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Best Balanced Mutual Funds

Scheme Name AUM(Cr.) 1y % 3y % 5y % Expense Ratio(%)
BNP Paribas Substantial Equity Hybrid Fund-Reg (G)316.4620.54002.5
AXIS Triple Advantage Fund (G)271.0720.497.57.722.34
Motilal Oswal Equity Hybrid Fund - Regular (G)269.7520.01002.47
DSP Equity & Bond Fund - (G)6148.9219.617.4910.851.9
AXIS Equity Hybrid Fund - Regular (G)1855.8218.02002.21

Hybrid funds entail the combination of equity and debt in a single mutual fund portfolio. These hybrid funds can be further sub-categorized into compartments based on whether equity is predominant in this mix or debt is predominant.

Hybrid funds or balanced funds come in different combinations of equity and debt. Equity and debt funds represent two extremes of the investment spectrum. The actual needs of investors lie somewhere in between. The answer in most cases is to buy equity and debt funds in the required proportion. But that is easier said than done. It calls for retail investors to understand and evaluate equity funds and debt funds in detail so as to make an informed decision. A mid-way solution could be the Hybrid funds or Hybrid Funds. These funds combine equity and debt either in pre-determined proportions or in dynamic proportions and then offer it as a readymade product for the investors. As an investor you have a wide choice before you with hybrid funds.

Hybrid funds are also popularly known as balanced funds. Like any hybrid product, they offer a mix of equity and debt. There also hybrid funds that offer a mix of equity and equity futures as in the case of arbitrage funds. Hybrid funds can either be passive or active in terms of allocation. For example, the Hybrid fund can decide on a broad allocation of 80:20 in favour of equities and just maintain that ratio by rebalancing. That is passive allocation. Another option is to keep changing the mix based on the view of the fund manager. The Fund manager can increase the proportion of equities when markets are undervalued or increase the proportion of debt when the interest rates are likely to go down. While these are good on paper, they tend to give a lot of discretion to the fund manager and makes them less objective as hybrid products.

Balanced Mutual Funds or hybrid funds invest in different combinations of equity and debt. The mix is determined in advance at a broad level and then it is marketed as an equity hybrid fund or as an MIP Hybrid. The hybrid fund does the job of asset allocation on behalf of the investor. Instead of you making the decision of how much to allocate to equity and how much to debt, the hybrid fund creates an acceptable formula for you to mix equity and debt. When you mix equity and debt on your own, you do not get the added benefit of professional fund management and professional asset selection. Leading Hybrid funds have given returns of between 11-15% over a 10-year period. In short, hybrid funds have the potential to give higher returns than debt funds and only marginally lower returns compared to equity funds.

There are two ways of classifying the hybrid funds. Hybrid funds can either be classified on the basis of the asset mix or on the basis of the discretion available to the fund manager. Let us first look at hybrid fund categories from the point of view of the asset mix.

  • Hybrid funds that are predominantly equity Hybrids. These funds invest more than 65% of their asset allocation in equities and the balance in debt. This ratio can vary but typically, the fund manager will not allow the equity proportion to go below the 65% mark. That is because, 65% exposure to equity is the bare minimum requirement for be classified as an equity fund for tax purposes. Once a hybrid fund is classified as an equity fund due to exposure to equity above 65%, then dividends and capital gains are taxed at a concessional rate. That substantially improves the post tax yields.
  • Debt Hybrids like a Monthly Income Plan (MIP) is a classic example. Here the predominant exposure is in debt. So an MIP will have around 75-80% in quality debt paper and the balance will be invested in equities. For tax purposes, the MIP will be classified as a non-equity fund but the small equity exposure enables the company to earn Alpha. Being predominantly debt oriented, the MIPs are also very useful for retirees who can afford to take slightly higher risk on their investments for higher returns.
  • Hybrid funds can also be in the form of arbitrage funds. In arbitrage funds, the fund manager buys a portfolio of equities and sells equivalent futures against that. The spread is the profit and it is like earning interest. The returns on these arbitrage funds vary from 6-8% per annum depending on the spreads in the market. Since futures are leveraged products, these funds are classified as equity funds due to predominant exposure in equities and get preferential tax treatment. This makes them more attractive compared to other fixed income instruments.

Hybrid funds can also be classified based on the discretion to the fund manager on asset allocation.

  • Hybrid funds or balanced funds can be static allocation funds where the mix between equity and debt is broadly fixed in a range. The fund manager normally does not go outside these limits. These are the most common type of hybrid funds in India.
  • There are also dynamic allocation hybrid funds where the equity / debt mix can widely be changed. It can even move from a predominantly equity to predominantly debt fund and vice versa. Such shifts are either based on the discretion and outlook of the fund manager or based on lifestyle goals. That is why dynamic allocation plans are quite popular when it comes to long term planning like retirement, children’s education etc.

An aggressive investor wanting little bit of stability can opt for hybrid funds. Similarly, if you are a conservative investor looking to get that little bit extra via equity exposure, then MIPs or monthly income plans could be the product for you. That is how these hybrid funds or hybrid funds combine equity and debt in different proportions to create customized products for investors. Hybrid or balanced funds do the job of asset allocation on your behalf. They offer you the added benefit of professional fund management and professional asset selection as well as in-built diversification benefits. And the returns can be quite attractive. Hybrid equity Funds have given returns of between 11-15% over a 10-year period depending on the equity exposure and the market performance.

