Hybrid funds combine the growth prospects of equity with the stability of debt to try to deliver returns with lower volatility.
Among hybrid funds – those with a bias for equity are called hybrid aggressive funds (earlier called equity-oriented funds). Those with more debt are called hybrid conservative funds (earlier called MIP or debt-oriented funds). Over the last few years, a new type of hybrid funds have gained popularity. These hybrid funds employ derivative instruments, like futures and options, to hedge their portfolio, instead of using debt. The hedged portion of the portfolio essentially acts as debt, allowing the fund to lower the risk. At the same time, the unhedged portion generates higher returns. Essentially they are equity-oriented in their portfolio but come with risks similar to debt-oriented funds.
So hybrid low risk funds can be classified as under:
Among hybrid funds – those with a bias for equity are called hybrid aggressive funds (earlier called equity-oriented funds). Those with more debt are called hybrid conservative funds (earlier called MIP or debt-oriented funds). Over the last few years, a new type of hybrid funds have gained popularity. These hybrid funds employ derivative instruments, like futures and options, to hedge their portfolio, instead of using debt. The hedged portion of the portfolio essentially acts as debt, allowing the fund to lower the risk. At the same time, the unhedged portion generates higher returns. Essentially they are equity-oriented in their portfolio but come with risks similar to debt-oriented funds.
So hybrid low risk funds can be classified as under:
While all of the above seek to reduce volatility, they achieve this in different ways. Conservative hybrid funds invest a maximum of 25% of their assets in equity and the remaining goes into debt. Equity savings and balanced advantage funds, on the other hand, typically invest at least 65% of their holdings in equity and hedge a part of it using derivative instruments. Some portion is also invested in debt.
Volatility and downside containment
The general theory that debt reduces risk in a portfolio is true of hybrid conservative funds as well. This category of funds appears to be marginally better than equity savings funds in containing downsides. The standard deviation of monthly rolling returns over a 3-year period, is slightly lower for conservative hybrid funds as compared to equity savings funds (4.1 vs. 4.7). Given the higher equity exposure of balanced advantage funds, it is no surprise that their annualised risk is highest at 6.7. However, the median probability of getting negative returns on a 1-month basis is pretty much the same for conservative hybrid and equity savings funds at a little over 25%. It slightly higher in balanced advantage funds at 30%.
On a rolling 1-year basis though, conservative hybrid funds fare much better than their equity counterparts. The median downside probability of the category is a mere 0.3% while those of equity savings and balanced advantage funds are 2.4% and 8.3% respectively. The extent to which conservative hybrid funds can fall is also lower. The worst 1-year return by a conservative hybrid fund was -6.3% (-4.1% if we ignore funds affected by the IL&FS crisis), whereas those of equity savings and balanced advantage were -6.5% and -10.2% respectively.
The general theory that debt reduces risk in a portfolio is true of hybrid conservative funds as well. This category of funds appears to be marginally better than equity savings funds in containing downsides. The standard deviation of monthly rolling returns over a 3-year period, is slightly lower for conservative hybrid funds as compared to equity savings funds (4.1 vs. 4.7). Given the higher equity exposure of balanced advantage funds, it is no surprise that their annualised risk is highest at 6.7. However, the median probability of getting negative returns on a 1-month basis is pretty much the same for conservative hybrid and equity savings funds at a little over 25%. It slightly higher in balanced advantage funds at 30%.
On a rolling 1-year basis though, conservative hybrid funds fare much better than their equity counterparts. The median downside probability of the category is a mere 0.3% while those of equity savings and balanced advantage funds are 2.4% and 8.3% respectively. The extent to which conservative hybrid funds can fall is also lower. The worst 1-year return by a conservative hybrid fund was -6.3% (-4.1% if we ignore funds affected by the IL&FS crisis), whereas those of equity savings and balanced advantage were -6.5% and -10.2% respectively.
It is mostly clear that even after considering the debt crisis, debt-oriented hybrid funds have a lower risk. But does the higher risk of equity funds translate into higher returns as well?
1-year returns from debt oriented hybrid funds have gone as high as 25.1% during the past 3 years, while those of balanced advantage funds have gone up to 40.3%. The category average of 1-year rolling returns for the last 3 years shows balanced advantage funds in the lead.
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