BAFs help first-time investors gain some experience in equity
Over the past one year, AHFs have delivered an average return of around 50%, while BAFs are up around 30% on average, as per data available with Mutual Funds India.
A fundamental difference between AHFs and BAFs is the flexibility of equity allocation. Hybrid funds follow a static allocation in a narrow range between equity and debt—65-80% in equity and 20-35% debt—versus dynamic funds, where equity allocation swings between 30% and 80%, depending on the market conditions.
Stock markets have seen a V-shaped recovery since the plunge in March 2020 largely fuelled by the twin boosters of very high global liquidity and policy response (both monetary as well as fiscal). The other aspect driving markets is the expected revival in corporate profits over the financial year 2022-24. This meant that funds with a higher allocation to equity would automatically benefit and score over funds operating on certain models, which guide the equity allocation levels.
“Most dynamic funds in the category have had lower allocations to equity principally due to rich valuations. While equity allocations in dynamic funds were lower as compared with aggressive hybrid funds, they had higher allocations to debt. Now, the returns generated from the debt portion were also subdued due to low single digit returns from good quality bonds,” said Umang Thaker, head of products at Motilal Oswal Asset Management Co. Ltd.
However, despite this, AHFs have witnessed outflows over the past few months. In May, as per the Association of Mutual Funds in India (Amfi) data, the combined balanced hybrid fund and aggressive hybrid fund category saw a net outflow of ₹435 crore, while the BAF/DAAF category received net inflows of ₹1,363 crore.
This has created confusion in investors as to which category to pick.
According to Bhavana Acharya, co-founder, PrimeInvestor.in, a mutual fund research portal, these two funds are not comparable. “Aggressive hybrid funds will have about 70-75% in pure equity. So, the entire 75% is open to market fluctuations. When the markets correct, these funds are going to fall much more than balanced advantage funds,” she said.
The balanced advantage funds will have some portion of funds that are hedged. How much that hedged component is, depends on the fund.
“A fund with no hedging will be similar to an aggressive hybrid fund. So, the primary difference between AHF and BAF is that, aggressive fund will fall more, and if market rises, it will rise more. This is the first risk an investor should be aware of,” added Acharya.
In terms of taxation, aggressive funds are treated similar to equity funds and long-term capital gains (LTCG) of more than ₹1 lakh are taxed at 10% without indexation, while short-term capital gains (STCG) are taxed at 15%.
In case of BAFs, capital gains are taxed based on the orientation of the fund. Equity-oriented funds are taxed just like equity. If a balanced fund is oriented like a debt fund, STCG is added to the income and taxed as per the income tax slab, while LTCG is taxed at 20% after indexation and 10% without the benefit of indexation. In practice, most BAFs are positioned in a way that gets them equity taxation.
So, which category of fund will be better suited for investors when it comes to short-term investment horizon, given pricey equity valuations, and risks of inflation looming?
“Dynamic funds offer an added advantage of flexibility to manoeuvre as per market conditions. Given the worries around elevated valuations and inflation risks, dynamic funds would be better positioned to adjust allocation in case of a sharp correction. As such, dynamic funds are better suited to protect downside and hence generate better risk-adjusted returns,” said Thaker.
According to experts, one cannot say with certainty which category will outperform, but from the perspective of fresh allocation at this stage, one should consider dynamic funds over aggressive hybrid funds.
Moreover, financial planners are of the view that BAFs score over AHFs. One key drawback of aggressive hybrid fund is that they come with higher expense ratio on the debt allocation.
“If investors can do asset allocation themselves, it always better to have a debt and equity portion defined separately by themselves. That is the most ideal way to manage asset allocation. But most people don’t have that level of sophistication. So, hybrid funds have been created out of a need for allocation,” said Tarun Birani, founder, TBNG Capital, a Sebi-registered investment adviser.
For any first-time investor, a balanced advantage fund could be a good way to build some experience around equity. Also, for a retired investor, DAAF is a good choice, as it provides rebalancing on a regular intervention.
Birani said a conservative investor can have at least 30-35% of a portfolio in a dynamic allocation fund, while an aggressive investor should not look at DAAFs. A sophisticated investor should rather go for pure equity and pure debt funds.
“The advantage here is that investors get different types of market cap exposure and investing styles, like they can have growth and value themes, and on the debt side, they can have short-term fund and a corporate debt fund. Variety in this type of portfolio will be more,” said Acharya.
However, if investors don’t have much amount to build a diversified portfolio or are beginners, then the aggressive hybrid will work, because it will be less risky than just pure equity fund.
While choosing a BAF, an investor should look at how much of the portfolio is hedged and how much is open within each fund. Investors should also note that in a dynamic allocation the extent of hedging will keep on changing from month to month and from fund to fund. When it goes to choosing between them, it always goes to what purpose you are investing for and the time frame.
While in AHFs, one needs at least 3-4 years of holding and they can’t use it for short-term goals, BAF can’t be substitute for debt, and they can be used for improving returns.
BAFs are preferred as they are better equipped to arrest drawdown. Investors should evaluate categories based on the risk-return trade-off. Past returns should not be the only criteria as that is likely to change with time.
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