Aggressive Hybrid Funds: Reducing constant Rebalancing
Introduction
Investing in hybrid mutual funds can be a good option for those looking for a balanced approach to wealth creation. These funds invest in a mix of equity (stocks) and debt (bonds), offering both growth potential and stability. The equity portion aims to provide higher returns over the long term, while the debt portion helps reduce risk and provides regular income. Hybrid mutual funds are suitable for investors who want diversification without having to manage individual stocks and bonds. They are ideal for those with a moderate risk appetite, looking for a combination of capital appreciation and income generation.
Hybrid mutual funds come in different types, each designed to suit varying investment goals and risk preferences. The most common types include:
Balanced hybrid funds, which allocate around 60-70% in equities and the rest in debt, offering a mix of growth and stability.
Aggressive hybrid funds invest a larger portion, typically 65-80%, in equities, making them more suitable for investors with a higher risk tolerance who seek higher returns.
Conservative hybrid funds, on the other hand, focus more on debt, with around 65-80% in bonds and the rest in equities, catering to those who prefer stability and lower risk.
Dynamic asset allocation funds adjust their equity and debt allocations based on market conditions, providing flexibility and aiming to minimize risk during volatile periods.
Each type of hybrid fund allows investors to balance risk and return based on their financial goals and risk appetite. It's important to assess your investment goals, time horizon, and risk tolerance before investing.
In this blog, we will cover Aggressive Hybrid Funds and their characteristics
What Are Aggressive Hybrid Funds?
Aggressive Hybrid Funds are a unique category of mutual funds that blend investments in both equity and debt markets. According to the guidelines set by the Securities and Exchange Board of India (SEBI), these funds allocate 65% to 80% of their portfolio to equities, aiming for higher growth potential. The remaining 20% to 35% is invested in debt instruments like government bonds, corporate bonds, and other fixed-income securities. This combination allows the fund to take advantage of equity market growth while offering some protection against market fluctuations through the stability of debt investments. Also, these funds are taxed as equity in the hands of investors.
The main goal of an Aggressive Hybrid Fund is to deliver superior long-term returns through exposure to equities while minimizing risk through a more conservative allocation to debt instruments. The funds invest in only high quality bonds (AAA rated) for safety. This unique combination makes Aggressive Hybrid Funds an attractive option for investors looking for a higher risk-reward ratio, without completely exposing themselves to the full volatility of equity markets.
How Aggressive Hybrid Funds Work
Aggressive Hybrid Funds function by maintaining a diversified portfolio, which allows them to strike a balance between risk and return. The equity portion of the fund aims to generate capital appreciation over time, while the debt portion provides a steady stream of income and helps stabilize the overall performance of the fund.
Equity Allocation (65% to 80%): The equity allocation is designed to capture the growth potential of the stock market. By investing in a diversified mix of large-cap, mid-cap, and sometimes small-cap stocks, these funds benefit from the long-term potential of the Indian and global equity markets.
Debt Allocation (20% to 35%): The debt portion adds stability to the portfolio. It acts as a buffer during market downturns, providing regular income and reducing the overall volatility of the fund’s performance. This portion can include bonds, government securities, and other fixed-income instruments that are relatively less risky than equities.
This strategic asset allocation helps to balance the risk and return potential, making Aggressive Hybrid Funds a good option for investors who have a moderate to high-risk tolerance but want some degree of safety and stability in their investments.
Why Invest in Aggressive Hybrid Funds?
Balanced Growth with Stability: Aggressive Hybrid Funds provide exposure to both equities and debt instruments, allowing for growth potential from the stock market while offering some stability through safer, fixed-income investments. This balance helps reduce the impact of market volatility.
Diversification: These funds automatically diversify investments across different asset classes—equities and fixed-income securities—helping to spread risk and minimize the potential negative effects of concentrating on a single asset type.
Best Suited for Long-Term Goals: With a typical investment horizon of 7-10 years, Aggressive Hybrid Funds are designed for medium to long-term growth. The larger equity allocation offers higher growth opportunities, while the debt portion helps cushion the impact of short-term market fluctuations.
Flexibility in Risk Management: These funds provide flexibility by allowing a higher exposure to equities for growth, while also maintaining a safety net through debt investments. This dual approach helps manage risk during periods of market volatility.
