Risk averse investors can check out debt-oriented hybrid funds

Six mutual fund houses — Axis, HDFC, ICICI Prudential, SBI, Kotak and Union KBC — have launched closed-ended debt-oriented hybrid funds investing in a mix of fixed income instruments and stocks in January. These closed-ended hybrid funds invest approximately 80% of the money in high quality bonds, which over a three-year period, ensure return of capital. The remaining 20% of the money is invested in stocks, which offer extra kicker to the returns. Some products come with a five-year term, too. Most market participants look at these products as means to generate a bit higher post-tax returns than fixed deposits. “Closed-ended hybrid funds are good investment option for investors who need conservative exposure to equities and do not need liquidity,” says Jignesh Harshadrai Shah, investment advisor of Capital Advisors. Though units of such schemes are listed on the stock exchange, they are rarely traded on the bourse. Investors typically get to exit at a steep discount to the prevailing net asset value of the scheme. In short, investors should be prepared to hold on to investments till the maturity of the scheme.

Industry participants attribute the surge of such new fund offers to change in investors’ preference and the current market scenario. “Retail investors are demanding safer mutual fund products,” says G Pradeepkumar, chief executive officer of Union KBC Asset Management Company. Investors are more comfortable with these hybrid funds because they offer protection against any huge downside at the end of the tenure of the scheme and a little exposure to equity would provide extra returns, he adds. “Higher interest rates hovering in the range of 8-9% on three-year paper give scope for relatively higher exposure to equity of 20% in the current scenario in such funds,” says Surajit Mishra,national head — mutual funds, Bajaj Capital. “Such products in the past have generated post-tax returns of 6.1-12% in the past,” he adds.

However, the “returns” depend on the extent of exposure to equity and how equities perform during the period. “Three years ago, the interest rates were lower than what they are today. That is why hybrid funds launched in those days are delivering low returns,” says Mishra of Bajaj Capital. Low interest rate means that the fund manager has to put more money in fixed income instruments to ensure return of capital, leaving less allocation to equity. Also, the equity markets have not done well in the past three years. For example, CNX Nifty, the market bellwether index, delivered 2.31% in the three-year ended January 10. In fact, mutual funds are targeting investors who are keen to invest in equities but are afraid of losing money in the stock markets.

However, everybody is not in favour of investing in hybrid funds. “Many hybrid funds have not lived up to the returns expectations of the investors. Investors are better off building such a structure for themselves,” says Abhinav Angirish, managing director of investonline. in — an online mutual fund distribution entity. He asks investors to invest in a good debt fund and diversified equity fund with a good long-term performance record in the ratio of 80:20 with a three-year time frame. Many experts also believe that closed-ended hybrid funds are not tax-efficient. Capital gains of these schemes are taxed as a debt fund — lower of 20.6% with indexation and 10.3% without indexation. If an investor invests in a combination of debt and equity schemes, only the debt fund is taxed and equity fund returns are tax free after one year.