Hybrid Funds – The Quintessential Gastronomy Connection

The making of the ubiquitous “roti” also known as “chapati” or the Indian flatbread, requires a combination of wheat flour (“atta”) and some water,to make the dough. It is then divided into small dough balls and rolled to make a chapati. But, if you roast it with “ghee” or clarified butter it becomes a “paratha” or if you deep fry, it becomes a “Puri” and if youmix some ghee to the dough and then bake the dough balls, it becomes a “Bati”, a Rajasthani accompaniment. So, even if the basic ingredients are same, i.e wheat flour and water, changing proportion of ingredients and adding a couple more of them or tweaking the preparation method, will give a remarkably different end result.

Hybrid funds are also similar in many ways, wherein the main ingredients of investments are Equity, Debt and Gold Hybrid funds effectively blend atleast two or all of these asset classes to optimize risk and returns to suit the need of investors with varying risk tolerance. Each asset class has a role to play in the composition of a hybrid fund -

Why Hybrid Funds?

While each asset class has a specific role to play, we also observe that different asset classes perform differently under each market cycle.

As these asset classes have low or negative correlation amongst themselves, investment in multiple asset classes helps reduce the volatility of the overall portfolio during period of sharp movements in a single asset class. The non-unidirectional relationship between various asset classes is the key reason why hybrid funds are a great choice for individual investors.

How do we choose among Hybrid funds?

Risk, in theory, is directly proportional to return which means higher the expected risk, higher is the expected return and vice a versa. So, it is important
to assess risk tolerance level before choosing a hybrid fund.

Let us have a look at the range of Hybrid Funds offered by HDFC MF and how each one caters to different investor needs. Based on the Asset allocation, especially the exposure to equities, one hybrid fund varies from another. The equity allocation ranges from minimum 10% to maximum 100% and there are six different categories under hybrid funds to suit different investor segments from conservative to aggressive:

Disclaimer: In view of the individual circumstances and risk tolerance, each investor is advised to consult his / her professional advisor before making a decision to invest. *Arbitrage Fund are also classified as hybrid fund but are not considered for potential long-term capital appreciation, hence excluded in this presentation. $ The Fund invest in equity, debt and gold ETF schemes and thus indirectly takes exposure to various asset classes. ** Total Hedged and Unhedged allocation will be minimum 65%. ^ Model based investment. # Unhedged equity exposure shall be limited to 90%. All allocation is percentage of Total Asset.

Rebalancing of portfolio is an important step in controlling risk over time. Markets do not always move in single direction and when the tide turns, you may realize that you are over/under exposed to risk if you do not periodically rebalance. The below charts show investors who start off the investment journey with suitable allocation to debt and equity but where one has done rebalancing and other has not.

Also, individually rebalancing the portfolio may become difficult because you may not like to sell the assets which are performing well and then there are costs associated with redemption such as Exit Load or Short/Long Term Capital Gain Tax#.

In such a situation what do we do?

Hybrid Funds tend to provide a solution to rebalance the portfolio and they may be classified based on asset allocation as:

- Static Asset Allocation

where the exposure to assets are predefined.

- Dynamic Asset Allocation

here where exposure is managed dynamically on basis of valuation models.

Since the Fund Manager is rebalancing the portfolio, incidence of short/ long term capital gain tax is not applicable to the fund and consequently there will be no impact on investors in the fund.

Hybrid Funds –
The Low - Volatility option compared to pure Equity Funds

Emotions play an important role in decision making by an investor, especially when markets are highly volatile because it tests investor’s ability to hold or buy.

When markets correct, fear takes over and investors overestimate the risk of losing money in a portfolio which may lead to panic sale.
Hybrid Funds help to lower volatility as compared to pure equity funds and thereby may reduce panic amongst investors during sharp fall in markets.

How do we choose among Hybrid funds?

Standard deviation is used to measure market volatility i.e. measuring how widely a series of variables are dispersed from its mean. For instance, if the returns of a fund vary in a narrow range, then standard deviation will have a relatively lower value, which means lower volatility and vice versa. Below mentioned graph measures the Standard Deviation of Hybrid Funds’ Benchmarks vs NIFTY 50 TRI.

Source: MFI, www.niftyindices.com. Gold price is from World Gold Council and internal calculation. Data from January 1, 2012 to March 31, 2024. CAGR – Compounded Annual Growth Rate (%) Disclaimer: In view of the individual circumstances and risk profile, each investor is advised to consult his / her professional advisor before deciding to invest. Risk is measured as Standard Deviation and is calculated on daily rolling returns.

From the graph, we may say that volatility of a fund is a function of equity exposure in its portfolio and the risks involved in a hybrid fund is relatively lower than that of a pure equity fund.

Hybrid Funds –
A portfolio rebalancing approach to investing

Portfolio rebalancing means selling an asset which has contributed in the portfolio return and buying an asset which has not contributed in the overall returns of the portfolio. In a nutshell, rebalancing follows an investment tenet of “Buy Low and Sell High"

Hybrid Funds – An Ideal Base to Create Pension Stream

Retirees mostly depend on their income from investments for meeting their monthly expenses and, therefore, require regular cash flows from their investments. Traditionally, in India, most retirees have relied on bank deposits for this purpose. However, one must realize that a 100% exposure to fixed income investments may not result in returns in excess of inflation. While, the
risk appetite of a retiree is expected to be low, one can include some amount of equity exposure with the help of a hybrid fund or a combination of equity and debt fund. For instance, a 10% exposure to equities can be achieved through a mix of HDFC Hybrid Debt Fund and a pure debt fund, like HDFC Corporate Bond Fund.

To create a pension stream, one can start a Systematic Withdrawal Plan (SWP) with a monthly / quarterly frequency for a fixed amount. Depending on the investor’s requirement. SWP is reverse of Systematic Investment Plan i.e. SWP would generate fixed cash flows by redeeming units periodically on a fixed date for fixed term and for a fixed amount out of the amount invested.

Conclusion

Whether an investor is investing for the first time or is an experienced investor, there is a hybrid fund for each to suit their requirement. All they need to do is to assess their risk tolerance level and choose the scheme that suits them.

# In view of the individual circumstances and risk profile, each investor is advised to consult his / her professional advisor before deciding to invest.

Disclaimer: Views expressed herein involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein.

HDFC Mutual Fund/AMC is not indicating or guaranteeing returns on any investments. Investors should seek professional advice before taking any investment related decisions and alone shall be responsible.

 

+Investors in the Scheme shall bear the recurring expenses of the Scheme in addition to the expenses of other schemes in which this Fund of Funds scheme makes investment (subject to regulatory limits)

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