Should you look at conservative hybrid funds amid the market rally?

After correcting nearly 11% from their all-time highs, Indian indices are again witnessing a rally, making investors reassess the best course of action. 

With overheated markets, the challenge of balancing risk and returns has become more pronounced. For those seeking stability and inflation-beating growth, multi-asset allocation funds (MAAFs) may be a viable alternative to debt mutual funds or fixed deposits (FDs).

MAAFs are structured to invest in a mix of asset classes—commonly equities, debt, and gold—offering diversification benefits. As per Securities and Exchange Board of India (Sebi) regulations, these funds must allocate at least 10% of their portfolio to three asset classes, making them less volatile than pure equity funds.

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According to Ventura Securities, the popularity of MAAFs has surged in recent years. The assets under management (AUM) for these funds grew from ₹17,908 crore in August 2021 to ₹98,283 crore in August 2024. The number of funds in this category has increased from 9 to 24 over the same period.

“MAAFs are ideal for investors who are looking to restrict the risk and at the same time generate returns with reasonable allocation in equity as well. The funds focusing on the right asset class allocation are much better to invest as they constantly keep an eye on the portfolio asset allocation based on market conditions and other factors,” said Harshad Chetanwala, co-founder of MyWealthGrowth.com.

Aggressive and conservative MAAFs

Conservative MAAFs typically maintain equity exposure below 65%, ensuring lower volatility than their aggressive counterparts, which allocate more than 65% to equities. The higher equity allocation in aggressive MAAFs results in greater net exposure and higher risk, while conservative MAAFs focus more on stability with significant investments in debt and gold.

Taxation is another key differentiator. For MAAFs, both conservative and aggressive, long-term capital gains (LTCG) are taxed at 12.5% if held for more than two years. Short-term capital gains (STCG) on aggressive MAAFs are taxed at 20%, whereas conservative MAAFs face STCG according to the investor's income slab rate. 

In contrast, debt mutual funds and FDs attract slab-rate taxation to both short-term and long-term gains or interest. FDs have the poorest tax proposition. In FDs, you face tax on interest annually, while mutual funds defer tax liability until redemption, allowing for potential compounding benefits. You also get to adjust gains and losses on debt funds vs capital gains and losses elsewhere. This isn't possible with FD interest. 

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In terms of risk and volatility, conservative MAAFs offer relatively low exposure to market fluctuations, while aggressive MAAFs come with higher potential returns but greater risk. Debt mutual funds remain low-risk investments focused on fixed returns, and FDs provide the least exposure to market risks, making them suitable for ultra-conservative investors.

Notably. the recent changes in the tax landscape have enhanced their appeal. “Most of these multi-asset funds will now get taxed at 12.5% post two years,” noted Juzer Gabajiwala, director at Ventura Securities.

Making the right choice

Not all MAAFs share the same strategy or asset allocation. For example, Motilal Oswal’s aggressive MAAF prioritizes equities, while Edelweiss focuses on fixed income with hedged exposure to gold and silver. Meanwhile, WhiteOak Capital employs a hybrid strategy with moderate equity exposure.

Currently, Edelweiss and WhiteOak are the only asset management companies (AMCs) offering conservative MAAFs with equity exposure below 35%. These funds prioritize stability by emphasizing allocations to debt and gold while keeping equity exposure minimal, making them suitable for risk-averse investors. 

Apart from MAAFs, there are also some debt-like dynamic asset allocation funds (DAAFs). One example is the PPFAS Dynamic Asset Allocation Fund, which has higher exposure to debt instruments—62.35% of its allocation—making the fund suitable for risk-averse investors. Besides, it allocates 21.93% to arbitrage and 13.78% to net equity while holding a small portion of 1.94% in cash equivalents.

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Edelweiss MAAF invests 55% of its portfolio in debt instruments, 28% in arbitrage opportunities, 11% in gold, and 6% in cash equivalents. 

The WhiteOak Capital Multi Asset Allocation Fund, on the other hand, takes a slightly more diversified approach. It allocates 35.4% to debt and 25.9% to equity. The fund also invests 19.1% in gold. Beyond these asset classes, WhiteOak’s MAAF allocates 7.5% to REITs, 2.3% to foreign equity, and 9.8% to arbitrage strategies.

“Each fund serves its own purpose. By investing in WhiteOak, people should not expect returns equivalent to Motilal Oswal equity points,” said Gabajiwala.

Apart from MAAFs and DAAFs, there are also arbitrage funds and equity savings funds for debt-like asset allocation. Arbitrage funds keep more than 65% gross equity but hedge away almost all their equity exposure. Their return is similar to liquid funds, but in bear markets, the spot-futures spreads can narrow, reducing their returns.

Equity savings funds (ESFs) combine gross equity exposure of over 65% with moderate net equity exposure, with low to moderate exposure to net equity and debt. These funds typically avoid exposure commodities, focusing instead on debt for stability. They generally follow a one-third exposure to equity, debt and arbitrage. The lack of flexibility or commodity exposure keeps their returns limited, compared to DAAFs or MAAFs.

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Despite the benefits that MAAFs offer, it is important to align them with your financial goals and risk tolerance. “MAAFs should be considered for investment when one wants to diversify their portfolio into multiple assets, which have low correlation with each other, to reduce their portfolio risk and not for tax efficiency. Doing otherwise would be akin to putting the cart before the horse. Tax efficiency should be the by-product and not the main consideration for investment decisions,” said Abhishek Kumar, a Sebi-registered investment advisor.