Two categories of hybrid mutual funds offer a 16% return over three years. Is it time to restructure the portfolio?

Two categories of hybrid mutual funds: aggressive hybrid funds and multi-asset allocation funds – have offered an average return of around 16% over the last three years. These plans offered a return of up to 24% over the said period.

Aggressive hybrid funds returned an average of around 15.41 per cent over the past three years. JM Aggressive Hybrid Fund, the best in the category, returned 24.43 per cent over the same period, followed by ICICI Prudential Equity and Debt Fund, which returned 23.15 per cent. PGIM India Hybrid Equity Fund returned the lowest of around 9.41 per cent over the same period.

Multi-asset allocation funds returned an average of around 15.58% in the above-mentioned period. Quant Multi Asset Fund, the best and oldest in the category, returned 22.33% in the last three years. ICICI Prudential Multi-Asset Fund, the largest fund in the category in terms of assets under management, returned 22.02%. Motilal Oswal Multi Asset Fund returned the lowest at around 8.28%.

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The question now arises: what factors contributed to this performance?

Aggressive hybrid funds

“The performance of aggressive hybrid funds has been driven by several key factors. First, robust growth in equity markets has played a major role as these funds typically allocate over 70% of their assets to equities against the minimum requirement of 65%, allowing them to benefit from the bullish market momentum. Second, strategic investments in mid-cap and small-cap stocks have significantly boosted returns. Moreover, effective stock selection and smart debt management have further improved the overall performance of these funds, enabling them to outperform the benchmarks,” said Sagar Shinde, Vice President, Research, Fisdom.

Another expert believes that the growth in the equity markets and the fact that the Sensex index has gone up from 25,000 in March 2020 to 80,000 at present have helped these funds to deliver better returns. Also, the rise in interest rates has helped improve the profitability of the debt component.

“The performance of aggressive hybrid funds has been very good over the last three years as equities, which account for a minimum of 65% in this category, have performed very well post-pandemic. The broader large-cap index like the Sensex was around 25,000 in March 2020 and is now at 80,000. Also, rising interest rates have helped in getting better returns for the debt component in aggressive hybrid funds,” said Rajesh Minocha, Certified Financial Planner (CFP), Founder, Financial Radiance.

Multi-asset allocation funds

“Multi-asset allocation funds also hold commodities, apart from debt and equity. The current cycle has been unusual as gold prices have also risen during this period along with the rise in equity and debt. Generally, equity and gold are inversely related as we saw during the pandemic, but now gold prices have also risen considering the global geopolitical situations and the weakening of the rupee against the dollar,” Minocha mentioned.

“The strong performance of the multi-asset category can be attributed to several key factors. First, the diversified asset allocation within these funds, which typically includes a mix of stocks, bonds and other asset classes such as commodities or real estate, has allowed them to capitalise on positive trends across different markets. For instance, the simultaneous rally in equity markets and gold prices has significantly boosted returns,” Shinde said.

He added that “in addition, the ongoing economic normalisation post-pandemic has created a more conducive environment for these funds as growth and inflation rates are beginning to stabilise. Moreover, fund managers have effectively improved performance by dynamically adjusting portfolios in response to various market conditions such as geopolitical events, potential interest rate cuts and changes in valuations, thereby optimising returns in a volatile environment.”

Speaking of the taxesAggressive hybrid funds are taxed as equity funds, while multi-asset allocation funds are taxed as debt funds.

In the announcement of the union budget, there was an increase in capital gains tax for capital mutual fundsShort-term gains on specific financial assets were changed to 20% from 15%. Long-term gains on all financial and non-financial assets were changed to 12.5% ​​from 10%.

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Following the change in the tax structure, which category should investors choose at this time?
“While most multi-asset allocation funds are taxed as debt funds, there can be funds that are taxed as equity funds. They could invest in arbitrage to qualify for capital taxation. Capital taxation is an advantage for those in the 30% and above tax bracket as the maximum tax would be 20% for less than one year of holding and 12.5% ​​for more than one year of holding. There is no tax on long-term capital gains up to Rs 1.25 lakhs per annum. However, in case of debt-based taxable funds, the tax structure will now be based on the tax bracket, more so as the indexation benefit has also been done away with in the latest budget,” advises Rajesh Minocha.

