Conservative hybrid funds predominantly invest in debt (around 75-90%) and the rest in equities aiming to earn slightly higher returns compared to pure debt funds. The debt portion of the portfolio intends to provide safety and stability of a regular income from coupon payments, whereas the equity portion has the potential of generating extra income through dividends along with capital appreciation over a period.
The category, however, has not found much favor with investors. Since April 2019, conservative hybrid funds have witnessed outflows each month.
As you are aware, debt funds are going through a turbulent phase. From the IL&FS crisis to the collapse of six debt schemes of Franklin Templeton, there have been various instances where investors had to suffer a significant erosion of wealth.
Unfortunately, Conservative Hybrid Funds, also known as Debt Hybrid Fund or Regular Savings Fund, have been affected due to their high debt component.
So are conservative hybrid funds exposing you to higher risk?
Among the schemes in the category, Franklin India Debt Hybrid Fund, Nippon India Hybrid Bond Fund, and UTI Regular Savings Fund have created segregated portfolios for their respective exposure to downgraded papers of Vodafone-Idea and Yes Bank. Whereas, some schemes had to completely write off their exposure to beleaguered firms like Sintex, Reliance ADAG group companies, and DHFL.
Despite this, some schemes, including those belonging to popular fund houses, continue to hold a high exposure to low rated papers.
Aditya Birla SL Regular Savings Fund has exposure of 26% to debt papers rated AA and below, HDFC Hybrid Debt Fund has exposure of 38%, ICICI Pru Regular Savings Fund has 56%, Nippon India Hybrid Bond Fund has 67%, SBI Debt Hybrid Fund has 26%, and UTI Regular Savings Fund has 24%.
The lockdown over the past 3 months has severely slowed down economic activity. This could impact creditworthiness of corporate and therefore, there would be a rise in the pace of downgrades and defaults.
Mutual funds holding exposure to such firms, especially those with higher allocation to low-rated instruments, will be badly affected. If and when such a situation arises, funds will have to either mark down the asset or segregate the affected security. In either case, fund’s NAV will get negatively impacted.
Inter-scheme transfers in hybrid funds have also been a concern. Over the last couple of months, due to illiquidity in the market, debt funds have increasingly opted for inter-scheme transfer of bonds from riskier categories to other schemes of the fund houses to meet redemption demand. If the security being transferred is of low grade and therefore, less liquid, it would expose the scheme/s to unwarranted risk. This would be unfair to investors in those schemes and may consequently lead to redemptions (in that particular scheme) as well.
The average maturity profile of conservative hybrid funds is 2-7 years. Having predominant exposure towards medium to longer duration debt instruments along with significant equity component, most conservative hybrid funds tend to be volatile in nature.
In the current scenario, the equity component of these funds too is vulnerable amidst the uncertainty looming due to the pandemic, bleak economic outlook, and global cues such as geopolitical tensions and social unrest in various parts of the world. Going further, high bouts of volatility cannot be ruled out.
Table: Report card of Conservative Hybrid Funds
|Baroda Conservative Hybrid Fund
|Canara Rob Conservative Hybrid Fund
|BNP Paribas Conservative Hybrid Fund
|ICICI Pru Regular Savings Fund
|LIC MF Debt Hybrid Fund
|Kotak Debt Hybrid Fund
|L&T Conservative Hybrid Fund
|Essel Regular Savings Fund
|Axis Regular Saver Fund
|IDFC Regular Savings Fund
|CRISIL Hybrid 85+15 – Conservative Index
Data as on June 12, 2020
(Source: ACE MF)
That said, those funds with higher allocation to government securities, PSUs, and other top rated instruments will fare better as these securities have high liquidity. Axis Regular Saver Fund, Baroda Conservative Hybrid Fund, BNP Paribas Conservative Hybrid Fund, IDFC Regular Savings Fund are some of the schemes with higher allocation government, quasi-government and other AAA rated papers.
Interestingly, Franklin Templeton which has been under the scanner recently for taking high credit risk in its debt funds has significantly increased its allocation to government securities (by around 27%) in its debt hybrid fund during the month of May.
How to select worthy debt-oriented funds?
Apart from liquidity and safety, the fund needs to have a good performance track record among other parameters before you decide to invest in it.
In the current market environment where debt funds are facing heightened credit risk and liquidity challenges, it is important to be extra cautious while selecting debt-oriented schemes for investment. Ensure that you invest in the right funds based on your risk appetite and investment objective.
Invest in worthy schemes after evaluating parameters such as:
- The portfolio characteristics of the debt schemes
- The average maturity profile
- The corpus & expense ratio of the scheme
- The rolling returns
- The risk ratios
- The interest rate cycle
- The investment processes & systems at the fund house
It would be preferable to invest in instruments issued by government and public sector enterprises, and stay away from those having high exposure to private issuers.
This article first appeared on PersonalFN here