VR Logo

Aggressive hybrid funds: Who should invest in them and why?

Aggressive hybrid funds are mandated to invest 65-80 per cent in equity and the rest in debt. We assess their investment case

Aggressive hybrid funds: Who should invest in them and why?

Among open-end hybrid funds, aggressive hybrid funds are the largest category in terms of the assets under management (AUM). Having said that, their present AUM of Rs 1.32 lakh crore is a bit lower than the category's AUM of Rs 1.65 lakh crore in 2018, owing to consistent outflows over the past few years.

These funds are mandated to invest 65-80 per cent of their assets in equity and the remaining in fixed income. The combination of equity and debt makes this category an ideal investment option for first-time investors who are not familiar with the volatility of the equity markets. Since its debt portion cushions the portfolio, the category is known to contain the downside of the market much better as compared to pure equity funds. Therefore, it provides psychological comfort to investors who have just embarked on their investment journey.

The graph 'Downside protection' shows how aggressive hybrid funds have been able to protect the downside much better than even large-cap funds, the most conservative equity category, whenever the markets have gone through a rough phase.

Interestingly, this downside cushion has not come at the cost of returns. The long-term returns of these funds are not far behind those of large-cap funds, as can be seen in the graph titled 'Neck and neck'. In fact, over a horizon of 10-15 years, the returns of aggressive hybrid funds have actually surpassed those of large-cap funds. Conservative-growth investors who tend to panic during sharp market corrections will certainly find these risk- reward outcomes more than acceptable

How are they managed?
Since these funds are suitable for first-time investors or conservative investors who dislike the wild ups and downs in the investment value, most AMCs manage their aggressive hybrid funds keeping such investors in mind. Therefore, the portfolios of most of these funds are positioned fairly conservatively. On the equity side, most funds have a heavy bias for large-cap stocks, while on the debt side, the majority of them refrain from going overboard on the bonds rated AA and below.

Having said that, some funds take more aggressive positions on either the equity or the debt side to enhance returns. Of course, this aggressiveness has an impact on their inherent risks and volatility. Hence, investors need to be careful while choosing these funds.

The graph 'Aggressively positioned' showcases the funds that invested more than 35 per cent of their equity allocation in mid- and small-cap stocks or greater than 25 per cent of their debt portion in bonds rated AA and below as of March 2021-end.

Note that quite a few of them have ranked among the top performers in the last one year but remember they may potentially also lead you to greater swings and risks.

Besides, some aggressive hybrid funds have exposure to AT1 and perpetual bonds, which again adds to their risk level. These bonds yield higher returns but they are riskier, with a weaker claim on the assets of the issuer. Also, the new valuation norms recently introduced by SEBI can add more volatility to these funds. Troubles related to the AT1 bonds issued by YES Bank are a grim reminder of the potential risks inherent in these instruments. These bonds were written off completely last year and as a consequence, 30 mutual fund schemes collectively suffered a loss of about Rs 2,700 crore.

More than half of the funds in the category had exposure to these bonds in the past, but that is no longer the case. In fact, as per the March 2021 portfolios, 21 out of the 34 aggressive hybrid funds (excluding fund of funds, retirement funds and children plans) did not have any investment in AT1 bonds at all. But only a few funds have notable investments in them. As revealed in the table titled 'Funds overboard on AT1 bonds,' some funds have more than 25 per cent of debt allocation invested in such bonds. To be fair, credit risk does not seem to be a big issue with the exposure at the moment, as a big chunk of them are invested in the bonds of government-owned banks or the top three private sector banks, namely HDFC Bank, ICICI Bank and Axis Bank. Nevertheless, we believe that big investments in these instruments are best avoided even at the expense of some returns.

Choosing the right fund
Since aggressive hybrid funds are considered to be most suitable for first-time investors who have just embarked on their investment journey or investors seeking conservative growth, it is desirable that these funds are managed conservatively. Given this, we prefer the ones that keep tabs on both equity and debt side of the portfolio, even if that means foregoing some returns.

Finally, don't ignore expenses. They vary on a wide spectrum but you'd be better off sticking to the ones that are reasonably priced. We present our hand-picked selection in the next few pages.

To know our recommended funds in this space, see the June 2021 issue of 'Mutual Fund Insight'