The Mutual Fund Show: Should You Shift Into Hybrid Funds?
Transcript
00:00 Thanks so much for tuning in. You're watching The Mutual Fund Show on BKee Prime. My name
00:03 is Alex Mathew. As things stand at the end of market today, you have the nifty 50 that's
00:10 less than 2% away from all time highs. And that's despite all of the headlines globally
00:15 that are talking about a rating downgrade in the US, tensions in China with regard to
00:20 growth. All of that, notwithstanding the Indian equity market seems to be going from strength
00:26 to strength. And if anything, the broader markets are doing even better than the benchmark.
00:31 But the question is for you as the long term investor, is this the right opportunity to
00:36 take some money off the table and look at your asset allocation? And to that end, should
00:42 you consider hybrid mutual funds? What are the various options within this category?
00:48 And should you in fact, take that route? That's the focus of today's conversation. What are
00:53 the advantages and disadvantages of taking that route? Joining me is Shitej Mahajan,
00:59 who's Managing Partner and Chief Executive Officer of Complete Circle Wealth Solutions,
01:03 as well as Kirtan Shah, who is a Managing Director, Private Wealth at Trident's family
01:08 office. Thank you so much, gentlemen, for taking the time. And I will start with you
01:13 first, Shitej, just on the scenario right now. And the reason why I wanted to have this
01:18 conversation is that a recent conversation I had with one of the guests on the show,
01:23 Chief Executive Officer in the mutual fund space, and he himself said that if you've
01:27 been in the investment cycle for a while, say about 5, 7, 10 years, you've accumulated
01:34 a bit of a corpus, this might just be a good opportunity for you to rebalance. To that
01:39 end, is hybrid the right route to take?
01:41 So, Alex, thank you. And hi, Kirtan. It's always a pleasure to be with both of you on
01:50 this show. So coming back to what you asked, Alex, I think, extra location is the key part
01:56 which one should look at while rebalancing their portfolio. But not the reason that you
02:01 have accumulated wealth over the last 7-10 years, that's why you should do extra location.
02:04 If you're debating a lot, let's say, let's go by person from what you have decided. I
02:09 don't feel that one should do extra location part, but yes, if it's more than 5% from the
02:15 given part, so once you look at doing extra location, one should book some profits. Or
02:20 let's say if markets are not doing well, you're high on fixed income, then you move money
02:25 towards equity side. But yes, at these levels, once you look at doing rebalancing of the
02:30 portfolios, if you have more money which you can pop on the fixed income side and again
02:35 bring back your equity-debt relation at the same combination, then there's no need for
02:39 you to book some money out of equities because you ask me, "Where I'm going to trade in
02:46 P/E on index only?" It's not that the story is going to end or maybe a very big correction
02:52 is around the corner. But yes, if you're debating a lot from the given extra location,
02:56 once you decide that you're supposed to bring 60% in equity and 40% in fixed income,
03:01 right? Or you have 70% or 75% equity because of market movement, then once you look at
03:06 adjusting, rebalancing its equity and fixed income allocation or good allocation for that
03:13 matter, and they can either take a new top putting money back in fixed income or they
03:20 can just move to a balanced advantage fund, which is a hybrid equity fund as you mentioned,
03:25 that can be a good idea. If you see that you can't navigate through these times and
03:31 can't keep away as an allocation again and again, then give it to a fund manager
03:35 or a fund house who has a good balanced advantage fund depending on various other parameters.
03:40 So that's a better way of doing it because one, it is more time sufficient. Second,
03:45 it will not consume your time and it will not test your patience whether you want to do profits or
03:51 not. Very fair point. And in fact, those are the details that we're going to delve
03:56 very deeply into and I'm glad that you pointed that out. Kirtan, I'll throw that same question
04:00 to you first and then we go into the various options available in the hybrid category and
04:04 which are the better ones to choose. So first on that asset allocation part. Alex, very honestly,
04:11 I think as a retail investor, it is to time for you to try and time the market. For me,
04:17 as a retail investor, it is not just getting your timing correct in terms of exiting,
04:23 but I think it is more importantly, how and when will you come back? So while you're trying to time
04:28 the market, you have to be right twice and not once. Most of us don't get it right even once.
