Case Against Hybrid Mutual Funds

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Hybrid mutual funds have industry-wide assets under management (AUM) of INR 4.70 Lakh Crore. Hybrid funds (HF) invest in a mix of equity & debt (& gold in a few funds). In conservative HF, equity allocation is between 20-40% whereas, in an aggressive HF, equity allocation is between 65-85% and the rest is in debt. Many consider HF a safer way of investing in mutual funds, especially when equity markets are quite expensive.

Despite its popularity, we think HF should be avoided. Instead, you should invest separately in the best available options in pure equity funds and pure debt funds across mutual fund companies and create your own hybrid investment portfolio depending upon your risk profile. For example, if you are a conservative investor, allocate 20-30% in pure equity funds and the rest in pure debt funds. There are 3 important reasons:

1. Lack of choice: When you invest in an HF of a particular fund house, your investments are managed by the debt and equity team of the same fund house. There is a possibility that either the equity team or debt team is not the best in the industry. By creating your own asset allocation, you can select the best-performing equity fund management team and best-performing debt fund management team from different mutual fund companies which increases your overall returns. Also, at the time of redemption, you can choose to redeem from the equity portion or from the debt portion. Investing in an HF doesn’t give you the option to redeem from the asset class of your choice.

2. Lack of transparency: There is a lack of transparency on a day-to-day basis regarding your equity & debt exposure. When you invest separately in pure equity and debt funds, you are in better control to align the overall asset allocation suitable to your risk profile.

3. Expense Ratios: Usually expense ratios are higher for equity funds compared to debt funds. In an HF, you end up paying the expense ratio of equity funds even on the debt portion. By investing separately, the overall expense ratio goes down thus increasing your returns.

4. Taxation: Equity long-term capital gain tax is 10% after 1 year and for debt also it is ~10% after 3 years due to indexation benefit. If redeemed before 3 years, capital gains on the debt fund are as per the tax slab. Investment in any scheme with equity exposure should ideally be for more than 3 years. Hence, the tax advantage is not a meaningful factor for investing in an HF.

The only case for investing in an HF is in balanced advantage funds (which have wider ranges for equity allocation across market cycles) when you are too busy and do not have a reliable fee-only investment advisor to help you with asset allocation and are content with mediocre returns.

The known wisdom has been that you should never mix investment with insurance. The next known wisdom would be not to mix different asset classes in the same fund.

Truemind Capital is a SEBI Registered Investment Management & Personal Finance Advisory platform. You can write to us at connect@truemindcapital.com or call us at 9999505324.