Rebalancing Strategy: Fund managers of Aggressive Hybrid Funds regularly adjust the portfolio to match current market conditions. During periods of market uncertainty, they may shift more funds into debt instruments to reduce risk. In contrast, during market upturns, they might increase exposure to equities to capitalize on growth, all while adhering to strict regulatory guidelines for asset allocation.
Taxation: Aggressive hybrid funds have most of their assets invested in equity and are therefore taxed like equity instruments.
Taxation on Aggressive Hybrid Funds
The taxation of returns from mutual funds can significantly affect overall investment gains. In India, the tax treatment depends on the type of fund and the holding period. The tax treatment for Aggressive Hybrid Funds is similar to that of equity mutual funds, due to their substantial allocation to equities and hence fall under Capital Gains Tax:
Short-Term Capital Gains (STCG): If the units of the fund are sold within 1 year from the date of investment, the gains will be classified as Short-Term Capital Gains (STCG). STCG on equity investments (including Aggressive Hybrid Funds) is taxed at a rate of 15% plus cess & education tax at applicable rates.
Long-Term Capital Gains (LTCG): If units of mutual funds are sold after 1 year, the returns are treated as Long-Term Capital Gains (LTCG). As per the latest Union Budget 2024, LTCG above ₹1.25 lakh in a financial year will be taxed at 12.5%. For any LTCG up to ₹1.25 lakh, no tax is applicable. The ₹1.25 lakh exemption limit applies across all equity-related mutual funds, including Aggressive Hybrid Funds, meaning if your total LTCG from all equity funds exceeds ₹1.25 lakh in a financial year, only the amount above this limit will be taxed at 12.5% and cess & education tax on it.
Conclusion
Aggressive Hybrid Funds are a great choice for investors looking for a mix of growth and stability. These funds invest in both stocks for higher returns and bonds for safety, offering a automatically rebalancing approach to managing market ups and downs. They are especially suitable for long-term investors who can tolerate some risk in exchange for potential higher returns, while still having the security of debt investments during uncertain times. With the added benefit of regular adjustments by fund managers, Aggressive Hybrid Funds can help grow wealth over time. However, it’s important to consider personal goals, risk tolerance, and investment horizon when choosing these funds.
The NOBIAS Approach
At NOBIAS, we apply a customized asset allocation approach, ensuring that each investor’s portfolio is aligned with their long-term investment objectives. If you're looking to grow your wealth over time with a strategy that automatically balances risk and reward, Aggressive Hybrid Funds would be great for your portfolio. At NOBIAS, we take a sophisticated approach to asset allocation by incorporating the breakdown of large-cap and small-cap equity allocations within the overall equity portion. We focus on scaling the allocation of Aggressive Hybrid Funds in a way that optimizes both growth and risk management. as follows:
Large Cap vs. Small Cap Balance: For example, for Balanced (Moderate) Risk Profiles, we typically maintain 65% allocation in large-cap funds and 35% in small-cap funds within the overall equity portion of the asset allocation. Since this is not the same as the allocation in the Aggressive Hybrid Fund Allocation we then adjust it as in the following step.
Adjusting the Aggressive Hybrid Fund Allocation: To maintain a well-balanced and optimized portfolio, the equity portion in Aggressive Hybrid Funds is adjusted based on the split between large-cap and small-cap funds. For example, if 65% of the equity allocation for the fund you choose is in large-cap funds, this percentage is applied to the overall equity portion of the Aggressive Hybrid Funds. This ensures that the fund's equity exposure is correctly distributed between large-cap and small-cap investments, keeping the allocation aligned with the desired strategy for your Risk Profile.
Let’s say the average equity exposure in an Aggressive Hybrid Fund is 70%, and 65% of that is allocated to large-cap stocks, then we assume that our exposure is 65% large cap, 5% small cap and 30% debt/fixed income and look to fill-in any exposure where we may be short. Our strategy ensures that the total equity and debt exposure is balanced according to the desired risk-reward ratio. If the large-cap allocation in the Aggressive Hybrid Fund falls short, we adjust the exposure by recalculating the additional exposure to large-cap stocks needed to maintain the right proportion. This helps keep the overall allocation consistent with recommended allocation, ensuring the proper balance between large-cap stocks and other investments.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.