Bet on hybrid funds to contain portfolio volatility, suggest market experts

Inexperienced investors, in particular, should take refuge in the balanced advantage category, which invest in a mix of equity, debt and arbitrage opportunities

The Indian equity market has turned bipolar, with the Sensex (a large-cap index) up around 7 per cent year-to-date (YTD), while the BSE Mid-cap and BSE Small-cap are down around 14 and 18 per cent respectively. Many investors who entered the markets within the last one year or so and invested primarily in mid- and small-cap funds, have seen their portfolio values get eroded sharply. The outlook for the equity and debt markets are no longer as sanguine as they were in 2017. Interest rates are on the upswing in the West, prompting a withdrawal of funds by financial institutional investors (FII) from both the Indian equity and debt markets. High oil prices are hurting India's macro indicators. With the general elections due in April-May 2019, political uncertainty hovers over the markets. On the positive side, earnings are expected to improve. Due to all these factors, leading market experts are currently advising investors, especially the less experienced ones, to opt for more defensive categories funds that can cope with volatility well, such as balanced advantage funds.            

The total assets under management of this category equalled Rs 697.63 billion at the end of June this year, up 133 per cent since December 2017, attesting to the growing popularity of this hybrid category.

Balanced advantage funds invest in a mix of equity, debt and arbitrage opportunities. They are less volatile than aggressive hybrid funds (popularly known as balanced funds), which maintain a 65-100 per cent allocation to equities, and 0-35 per cent to debt instruments. Balanced advantage funds decide their equity exposure based on market valuations, measured by either price to earnings ratio, price to book value, etc. As valuations within the equity markets go up, these funds reduce their exposure to equities, and as valuations go down they increase exposure to equities. This means that when a bull run ends, these funds are not hurt badly since they have already reduced their equity allocation. "Balanced advantage funds are suitable for all kinds of investors as they reduce volatility through asset allocation," says Nilesh Shah, managing director, Kotak Mahindra Asset Management. ­      

When allocation to equities falls below 65 per cent, these funds increase exposure to the arbitrage component. Thus, together the equity and the arbitrage components always constitute 65 per cent or more of the portfolio, making these funds eligible for equity-like tax treatment. For instance, if during a bull run the equity exposure of these funds falls to 40 per cent, then the arbitrage component rises to at least 25 per cent. Investment in arbitrage instruments reduces volatility in the portfolio.

According to Shah, investors betting on these funds should maintain an investment horizon that extends from bull cycle to bull cycle or from bear cycle to bear cycle. "These funds are suitable for lump sum as well as SIP investment, and they are suited for first timers as well as seasoned investors," he adds.

Funds sorted based on weighted average returns with 50% weight to 5-year, 30% to 3-year, and 20% to 1-year return.  Source: Ace Mutual Fund