Why are hybrid funds in the limelight

Hybrid funds are quietly making a splash

For a long time, the Indian mutual fund segment was dominated by equity funds and debt funds. In the last few years, and especially after the COVID pandemic, there has been a sharp spike in the number of passive funds and passive fund AUM. Now, unlike equity funds and debt funds, passive funds don’t have managers taking a view on individual stocks or bonds and worrying about when to buy or when to sell. Instead, the passive funds identify an underlying benchmark index or an underlying asset class and uses the passive fund to just mirror the asset class. So, index funds, index ETFs, Fund of funds, gold ETFs, silver ETFs; all fall under the category of passive funds. 

Now, there is a new kid on the block seeing a lot of interest from investors. We are talking about hybrid funds, which offer different combinations of asset classes like equity, debt derivatives, commodities, and real estate. The idea is to not only ride the cycles of various asset classes, but also to reduce the risk overall through automatic diversification. Just to illustrate, in the month of September 2023, hybrid funds got net inflows of Rs18,818 crore; much higher than equity funds, debt funds or passive funds. What is the story behind these numbers?

Table of Contents

1. Hybrid funds are quietly making a splash
2. Hybrid funds – what is driving the numbers
3. What has triggered the growth in hybrid funds
4. It is actually a shift to asset allocation

Hybrid funds – what is driving the numbers

To understand the growth of hybrid funds, we look at data for September 2023 and compare that with September 2022. The table below captures the hybrid funds data pertaining to folios, net flows, and net AUM as of September 2023. 

However, standalone numbers only tell a small part of the story. Looking at the above numbers, one can conclude that BAFs, balanced hybrid funds and arbitrage funds are the most sought after, which is right to some extent. But the full impact is visible only when you compare it with the year ago period. The hybrid fund data as of September 2022 is captured in the table below.

A quick look at the above table would tell you that Balanced hybrid funds and BAFs have maintained consistent growth over the previous year in terms of AUM while the growth in conservative hybrids is relatively tepid. However, arbitrage funds have attracted a lot of interest due to reasons we will come back to later. But the big story has been the doubling of AUM of multi-asset allocation funds, albeit on a smaller base. 

What has triggered the growth in hybrid funds

Let us look at the growth in hybrid funds AUM yoy and the folio growth across 4 categories of hybrid funds that have been in the news for all the right reasons.

1. Let us look at the dynamic allocation funds or the BAFs. These are hybrid funds that allow the fund manager to substantially tweak between equities and debt and also throw in derivatives to enhance returns and manage risk. In terms of growth yoy, the BAFs have seen folio contraction of -2.53% but AUM expansion of 12.8%. The retail mania seen in NFOs in 2021 and 2022 is not there for BAFs any longer.
   
    
2. The second category is Balanced hybrid funds, which are the aggressive hybrids with a larger exposure to equities. This category has seen a marginal increase of 1.54% in total folios while the AUMs are up 13.6% yoy.
   
    
3. The third and very important category we look at is arbitrage fund. These are actually treasury products and have seen folios contraction of -7.64% while the AUM has expanded by 40.8%. Arbitrage funds are institutional and HNI products and there has been a consolidation in this segment. These arbitrage funds have given much better returns compared to liquid funds amidst the volatility and their treatment as equity funds is an added advantage. 
   
    
4. Lastly, we turn to multi asset allocation funds that saw whopping folio growth of 67.8% while the AUM grew by 101.6%. It has been the big story of the last one year with accretion in retail participation and a slew of NFOs. Clearly, the natural diversification of a hybrid multi-asset allocation fund is appealing to investors in a volatile market.

It is actually a shift to asset allocation

For Indian investors, this marks the fourth important shift in terms of mutual fund investing. The first big shift was from closed ended funds to open ended funds, which was a natural progression. The second shift was from debt dominated funds to equity dominated funds. This came with greater confidence in Indian equities. The third trend visible in the last five years was the shift from active investing to passive investing, even as active fund managers struggled to beat the index on a consistent basis. These three trends are fairly matured now.

The latest trend we are seeing is towards the hybrid funds and this is actually a shift towards asset allocation. It has been empirically proven that over time, it is asset allocation that determines majority of your returns. In the last 20 years there have been occasions when equity has dominated, and occasions when debt or FDs or gold have outperformed. It is not just about being in the right assets, but also about being in the right asset at the right time. That is where investors are looking more closely at fund that offer smart allocation options. The shift to hybrids looks here to stay!