Interest rates are at a multi-year low and are treading at an uncertain path due to the risk of an uptick in inflation on one hand and the need to keep interest rates low, to sustain growth on a durable basis amidst the pandemic, on the other. Given the uncertainties, generating higher returns from debt funds may not be easy. In this scenario, adding an 'equity push' to the portfolio can help you to outperform pure debt investments.
If you are looking to earn better returns than debt funds but want to avoid the risk element of investing in pure equity funds, you can consider investing in a Conservative Hybrid Fund. These funds are more inclined towards debt instruments and come with a small equity allocation to boost returns when compared to pure debt schemes.
The hybrid strategy of conservative hybrid funds can help you benefit from the growth in equity and debt asset classes and contain the risk during volatile market conditions. However, since market conditions are expected to remain volatile, avoid investing in the category with a short term view.
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What are Conservative Hybrid Funds?
Conservative Hybrid Funds, also known as Debt Hybrid Funds, are mandated to invest 75% to 90% of total assets in debt instruments, along with 10% to 25% of total assets in equity & equity related instruments. The debt portion of their portfolio intends to provide safety and stability of regular income from coupon payments, whereas the equity portion has the potential of generating extra income through dividends along with capital appreciation over a period.
The debt investment of conservative hybrid funds can be spread across durations and credit profile, while the equity portion can range across market capitalisation and sectors.
Most Conservative Hybrid Funds tend to have a predominant exposure towards medium to longer duration debt instruments along with significant equity component and are therefore volatile in nature.
Investors having moderate to high-risk appetite, with an investment horizon of at least 3 years or more looking to earn better returns than pure debt schemes can consider investing in this category of funds. Keeping a longer horizon of over 3 years will ensure you get the indexation benefit on Long Term Capital Gains, thus improving your post-tax returns.
Table: Performance scorecard of Conservative Hybrid Funds
Data as on May 06, 2021
(Source: ACE MF)
*Please note, this table only represents the best performing Conservative Hybrid Fund based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing
Scheme selection plays an important role while investing in a conservative hybrid fund because each fund has the flexibility to follow a different duration strategy, credit profile, as well as equity allocation.
Some conservative hybrid funds may expose you to high risk if they have higher exposure to medium to low-rated debt securities. Despite instances of rating downgrades and defaults in the past some funds continue to hold lower credit quality papers. Be wary of such funds.
Moreover, investors should be prepared for higher volatility in the short term.
Best Conservative hybrid funds to invest in 2021:
Some of the best performing conservative hybrid fund based on our analysis and research at PersonalFN that fare well on both quantitative and qualitative parameters are as follows:
These funds have shown superior performance and consistency in terms of returns and have adequately compensated its investors for the level of risk taken by focusing on high-quality instruments.
Here are the parameters to look into while selecting the best Conservative Hybrid Fund
Quantitative parameters
Check whether the fund has a decent track record of delivering adequate and stable returns across time horizons when compared to the category average and the benchmark index. The fund should be able to take active and timely duration calls to reduce interest rate risk.
Furthermore, the fund should be able to justify the returns by generating competitive risk-adjusted returns for its investors. To determine whether the fund has rewarded its investors well for the risk they have taken, assess risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 2-year period.
So when you are shortlisting funds for your portfolio, give preference to those funds that stand strong on risk-reward parameters.
Qualitative parameters
The fund should be well-placed to determine the general maturity range for the portfolio after considering the interest rate outlook based on the economic environment (inflation, government's borrowing plan, fiscal deficit, etc.), the performance of the corporate sector, general liquidity situation, and so on.
Ensure that fund resists taking high credit risk by limiting exposure to moderate and low-rated securities and makes optimal use of portfolio diversification to mitigate risk. If your preference is safety over returns, you should consider funds primarily focusing on Government and Quasi-government securities. Avoid funds that have higher allocation to papers issued by private units.
For the equity portion, check the respective allocation of the fund in each market cap. If the fund has higher allocation to large caps it can provide stability to the portfolio and steady growth of capital. Whereas, a fund having substantial exposure to mid-cap and small-cap stocks can prove to be risky though they have high return potential.
The fund's portfolio should be well-diversified across securities issued by various companies and group of companies. Remember that a concentrated portfolio can expose you, the investor, to higher risk. Additionally, keep a tab on the expense ratio of the fund. Additionally, since the performance of a Conservative Hybrid Fund depends on the fund manager's ability to accurately and timely gauge the interest rate movement and keep a check on the credit risk, determine the qualification, experience, and track record of schemes they manage.
Most importantly, always give higher importance to fund houses that follow robust investment processes and systems along with sound risk management techniques in place.
Watch this short video on selecting mutual fund schemes:
At PersonalFN, we select and recommend mutual funds based on quantitative and qualitative parameters using our S.M.A.R.T Score Matrix:
S - Systems and Processes
M - Market Cycle Performance
A - Asset Management Style
R - Risk-Reward Ratios
T - Performance Track Record
The outlook for Conservative Hybrid Fund in 2021:
The massive surge in Covid-19 cases across the country due to the second wave has pushed total active cases beyond the 36-lakh mark. The lockdown-like restrictions in many parts of the country has hit various economic activities. With this the ability of businesses to return to normalcy on a sustained basis will be questionable. This may even increase the chances of defaults and bad loans by private corporates. In conditions like this focus should be on debt-oriented funds that look for safety rather than higher yields.
Furthermore, the government's borrowing plans, India's already high debt-to-GDP, and higher fiscal deficit (which could prove inflationary) are concerning; it may push bond yields up over a period. As you may be aware, bond prices and yields are inversely related. A surge in yield will impact bond prices negatively, thus causing a loss to the investors' value.
Therefore, going forward, debt securities, having exposure to longer maturity instruments, may be highly volatile going forward; while those focusing on shorter maturity instruments and following an accrual strategy may be still better-placed to tackle the interest rate risk.
Meanwhile, the equity market too is witnessing high volatility though it continues to trade at higher levels. Due to uncertainties about corporate earnings growth amid the second wave of COVID-19 the equity market valuations seems expensive and thus the margin of safety has narrowed. Therefore, equity market volatility may persist and we may witness some further consolidation in the near term till the pandemic situation is under control.
Various high-frequency economic indicators are already showing signs of slowdown. It is likely that the reading for the ensuing few quarters could slip back into a contraction, which means we could see a sort of 'W-shaped' recovery, where we would dip again before moving up.
Therefore, investors must adopt a cautious investment approach to deal with market volatility. Ensure that you stagger your investment via SIP and have a long term investment horizon of 3 years or more when you invest in conservative hybrid funds.
PS: If you are looking for quality mutual fund schemes to add to your investment portfolio, I suggest you subscribe to PersonalFN's premium research service, FundSelect. Currently, with the subscription to FundSelect, you could also get Free Bonus access to PersonalFN's Debt Fund recommendation service DebtSelect.
Under DebtSelect, we give high weightage to schemes displaying worthy portfolio characteristics. We avoid debt mutual fund schemes that aim for higher yields by taking undue higher credit risk with substantial exposure in instruments issued by private issuers.
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Warm Regards,
Divya Grover
Research Analyst
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