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How Hybrid Funds Help Ride Market Volatility: 3 Things You Must Know

As concerns over elevated inflation and global economic uncertainty continue amid geopolitical tensions, hybrid funds can prove a potent arsenal against stock market volatility

November 18, 2023
November 18, 2023
Hybrid funds amid market volatility

Hybrid funds amid market volatility

India’s stock markets continue to see a robust growth momentum, thanks to the growing interest of investors and a surge in capital inflows. However, there may not be much action on the Reserve Bank of India’s (RBI) repo rate front, which impacts returns, as concerns over elevated inflation, geopolitical tension, and a global slowdown still loom, at least not until the second half of 2024 when the general elections would be over, which will likely keep the market volatility. 

Given these adverse conditions, hybrid funds could be one of the ways for investors to beat volatile markets, especially senior citizens whose risk-taking ability significantly declines at that age. Hybrid funds invest in a combination of equity and debt instruments, typically in a 60 and 40 per cent ratio, thus providing a better chance to withstand market volatility. 

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How Do Hybrid Funds Work?

 

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Hybrid funds combine equity and bond components and sometimes money market instruments in a single portfolio, which could be either a moderate to higher equity component or a conservative or higher fixed-income segment. While equity provides higher growth, debt acts as a shock absorber against any downturn. So, hybrid funds can suit individuals looking for safety, income, and modest capital appreciation. 

 

Says Ajit Menon, CEO of PGIM India Mutual Fund: “Being exposed to just one asset class can be good at some points and bad at other points in a cycle. Since it is humanly impossible to time the ups and downs, it would be better for an investor to invest in a hybrid fund that has both asset classes in a proportion that provides better stability against ups and downs.”

 

How Do Hybrid Funds Help Beat Volatility?

 

Since hybrid funds combine debt and equity assets, the debt or the fixed-income component provides a cushion against volatility, significantly reducing the overall risk. Fixed income or interest-bearing investments usually do not fluctuate with market ups and downs and keep up with the market volatility, although investors should be mindful of interest and credit risk in poorly rated debt instruments. 

 

Menon says, “Hybrid funds like the balanced advantage funds (BAF) have an in-built mechanism to tweak the allocation between equity and debt based on factors, such as long-term average price-to-earnings ratio (P/E), and other economic indicators.” 

 

He explains, “When valuations turn expensive, the BAF model reduces equity exposure. Similarly, when valuations are attractive, the model increases equity exposure. This codifies the ‘buy low, sell high’ principle of investing and helps an investor to cut down risk and maintain an optimal level of asset allocation required to shield the portfolio from downside and at the same time participate in the upside of equity.”   

 

Choose As Per Your Needs

 

The Securities and Exchange Board of India (Sebi) classifies hybrid funds into conservative, balanced, aggressive, dynamic, multi-asset, arbitrage, and equity savings. Each of these funds follows a distinct strategy for allocating debt and equities in the portfolio based on their risk-reward framework and financial objectives. So, investors can choose them as per their needs. 

 

Says Menon, “Investors with an investment horizon of less than one year to a year may consider arbitrage funds, which carry relatively low risk. For investments of above one year to three years, a hybrid conservative fund which has approximately 25 per cent equity could work. For periods above three years, an equity savings fund that can take a maximum exposure to equity of 40 per cent would be helpful.” 

 

Furthermore, he adds, “Investors with an investment horizon of three years and above can consider hybrid aggressive or balanced funds. Balanced and multi-asset funds can be a core part of longer-term goals for conservative and risk-averse investors.” 

 

So, for investors, including first-time or risk-averse individuals, hybrid funds can be an excellent option to enter the stock market. These funds will also suit those who want to leave the asset allocation decision with the fund managers.

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