What do we understand by hybrid mutual funds or balanced funds in the Indian context? We all understand equity funds and debt funds in plain vanilla terms. But when equity and debt are combined into a single portfolio (balanced or hybrid fund), it combines the security and regularity of debt with the long term wealth creation potential of equity. One of the major merits of hybrid funds is that it combines the best features of equity and debt and enhances the risk-adjusted returns for the investor. With hybrid funds you can have the cake and eat it too. Let us look at who should invest in the different types of hybrid funds.

  • A young investor who is having a predominant exposure to equity funds can diversify risk by investing in hybrid funds. This introduces debt gradually or in the proportion required. You can choose equity hybrid funds or MIPs as the case may be.
  • Investors who are look at tax efficiency with stability can also opt for hybrid funds. Under the hybrid category, equity hybrid funds with 65% plus to equity or arbitrage funds are treated as equity funds for tax purposes. You can use these funds to get more tax efficient returns.
  • For retired persons looking at regular income with a slightly higher risk and return, MIPs are the ideal ploy. These are predominantly debt funds and so bring stability. However, a small 15-20% of the allocation is made to equities and that results in a small alpha over pure debt funds. Basically, it makes money work harder for you.
  • Hybrid funds can also be an important tool for financial planning. In case you are looking at planning for retirement or to create a nest egg or for your children’s education abroad, then dynamic funds can help you get the best of the market environment. Of course, the risk of discretion exists in these cases.
  • Arbitrage fund are useful to HNIs and institutions to park their temporary surpluses so that they can earn higher post tax returns.

Essentially hybrid funds are about getting your investment mix right both ways. It is all about getting the stability of debt and the wealth creation potential of equities. The best hybrid funds have managed to mix aggression with stability in their asset mix. A lot of the success of hybrid funds also lies in how well you lay out your philosophy based on the undertone of the market. You need to position the hybrid funds in the right slot. Here is what you must consider before investing in hybrid funds:

  • Check the past performance of the fund over a 3 year period but make it a point to compare with the right peer group. That is very important. Occasional underperformance is OK but consistent underperformance is not acceptable.
  • Check the risk quotient of both the equity and debt component. For example, within equities you don’t want too much exposure to staid non-movers and you don’t want to take excess risk of small caps. In debt, avoid funds that go too much down the credit risk curve. Also be cautious on funds where the duration is too long. Such information is available in the fact sheet.
  • Prefer a hybrid fund that is a consistent performer in terms of returns and in terms of investment strategy. A balance that keeps varying its mix too often is not a very good idea. You need a well thought out strategy and consistency of execution. Ideally, look at fund teams that have been around for a long time and have delivered.
  • Let us now come to the equity component. Fund managers maybe inclined to focus more on mid-caps and small caps as they have given alpha in the past. But that is fraught with risk as they tend to be more volatile in challenging times. Get the balance right within the equity gamut.
  • A similar test needs to be applied in case of debt too. Funds do tend to shift a little more in favour lower-rated bonds to prop up their returns. While some credit diversification is understandable, be cautious about too much exposure as it carries default risk. We have seen that in case of bonds issued by IL&FS and Amtek Auto in the past.
  • Finally, ensure that the individual mix of equity and debt on a granular basis is not going out of sync with your financial plan. You cannot have your debt exposure going up more than warranted due to too many MIPs in your portfolio.

A hybrid fund basically combines the best features of equity and debt and saves the investor the challenge of allocation. Instead of going through the allocation process, the investor can directly select a hybrid fund with a certain mix and move towards goals. Broadly, there are 3 key benefits of opting for hybrid funds.

  • Hybrid funds can play an important role in financial planning and asset allocation. Normally, the investor creates a long term portfolio by combining equity and debt funds in appropriate proportions. This can be automated using the hybrid funds and opting for the appropriate mix. Hybrid funds can go a step forward and be structured as asset allocation funds wherein the combinations of equity and debt are automatically tweaked as your life goal and life stage changes.
  • Hybrid funds are tax efficient. Normally, debt funds bought in isolation are taxed at an unfavourable rate compared to equity funds. However, hybrid funds with 65% exposure to equity are classified as equity funds for tax purposes. That means you can have a portfolio of up to 35% in debt and still enjoy higher post-tax returns.
  • You get the benefit of professional management which saves you the task of fund picking. With a vast array of equity and debt funds available in India, there is a problem of choice that most investors face. Hybrid funds not only give you professional fund asset selection but also have diversification built into the entire process.

Any asset class, be it equity or debt has risk associated with it. For example equities have market risk, company risk, macro risk and industry risk while debt funds have interest rate risk, default risk and inflation risk. When you evaluate the performance of any fund, it has to be seen in terms of risk adjusted returns. Let us take an illustration. Should you prefer an equity fund giving 15% returns with 20% volatility or a fund that gives 17% returns with 50% volatility? Obviously, the first fund is better when the returns are adjusted for risk. Hybrid funds have risks that encompass equity risk, debt risk and the allocation or diversification risk. Here are 4 ways to look at risk adjustment of returns.

  • Sharpe ratio can be used to calculate risk adjusted returns. The Sharpe ratio uses the excess returns as the numerator and the standard deviation as the denominator. This is useful for portfolios that are not properly diversified.
  • Treynor ratio can also be used to calculate risk adjusted returns. The Treynor ratio uses the excess returns as the numerator and the Beta (systematic risk) as the denominator. This is useful for portfolios that are adequately diversified.
  • Fama excess returns can also be used to measure how much of the outperformance of the fund is generated by managerial expertise, how much by market forces and how much by sheer chance. It is a useful risk segregation tool.
  • Duration is one more approach to risk measurement for the debt component. For example, longer duration debt portfolios are more vulnerable to rising rates but benefit more when rates are falling. You need to tweak your risk accordingly.