Types of Asset Allocation / Hybrid Funds

  1. Aggressive Hybrid Funds
    These funds have a static asset allocation strategy with the flexibility to keep its asset allocation within prescribed ranges mandated by SEBI. SEBI requires these funds to invest 65 – 80% of their assets in equity or equity related securities and rest in money market or debt securities. Aggressive hybrid funds follow a rigorous rebalancing process to keep their asset allocations within the prescribed limits. It follows a process to buy low and sell high and rebalance its asset allocation. As per our tax laws, mutual fund schemes which invest 65% or more of their assets in equity and equity related securities enjoy equity taxation.

  2. Equity Savings Fund Equity savings fund essentially aims to generate returns by investing in equity, debt and arbitrage opportunities. This last component sets them apart from other hybrid funds. Essentially, the fund manager looks to exploit the pricing inefficiencies in the cash and derivatives segments of the equity market. Thus, the fund's overall equity exposure is partially hedged, reducing its volatility as compared to an aggressive hybrid fund, where the equity exposure is fully unhedged.

  3. Dynamic Asset Allocation Funds These hybrid funds also known as balanced advantage funds, dynamically manage their equity and debt allocations. SEBI has no asset allocation limits for these funds; theoretically, they can invest 0 – 100% in equity or debt. Different fund managers use different valuation metrics for dynamic asset allocation, the most common being P/E and P/B ratios. The taxation for these funds can be impacted if the allocation to equity and equity related instruments is less than 65%.

Summary Points

Let us take an example to show market value (at the end of 2019) of Rs 1 lakh investment made in 1998 for different asset allocations with annual asset allocation rebalancing to the target asset mix. You can see that the maximum wealth creation has taken place in 70% equity and 30% debt asset mix.

Source: Advisorkhoj, 31st December 2019 (Nifty 50 as the proxy for equity and Nifty 10 year G-Sec Index as the proxy for debt.)

This analysis has several important lessons for investors:-

  • The asset mixes in the above analysis gave double digit returns over the 20 year period. This shows that you can beat inflation with asset allocation.
  • While risk and return are related, you need not take excessive risk to get the best results in terms of wealth creation.
  • With asset allocation it is possible to balance risk and return to get superior absolute returns.
  • The most optimal asset mix has been around 70% (equity). Hence from a long term perspective investors can look at Aggressive Hybrid Funds as suitable investment options.

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