substantially tweaked.

Post the re-allocation using aggressive hybrid funds, the equity allocation has gone up from 20% to 32% while the debt allocation has come down from 60% to 52% and the allocation to gold has also come down from 15% to 12%. The advantage with this method is that even as your reallocating your asset mix, it is being done in a gradual manner instead of taking absolute exposure to equity or debt.

Let us now turn to the second scenario wherein the investor tries to tweak the portfolio mix in favour of debt with the use of conservative hybrid funds. Here is how it would work and here is how the outcome will look like.

Scenario 2: Increasing your debt exposure through conservative hybrid funds

Starting Amount – Rs.20,00,000 Addition of Rs.5,00,000 in conservative hybrid in Ratio of 20:80
Asset Class Current Mix Amount (Rs) Addition Amount (Rs) New Allocation
Equity 60% 12,00,000 1,00,000 13,00,000 52.00%
Debt 20% 4,00,000 4,00,000 8,00,000 32.00%
Liquids 5% 1,00,000 1,00,000 4.00%
Gold 15% 3,00,000 3,00,000 12.00%
20,00,000 25,00,000

The above table illustrates how to use a conservative hybrid fund to increase your debt exposure. By using a conservative hybrid fund to tweak the asset allocation, the investor is not taking on too much of absolute risk. The additional amount of Rs500,000 is invested in a conservative hybrid fund with debt / equity ratio of 80:20. As a result, the new allocation has been tweaked in favour of conservatism.

Post the re-allocation using conservative hybrid funds, the equity allocation has gone down from 60% to 52% while the debt allocation has gone up from 20% to 32% and the allocation to gold has also come down from 15% to 12%. The advantage with this method is that even as you are reallocating your asset mix, it is happening in a gradual manner and phased manner, without disrupting your portfolio in the short run.

After all, tweaking the asset class mix of your long term portfolio, can be best managed with hybrid funds, when you don’t want too much of disruptive risk in your portfolio.

Related Story

Open Free Demat Account (Rs699)