04:34 So even if let's say the markets are expensive and you think you want to really get out of
04:38 equities and move to some other product, you might be able to do that, but you don't know
04:43 when to come back. Will you come back 2% down or 5% down? Typically, we miss the bus and by the time
04:49 we really decide that we really want to come back to the equities market, markets have run away.
04:53 So I think as a retail investor, you should definitely not try and time the market.
04:58 Even if the valuations are expensive and if at all we have some discussion around that,
05:03 I share a view on what I think of the valuations, but largely as a retail investor,
05:07 I would definitely suggest not to try and time the market. Yes, if your allocation is way off,
05:14 like Shetty was also saying, then try and rebalance it. Don't try and time the market
05:18 because you will never get it right. Fantastic. Okay. But that still sets the
05:22 context for this conversation and Shetty to a certain extent was pointing out some of the
05:27 advantages of going towards that hybrid route. But I want to just make this very clear at the start.
05:32 There are various options, gentlemen, available under that hybrid category,
05:36 but some are more tax efficient than others. And Shetty, you had started pointing this out
05:42 because of certain changes that have taken place not too long back in the taxation of fixed income
05:48 mutual fund schemes or rather schemes with a certain allocation to equity below a certain
05:55 threshold, right, or rather above a certain threshold. So can you explain which of these
06:00 hybrid schemes have a better tax efficiency? This is for you, Shetty.
06:11 Yeah. So am I audible Alex? Yes.
06:14 So Alex, yes. So I'm saying, obviously, this new regime is there on the fixed income side,
06:20 what you spoke about, and that, and, you know, a tax of full tax means that it's a part of your
06:29 income, whatever you are generating as a return on the fixed income side. Second, I'm saying,
06:34 when you keep on shifting between equity and fixed income, so let's say market will move up,
06:40 again, 8-10% from here, if it moves up, again, you do the reshuffling and the
06:44 readjustment between equity and debt. It will not only create a shorter capital gain for equity,
06:49 as well as a capital gain for fixed income also, if you move from fixed income to equity also.
06:54 I'm saying if you want to avoid that, then just taking what Kirsten has said, one can look at,
06:59 looking at a balanced fund category, where the taxation part has been taken care by the fund
07:04 itself as 65% plus allocation is toward equities. And whatever you gain after one year is treated
07:12 as a long term capital gain. One is this. Second, it will save a lot on, on weight shifting between
07:19 these funds by you, because nobody can get the timing right. So either you just keep on maintaining
07:25 that allocation if it's not a weighted one, or just look at a hybrid fund, where the fund will
07:31 do and make it more tax efficient for you. Let's talk about the options available and
07:38 why certain options are not as tax efficient as the others, Kirtan. So if you can break it down
07:44 for us, what are the various options available in the hybrid category? And which have that equity
07:50 taxation, which have the debt taxation? So Alex, in the hybrid category in 2018,
07:56 when SEBI came up with categorization, they split the category into seven buckets. The first bucket
08:03 is conservative hybrid fund, where the logic is that 10 to 25% of the investments will be in equity
08:10 and equity related products, which is arbitrage, and the remaining 75 to 90% will be in debt. So
08:16 conservative hybrid is a largely debt focused product. Then you have something called as balanced
08:21 hybrid, where 40 to 60% can be in equities, and 40 to 60% can be in fixed income. Now over here,
08:30 the clear bifurcation is that you can't have arbitrage here. So the 40 to 60% that we are
08:35 speaking about is going to be pure equities. The third category you have is aggressive hybrid,
08:40 like the name suggests 65 to 80% is in equity, and 20 to 30% is in fixed income. The fourth is
08:49 the most popular amongst all of these categories called the dynamic asset allocation or the balance
08:54 advantage fund, where the fund manager can choose how much equity or debt that she wants in the
09:00 portfolio and looking at the market situation, they can keep readjusting and balancing the
09:05 portfolio. The much newer category is the multi-asset allocation where there are three
09:11 asset classes in which you need to minimum invest 10% each. So there are funds who can be very
09:17 extreme and different from each other. There are funds which can have 65% in equity and then there
09:21 are funds which can have 65% in fixed income also, because the regulation says you only need 10%
09:26 in three different asset classes. Then there is simple pure arbitrage funds where you do arbitrage.
