Conservative hybrid funds: Not the best investment mix of debt and equity

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Conservative hybrid funds aren’t among the most sort after by investors. According to Value Research, the 36 conservative hybrid schemes managed assets of only Rs 14,645 crore as of April 30, 2021. Why have investors not taken to this category? Does it make sense to invest in these schemes?

What is the investment mix?

Conservative hybrid schemes are mandated to invest 75 to 90 percent of their assets in bonds and 10 to 25 percent in equities. SEBI’s (Securities Exchange Board of India) re-categorisation norms do not prescribe any restrictions on the quality or the duration of the bonds to be held. It also does not specify if the fund manager has to invest in stocks of specific market capitalization. Therefore, the fund manager has considerable flexibility in choosing her investment avenues. According to Value Research, conservative hybrid funds, on an average, have 13.37 percent and 5.47 percent of their portfolios in AA and A-rated bonds, respectively.

These schemes are generally pitched to investors as being a relatively low-risk option.

Now PPFAS AMC has rolled out a new Parag Parikh Conservative hybrid fund (PCH) from May 9. Now, PCH intends to invest minimum 75 percent of its assets in bonds and up to 10 percent of in units of real estate investment trusts and infrastructure investment trusts. The scheme will invest 10 to 25 percent of the portfolio in stocks.

“While the fixed income component of the portfolio will have government securities and AAA rated PSU and corporate bonds, the focus will be on avoiding excessive credit risk,” says Rajeev Thakkar, CIO, PPFAS Mutual Fund. “Stocks with attractive dividend yield and good cash flow, special situations and other low-risk strategies such as cash-future arbitrage will be considered while building the stock portfolio,” he adds.

Why investors haven’t rushed in

These schemes are positioned in such a manner that the conservative fixed income investors looking for a percentage point or two more than debt fund returns would only find them attractive. Making dividends taxable and sub-optimal net returns delivered by these schemes have made investors turn away. Conservative hybrid funds have given 6.77 and 7.54 percent over three and five years, respectively. Short duration funds with no exposure to equities have delivered 6.61 and 6.58 percent over the same periods of time.

A high expense ratio is charged by most of these schemes, thus pulling down returns. The expense ratio for regular plans is usually 0.76-2.33 percent.

“Low interest rates on bonds have made a few conservative investors look for small allocation to stocks in search of better yields,” Ravi Kumar TV, Founder of Gaining Ground Investment Services.

Risks persist

Some fund managers take credit and duration risks (by investing in medium to long term bonds) to increase returns. Investing in the shares of mid and small-sized companies can make the equity component volatile, though during rallying markets, it can be rewarding. Given the limited track record of REITs and InvITs, investors have to remain watchful.

Should you invest?

The yields from many debt fund categories, at 5 percent over the past one year, look unattractive as the expected inflation rate is around 5 percent over this year. So, an investment rooted in debt with a small equity kicker seems attractive.

“The hybrid conservative category has not done well in the past. However, it may be due for a comeback as equities look good from a medium to long term horizon and interest rates may take time to rise,” says Ravi Kumar.

When an investor has a three-year time frame, the profits earned on the units are treated as long term capital gains and taxed at 20 percent post indexation. Investors looking for regular income should ideally stay put for three years and then go for a systematic withdrawal plan (SWP).

But why not invest in debt and equity funds separately instead of mixing the two?

Deepak Chhabria, founder and managing director of Axiom Financial Service concurs, “Conservative investors with large portfolios are better off investing in good quality bond funds and well-managed large-cap equity schemes in line with their desired asset allocation.”

Conservative investors, especially retirees, may find hybrid conservative schemes attractive. However, they should instead look for combining assured returns schemes and mutual funds offering market-linked returns.

The senior citizen saving scheme, Pradhan Mantri Vaya Vandana Yojana and Reserve Bank of India Floating rate saving bonds are good options for the retired. “After investing in these avenues, they can consider balanced advantage funds as they offers exposure to debt and equity in a rule-based manner and offer tax efficient returns,” adds Chhabria.

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