The other expert recommends that the decision to choose the right category for investment should be based on the investor’s financial objective, with taxes being a secondary consideration rather than the primary factor.

“Investors should prioritise their investment objectives and risk tolerance rather than focusing solely on tax implications when choosing between aggressive hybrid and multi-asset allocation funds. For those looking to diversify across multiple asset classes (such as REITs, gold, silver, international equities, domestic equities and debt), multi-asset allocation funds are a suitable option. While some multi-asset funds are taxed as debt, it is important to note that some, such as those offered by ICICI and many others, are taxed as equity, so investors should check the specific tax treatment of the fund they are considering,” advises Shinde.

“Aggressive hybrid funds are best suited for investors who want greater exposure to domestic equities while maintaining some allocation to debt. These funds, taxed as equities, offer a tax advantage for long-term investors, but offer less flexibility in asset allocation compared to multi-asset allocation funds. Therefore, the decision between these two categories should be guided by the financial objectives of the investor, with taxation being a secondary consideration rather than the primary deciding factor,” he added.

In the last one year, aggressive hybrid funds and multi-asset allocation funds have offered an average return of around 30.80% and 25.67% respectively. These schemes gave returns of up to 50.97%, which was offered by JM Aggressive Hybrid Fund, an aggressive hybrid fund.

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Given the current performance, are you willing to invest in these categories? What is the outlook for these funds?
An expert recommends that the outlook for both categories is positive, mainly due to strong macroeconomic factors in India. He also says that as the Indian economy continues to show resilience and growth, equities as an asset class are expected to perform well, which will benefit both categories of funds.

Aggressive hybrid funds

“Aggressive hybrid funds are likely to benefit from this growth due to their significant exposure to domestic equities. These funds are expected to generate strong returns in a favourable equity market environment. However, they may experience higher volatility as they are primarily focused on equities with a lower allocation to debt,” Shinde said.

“The outlook for aggressive hybrid funds is good if the investor has a time horizon of less than 3 or 4 years. This investment should not be exclusively allocated to equity funds, as it will be subject to market risk. However, the investor should choose this category based on their risk appetite; otherwise, there are funds such as balanced advantage funds or dynamic asset allocation funds that can also have the same structure, but the composition between equity and debt is dynamically managed by the fund manager,” says Minocha.

He also added: “Returns in these categories, whether aggressive hybrids or dynamically managed, are very high at the moment and investors should moderate their return expectations as the euphoria in the markets settles. This type of return will continue to be very good, as it could comfortably outperform post-tax inflation, for such short-term products, compared to other financial products available on the market.”

Multi-asset allocation funds

“On the other hand, multi-asset allocation funds also benefit from the positive outlook for equities, but with the added advantage of reduced volatility. This is because these funds diversify their investments across multiple asset classes such as gold, debt and sometimes real estate, international equities in addition to domestic equities. Flexibility in asset allocation allows fund managers to dynamically adjust the portfolio, which helps smooth out volatility that could affect more equity-weighted funds such as aggressive hybrid funds,” Shinde said.

Minocha said: “Multi-asset allocation funds have good future prospects and offer good diversification across at least three asset classes for the investor over such short time horizons. However, the returns currently experienced by investors are unrealistic and the purpose of diversification is lost. All asset classes in this category have been rising and the correlation between them is not negative.”

He also mentions: “We should see a rationalisation of returns in this category, but it will still be a superior product compared to other financial products for this time horizon. We may see lower returns compared to equity funds in a bull market scenario, but its importance for diversification should not be dismissed as we will see its importance in bear markets.”

(Disclaimer:The recommendations, suggestions, views and opinions of the experts are their own and do not represent the views of The Economic Times.

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