Are hybrid mutual funds less risky than equity mutual funds?

Published: May 3, 2021 at 11:07 am

Last Updated on December 29, 2021 at 6:13 pm

Nearly three years have passed since mutual funds complied with the SEBI recategorization rules. We now have enough data to classify hybrid mutual funds in terms of their risk with respect to equity mutual funds. We shall use the standard deviation of monthly returns over the last three years to classify hybrid mutual funds.

Let us first go over the definitions of hybrid funds.  (1) Conservative Hybrid Funds: 10% to 25% equity and rest in debt. (2) Balanced Hybrid Funds: 40 to 60% equity without arbitrage and rest in debt. (3) Aggressive Hybrid Funds 65-80% equity. AMCs will be allowed to offer either an aggressive hybrid fund or a balanced hybrid fund, not both.

(4) Dynamic Asset Allocation or Balanced Advantage Fund: Variable asset allocation with no limits. (5) Multi-asset allocation: 10% of equity (including international equity), 10% debt and 10% gold and rest is variable. (6) Arbitrage funds are not “hybrid” funds! They only need to invest 65% in equity and equity-related investments. There is no minimum allocation requirement to arbitrage!

(7) Equity savings funds should have a minimum of 10% in debt and 65% in equity and equity-related instruments. The direct equity exposure limit within this 65% is variable but must be specified in the scheme document. How robust are these definitions?

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

As recently discussed, we cannot classify mutual fund in terms of returns. If there is a stock market crash in one year, debt funds would have beaten equity funds and vice-versa if there is a bull run. The spread in returns is too much to use as a classification metric: How to arrange mutual funds in terms of their returns?

So we turn to the volatility in monthly returns. In particular, how much do monthly returns deviate from the average monthly returns over the last 36 months? This is measured with the standard deviation. Higher the standard deviation, the higher the volatility (fluctuations) in the NAV of the mutual fund.

It must be understood that volatility is only one form of risk. Other types like credit risk and reinvestment risk will not manifest in the NAV until there is a credit event or change in interest rates (we are referring to liquid funds and money market funds here. NAV fluctuations in longer-term funds occur daily due to bond market supply-demand fluctuations).

standard deviation over the last three years of aggressive hybrid funds compared with Nifty index funds and active large cap funds
standard deviation over the last three years of aggressive hybrid funds compared with Nifty index funds and active large cap funds

The y-axis represents the standard deviation. The x-axis the fund number (not shown). First, let us locate the blue dots, the nifty index funds. They are clumped together and form a nice reference point.

Relative to this, the active large cap funds (brown squares) are on both sides. There is some spread, but not too much.  Next, the crosses – the multi-asset funds. They are all over the place, meaning there is too much freedom for fund managers. This category is poorly defined.

The equity savings funds (green dots) are a bit more volatile than conservative hybrid funds (red dots) but is just as volatile as dynamic asset allocation funds (denoted by +). The Balanced Advantage funds (grey dots) are also all over the place.

The aggressive hybrid funds (blue triangles) are just as volatile as active large cap funds. This is why I keep stressing that agg hybrid funds should be considered equity funds in asset allocation. IMO one should not add their debt allocation to the debt allocation in our portfolios.

The arbitrage funds are well-defined thanks to the arbitrage contribution! Now how do we define a conservative fund? It might be useful to many AMC fanboys who want to invent needs because their fav AMC is coming up with an NFO.

As per the last three years trailing data (this is variable as per the period considered), conservative hybrid funds are 2.5 to 3 rungs less volatile than aggressive hybrid funds and about 2 rungs more volatile than arbitrage funds. Is that useful? Not in the least!

The standard deviation of an arbitrage fund is comparable to that of an ultra short-term fund in the absence of any credit event or arbitrage event (when different securities are hedged). It is reasonable to classify arbitrage funds as “debt”.

It is also reasonable to classify aggressive hybrid funds (and even multi-asset) as “equity”. The rest, I am afraid, are somewhere in between.

Note about the arrows: Principal Arbitrage Fund suffered a credit default and has a higher standard deviation. HDFC Balanced Advantage Fund is only that in name. It typically has the higher volatility in its category. JM Large Cap Fund fell the least during March 2020 and has the lowest standard deviation. Close to 20% debt allocation is one reason for this.

Are hybrid mutual funds less risky than equity mutual funds?

To answer the titular question, for the last three years, the volatility of aggressive hybrid funds, arbitrage funds and multi-asset funds are reasonably well defined. They are either as volatile, a bit less volatile or significantly less volatile than equity mutual funds.

As for the rest of the hybrid categories, they are caught in between. Since the investor cannot clearly classify their volatility, they are riskier than equity funds due to incorrect perceptions.

Investors want the balanced advantage funds, dynamic asset allocation funds, equity savings funds or conservative hybrid funds to give “extra returns” during bull runs and not fall during bear runs. This is impossible. Since it is difficult to peg the risk level of these funds, I would treat them as riskier than equity funds.

Someday perhaps we might have index funds in these categories. Then things will become a bit more clear. Right now, there is too much room in the asset allocation to be confident about risk levels.

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)