09:33 And lastly is equity savings fund where 65% of your investments have to be in equity or equity
09:39 linked, which means arbitrage and the remaining can be in fixed income. So there are these seven
09:43 different categories. Now, if I have to talk about specifics to do with taxation, let's break them
09:50 down into three Alex. First is which of these funds have equity taxation. Now for us to understand
09:56 equity taxation, we have to understand that the fund needs to have 65% of investments in equity
10:03 or arbitrage. If they have 65% investments in equity or arbitrage, they'll be categorized as
10:09 equity taxation. Now there are four categories which fall into this taxation bracket,
10:13 aggressive hybrid, BAF, arbitrage and equity savings. These are the four which are taxed at
10:20 an equity level of taxation. Second is the old debt taxation, which indexation advantage used
10:29 to prevail before the 31st or 1st of April. There is one category in this space which is balanced
10:36 hybrid, because this is for a category where you have more than 35% in equities. So balance
10:41 hybrid has more than 35% in equity and any product which has less than 35% in equity will be charged
10:48 as good as your fixed income or at your marginal slab rate, which is the last category, which is
10:52 conservative hybrid. So six are divided amongst equity, old debt taxation and tax like your FD.
11:01 There is one category which is multi-asset. There is no real answer to this because like I explained,
11:06 it will depend whether you have more than 65% in equity, then equity taxation. If you have more
11:11 than 35% in equity, then old debt taxation. But if you have less than 35% in equity, you will be
11:18 charged like your FDs are charged. So multi-asset does not have one answer that will depend on
11:23 AMC's objectivity and how are they really doing asset allocation versus assets in the fund.
11:28 So for the purposes of this conversation, I would like to focus on the funds that have equity type
11:34 taxation. And I believe that is effectively the more popular ones as well in the category. And I
11:41 think both of you would like to talk about these as well. Now, having said that, let's establish
11:46 one fact, Shetij, if you are going through this route, what is the kind of time frame that you
11:51 should ideally keep when you say that you want to start, say, suppose today, I want to start an SIP
11:57 into one of these, or I want to make a lump sum into one of these, what is the ideal time frame I
12:02 should think of when I look at these schemes? So, three products falls into this category.
12:09 And I will not suggest it in any of the category. Arbitrage fund is there to work where you have
12:15 money with the clear visibility of three months plus up to one year or it's a little more over
12:21 one year, because it is only the arbitrage between what prices are here and in FLO. And it gives you
12:28 a job equity taxation, 65% plus is what they are having is in equity markets. And then you have
12:35 a hybrid equity, which is aggressive hybrid equity, which used to be your balance fund,
12:41 which we used to call them earlier. And then you have balanced advantage fund, these two funds are
12:46 there. So, if you're investing in these two funds, should be not less than two to three years at
12:51 least, in fact, at least three years. Because one is, these are like balanced advantage fund is
12:56 nothing but FD plus 2 to 3% return. Right now, returns are looking very good across stable,
13:02 across balanced advantage fund, but that's true for equity market also. Equity, we say that is
13:06 capable of generating 12-13% return, but right now returns are looking good because markets have
13:10 done well. But yes, that's how balanced advantage fund should be seen as. And they have an equity
13:16 taxation advantage also. So, anything which is one year plus, and if you have a gain of one lakh
13:21 plus, because one lakh is exempted, it will be taxed at 10% only. So, at least two to three years
13:27 is what we should look at for balanced advantage fund. Investment equity hybrid fund, which used
13:31 to be balanced funds, once you look at three year plus time frame, because they go up to as high as
13:36 65 to 75% or maybe up to 80% equity allocation in the scheme. So, not less than two to three years
13:43 for sure for BAF because that's the type of fund you should look at. And sometimes what happens in
13:48 a good market, you see when market is moving up and valuations are high, so you see most of these
13:54 BAFs are underperforming because they keep on maintaining a low equity, as in when market falls,
13:58 they keep on stepping up their equity, depending on various parameters, what they work on. So,
14:03 two to three years for BAF and three year plus for equity hybrid.
