Balanced or hybrid funds can work wonders for your portfolio

SPECIAL: Know more about Hybrid Funds

Based on their objectives and strategy, hybrid funds, also called balanced funds, come in three forms-monthly income plans (MIPs), asset allocation funds and capital protection funds.

The main objective of these funds is to offer you the best of both worlds-equity and debt.

HIGH ON RETURNS
Hybrid funds have given good returns in the last few years. For instance, balanced funds have returned 18 per cent in the last three years compared to 23 per cent returns given by the Bombay Stock Exchange Sensex.

Funds such as HDFC Prudence, Reliance Regular Savings Balanced, Birla Sun Life 95 and Tata Balanced have given more than 25 per cent annual returns in the period. In fact, in the last five years, these funds have performed better than the Sensex by returning more than 10 per cent compared to a modest 5 per cent rise in the benchmark index.

Balasubramanian says hybrid funds do well when stock markets are going through a difficult phase as they have a cushion of debt. So, they are better equipped to withstand shocks in falling markets. However, when stock markets are rising, they may not do as well as funds with 100 per cent equity component.

Rebalancing based on market conditions also works for these funds. Take a balanced fund with 70 per cent exposure to equity and 30 per cent to debt. If the stock market falls, the fund's equity exposure will drop to the extent of the fall, leaving the fund manager with no option but to buy more shares to maintain the 70 per cent equity level. Debt provides safety.

SPECIAL: How to choose the right Mutual Fund

Similarly, in a rising market, if the equity allocation moves up to 80 per cent, the fund manager will sell 10 per cent equity portfolio and buy debt, thus automatically booking profits. In fact, the debt component in balanced funds is managed in such a way that short-term debt funds, which are less volatile, comprise a big part of the portfolio. "The idea is to lower the risk," says Balasubramanian.

Even the fund managers for equity and debt are different. The equity part is managed actively with exposure to companies across sectors and market capitalisation categories. The debt part is managed more passively.

ALSO IN THE PACK
The other category within hybrid funds is debt-oriented MIPs, which allocate 5-25 per cent funds to equity and the rest to debt. Their performance over the last three years has been noteworthy, with many delivering more than 10 per cent returns.

Gaurav Mashruwala, a Certified Financial Planner, attributes the good performance of these funds to falling bond yields in the wake of the downward pressure on interest rates.

As bond prices and interest rates are inversely related, the net asset value, or NAV, of any fund's debt component rises when interest rates start falling and vice versa. Mashruwala says one can invest in MIPs for consistent returns, not capital appreciation.

"The idea of investing in these funds is that they give regular payouts. So, choose a fund with a consistent dividend record," he says.

Then there are capital protection funds, a new category of close-ended funds whose aim is to offer consistent returns and protect wealth in a volatile market and yet gain from the upside offered by the equity markets.

These funds invest up to 80 per cent in debt (usually with a lock-in of three years), which generates a fixed return and ensures that the principal remains safe. The balance, that is, up to 20 per cent, is invested in equity for wealth generation.

However, Mashruwala says these funds offer a psychological respite at a high cost.

"You can create your own capital protection plan by investing in a growth option of, say, an MIP, which has a similar composition of debt and equity, at a lower cost," he says. These funds have low liquidity and tradability.

"These are for those who want to invest in the equity market but wish to stay protected on the downside, that is, do not want to risk the principal amount," says Balasubramanian.

These funds don't have much of a performance history to boast of, unlike their counterparts. Also, they do not guarantee capital. It is something that is stated implicitly; capital protection is inherent in the way the portfolio is constructed.

THE RIGHT BALANCE
"Although equity and debt are more or less known to share an inverse relationship, there have been times when they have been positively correlated, especially when market cycles are turning," says Mashruwala.

In 2003, when the cycle was turning, funds investing in government securities gave double-digit returns just like the equity markets. This went on till 2004. Similarly, after the 2008 global financial crisis, the stock markets picked up after early signs of recovery and debt, too, did well after the Reserve Bank of India cut interest rates to revive the economy.