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How to Profit from Hybrid Funds?



Choosing between debt and equity is often a hard choice. When the stocks markets are doing well, we prefer equities, but when the markets tank, we gravitate towards fixed income. This distorts the asset allocation. This is where hybrid funds come to the rescue. By offering a blend of debt and equities, these funds aim to provide you the best of both worlds. Hybrid funds are a viable option for those who cannot manage their portfolios actively and are unable to rebalance when required.

How Does The Strategy Work?

Most of the funds being launched are close-ended structured products that hold out the dual promise of capital protection if stock markets don't do well and attractive returns if there is a bull run. The actual return will depend on how the equity portion performs (see graphic).

Will Equity Deliver On The Promise?

Experts are not too enthused by these products. The premise behind capital protection funds sounds good, but the reality is very different For investors, a better choice would be to go for open-ended hybrid funds, which include monthly income plans, asset allocation funds and some balanced funds. These funds have a different risk profile than closed-ended ones. While closed ended funds do not trade in underlying debt securities due to the lock in period, the open-ended funds actively trade in debt securities. This leaves them exposed to the interest rate risk.

Within closed-ended hybrid funds, though the structure across funds is essentially the same, one cannot paint all funds with same brush. A capital protection oriented fund, for instance, is not allowed to invest less than 83% of its corpus in debt instruments and that too AAA-rated ones. Pure hybrid funds (non-capital protection oriented), on the other hand, can invest in lower rated instruments (AA) for their debt portfolio.

Asset allocation funds enjoy far greater flexibility in managing the asset mix than any other hybrid funds. These mostly rely on some valuation parameter like PE ratio to decide on the allocation.

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