14:07 Now, hypothetically, we're speaking one day ahead of the monetary policy, where we hopefully will
14:14 get some direction. But then I think broadly, fingers crossed, but Kirtan, broadly, I think
14:21 there is consensus that states that we've reached the peak of the interest hiking cycle. Now, it is
14:28 interesting because you've seen the bond yields move, despite the fact that they went down to 7%,
14:35 they've moved back up, I'm talking about the 10-year bond yield to around 7.2 or thereabouts.
14:40 So, a lot of people are talking about strategically, if you put money into fixed
14:46 income right now, there is potential for capital gains over the next couple of years or whenever
14:52 that cycle turns, because when interest rates go down, fixed income goes up. So, from that
14:58 perspective, as a strategic investment, would you say that it makes sense considering that equity
15:03 markets could move up from this point, and you could also get capital appreciation from that
15:08 fixed income portion of the hybrid category? There are very similar view, I think.
15:15 We also believe that interest rates have peaked out and in our opinion, over the next 24 months,
15:22 we should definitely see capital gains on the fixed income side of the portfolio. But I'll
15:27 tell you the bigger problem with the BAF category is that on the fixed income side,
15:32 there are funds who are very, very different from each other. Now, what do I mean is if you
15:37 look at the average category, the average category does not take credit risk and the average category
15:43 also does not take duration risk. So, if you look at the average category fixed income portfolio,
15:51 you will see except one or two AMCs, there is hardly any AMC which takes credit risk.
15:56 And there is hardly any AMC which takes duration risk. Why is this important to understand?
16:00 Is because while you're expecting interest rates will peak out and then when rates will go down,
16:06 your fixed income side of the portfolio will make capital gains. These capital gains are only going
16:12 to be visible if you're taking a duration risk on your portfolio. But that is not typically how
16:18 BAF investments are done. BAF investments are largely done not taking the credit or not taking
16:24 the duration risk. So, I don't see that interest rate going down over the next 18-24 months will
16:30 have any significant impact on the fixed income portfolio of BAF. But having said that, definitely
16:36 it is going to be an added advantage because if interest rates were flat or were going up,
16:41 then the notional profit that you could have made on the fixed income portfolio
16:45 would have been lost. So, of course, from that perspective, it is only going to add more value
16:52 if interest rates fall, then the fixed income portfolio will slightly do better than you
16:56 otherwise would have expected it to do. But I just want to put this point forward saying that
17:01 there's not going to be any significant impact of rates falling on the fixed income portfolio
17:06 of BAF because they don't take duration risk. But it is still better than what it is today.
