SEBI norms allow fund houses to offer six variants of hybrid funds. However, most fund houses are active on two variants – aggressive hybrid funds and balanced advantage funds. Both the fund categories have the potential to deliver returns at par with a few categories of equity funds with a higher degree of safety because of their debt exposure; yet these funds have not met the expectations of many investors over the past few years.

Let us look at both these categories one-by-one.

Aggressive hybrid funds

Earlier known as balanced funds, aggressive hybrid funds can invest 65%-80% of their corpus in equity instruments. Over the long term, this category is expected to give returns at par with multicap funds with a lower volatility. The advantage cited is that the debt component (20% to 35% of the portfolio) cushions the fund in a falling equity market. Though the overall portfolio would gain less in a bull equity market, returns are expected to even out by virtue of losing less in a bear market.

Aggressive hybrid funds category has delivered CAGR of 9.1% in three years and 7.2% in five years as on January 03, 2020. We can compare these funds with multicap funds and ELSS as the fund managers do not have restriction to follow market capitalization in hybrid aggressive funds as well.

Multicap funds have delivered CAGR of 12% in three years and 8% in five years, higher than aggressive hybrid funds. Similarly, ELSSs have  delivered 11.8% in three years and 8% in five years.

Balanced advantage funds

In BAF, a portion of the equity component, say 80% of the portfolio is hedged by taking contra positions in stocks. The extent of hedging is decided by the fund manager. The difference between hybrid funds and BAF Funds is that in the former, 65% to 80% is in open (i.e. unhedged) equity whereas in BAF, net of hedging i.e. the effective equity exposure is lower. This lower cushions the impact in volatile equity market phases.

The CAGR return from a basket of 20 BAF funds is 9.2% and 7% in three years and 5 years respectively. Clearly, the returns are lower than that of multicap funds and ELSS.

Conclusion

Focussed allocation to equity and debt funds has an advantage of simplicity and clarity. Once you decide asset allocation of your clients, you may allocate to large cap / mid cap / small cap in equity, which is not possible with hybrid funds. Similarly, in debt, you may allocate to long duration or short duration depending on your clients risk appetite, which is also not possible with hybrid funds.

Source:  https://cafemutual.com/news/guestcolumn/440-why-it-makes-sense-to-shun-hybrid-funds