17:10 - So, small angle that I guess, gentlemen, we have to consider is the post-tax angle, right? So,
17:16 hypothetically, if we invest today, and if we're investing a lump sum, and if we're doing
17:22 investments into a hybrid category that hypothetically takes a 65% allocation towards
17:28 equity, and therefore is equity tax taxation, I get, what, 35% of my portfolio in fixed income,
17:35 even if it does not take that 10-year horizon of fixed income, I still get a pop from the capital
17:42 gains on that, and it's equity taxation. Shruthi ji, is there a significant advantage to be had
17:47 there? - You asked me and Ethan put it very nicely that, let's say if you have right now,
17:54 on a short term paper, 6.5% coupon coming on fixed income also, and you get a data of, let's say,
18:00 40 to 50 bips, that means on a 35% allocation, or let's say 30% allocation, somewhere it is,
18:06 you have arbitrage, it will move, then in 30% allocation, it's a steady 1.5% jump on the
18:12 yield, if you get a 50% delta also. So, right now, the good part is that there are good spreads on
18:17 the arbitrage side also. So, you may analyze close bonds and have 8% on arbitrage fund loans.
18:22 So, that 30%, right now, let's say, most of the banks are, if you say, market names, are in between
18:28 42 to 45%, except for the Edubuy, which is a little above more than 50% in equity, but you see,
18:34 you're making return on the equity side, equity moves, and if it is falling, then you keep on
18:39 adding money towards equity, you are making 7.5% on the fixed income side, and then 6.5% on the
18:45 fixed income side also. And that 6.5% is coming at a 10% gain only. And if you have a gain which
18:51 is less than 1 lakh rupee on annual basis, then it's always tax free to you. So, yes, you're right,
18:57 Alex, it adds a lot of weight to overall return, and it makes the fixed income return also tax
19:03 friendly. One last point before we talk about how to choose a fund. On the fixed income side,
19:10 Kirtan, again, hypothetically, from this point, based on everything that we know about monetary
19:15 policy and where interest rates are, generally, in a rising interest rate scenario, you need to be
19:20 wary about capital losses on your fixed income portfolio. So, from that perspective, that 35%
19:26 of your portfolio is also protected, because we're unlikely to see capital losses on fixed income
19:32 in the coming two years, correct? 100%, 100%. There's no doubt about it. But there is another
19:40 thought process to it that if I'm a, let's say, a conservative investor or a moderate investor
19:46 who's looking at investing for less than three years, right, the call that I really have to take
19:51 is that in the fixed income space, I'm largely confident that rates will fall over 24 months,
19:56 right? And I am going to make the yield plus the capital gains, right? Though I'll have to pay
20:00 slightly more tax for sure. But if I do the BAF angle, right, I am taking 40, 50, 60% exposure
20:08 to equity also, which my risk profile might not be okay with. So, I think, while theoretically,
20:14 all of us are on the same page that as an aggressive investor, this makes a lot of sense,
20:18 because your equity, your fixed income, your taxation, everything falls in place for you.
20:24 But that might not be the case for a conservative or probably a moderate risk investor, Alex.
20:31 Think of it from the perspective of whether or not you would shift out of equity into a hybrid
20:36 rather than from a fixed income into hybrid is, I think, the point that you want to make.
20:40 Keith, correct me if I'm wrong. Yeah, so I'm saying if I have to really,
20:45 let's say, take a new bet today, right, and if I'm a conservative investor, I would rather do
20:51 a fixed income because I know that over 18 months, interest rates are definitely going to fall.
20:56 But when I do a hybrid, I'm taking 50% exposure to equity, which I'm not very comfortable with,
21:02 and I don't know what will happen to equities over 18 months just to save tax, right. But if
21:07 I'm an aggressive investor, and I'm feeling that probably markets are pretty much in a fair value
21:14 zone, and I don't see a lot of opportunity from here on, then I might as well want to book some
21:19 profits out of equity and move to BAF temporarily. But not a conservative investor would want to do
21:25 that is my sense. Point well made. Okay, point well made. And I think that kind of underlines the
21:35 most important point, which I'm also taking from what Keerthana said, is that don't make investments
21:41 simply from the perspective of saving tax, because that's not going to achieve any purpose for you.
21:46 Think about your objectives. Think about your asset allocation strategy. Okay, so gentlemen,
21:50 with all of those aspects that we've spoken about setting the context for this leg of the
21:56 conversation, how do you go about choosing the right scheme if you have decided to go towards
22:02 a hybrid category? Shruti, I'll start with you. So there are a lot of good options available.
22:08 It's the good part about the Indian mutual fund industry is that, you know, we have various funds
22:14 available on various parameters. And these parameters ranges between price to wanting
22:18 value, dividend deal, trend ratio, interest rate scenario. So you know what we're talking about.
22:25 So that's a new addition what ICICI has started doing. They have added the interest rate scenario
22:29 also. So it depends on that. And one can actually choose between any of these funds. So I don't have
22:36 a person liking Bonai single, but he has ICICI BAF is one which is on the price to book value and
22:41 interest rate scenario. Then you have Kotak, which works on price to wanting price to book value and
22:47 trend ratio. Then you have Tata, which is put your price to wanting only. So, you know, it's a defined
22:54 parameter on which various companies work. Motigal has a BAF which works on price to wanting price to
22:59 value and dividend ratio also. So one can choose a couple of BAFs and you really don't have to do
23:06 any timing or you know, STP or SAP in BAF. That's been done by the fund manager. Many of the people
23:12 must be thinking that they are at the peak of the market, but that's the fund responsibility. Let's
23:16 say if the peak of the market will not be, you know, the all time high peak and there will be a
23:24 new peak coming, then you lose a lot of opportunities. So don't sit outside. If you have decided to
23:28 rebalance, then put, I think, many of these BAFs and do an income cent investment. That's my conclusion.
23:35 No, important, which is, which was the purpose of this conversation as well, right? Is that if you
23:39 think, if you're uncomfortable with the equity markets at a certain level, don't book out and
23:44 sit on the side. You book out and you redeploy into something like that. Anyway, so your point
23:51 well taken and I hope that the graphics played out on screen because we did ask you ahead of time to
23:56 give us your, or the schemes that you've looked at. And very important, I think, viewers to pay
24:01 attention to the kind of strategy that each of these funds employ. And that I think was elucidated
24:06 in the graphic as well. But Keith, I'm coming to you. Do you have any picks in this space and how
24:12 do you go about choosing the right fund? Alex, I think the purpose of building a portfolio is
24:18 to diversify, right? You don't want to put in a lot of funds in place with different AMC names
24:24 and just assume that you are diversifying. So with that thought in mind, we work with two funds,
24:32 right? And we think these two funds together put a brilliant diversified portfolio ahead of us. One
24:39 is ICICI BAF and another is Edelweiss BAF. And I'll give you a reason why this as a combination
24:45 works out really well for us, right? You have equity and you have debt, right? Now you look
24:51 at the equity component of ICICI, they follow the value style of investing. You look at the equity
24:56 component of Edelweiss, they follow the momentum style of investing. So I have diversification on
25:01 the equity side of portfolio. You look at fixed income side of portfolio of ICICI, they take
25:07 credit risk. And you look at fixed income side of portfolio of Edelweiss, they don't take credit
25:14 risk, but they will have a slightly higher duration, which takes interest rate risk.
25:20 Now, if I have to marry both of these, then I'm having the best of four worlds put together,
25:26 value style of investing, momentum style of investing, a little bit of credit, a little bit
25:30 of duration. And hence, I think if anybody wants to park money in BAF, a combination of both of
25:36 these funds will really do well in my opinion. Fantastic. I think we've covered all of the basis.
25:40 Gentlemen, always a pleasure speaking with both of you. Thank you so much for taking the time and
25:44 for speaking to BQ Prime. Thank you. Thank you.
25:48 All right. Well, then viewers, we've got quite a lot of your questions answered, I hope, on the
25:54 hybrid category, and also the strategy that you might want to employ if you do in fact feel that
26:00 the equity markets are overvalued. That, of course, is a conversation that we have on a regular basis.
26:05 And I would encourage you to stay tuned to BQ Prime to catch a look at that.
26:10 Thanks so much for watching. This is BQ Prime.
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