When the stock market experiences volatility, investors often seek safe investment options that can provide growth while minimising risk. One of the most attractive options during such times is the aggressive hybrid fund. These funds are designed to offer a balanced approach by investing in both equity and debt, providing stability and growth potential. In this article, we will explore why an aggressive hybrid fund is a good choice during volatile markets and how they can help manage risk effectively. We will also briefly touch upon the importance of the Cost Inflation Index when assessing investment returns.
What is an aggressive hybrid fund?
Aggressive hybrid funds are a type of mutual fund that invests in both equity and debt instruments. By regulation, these funds allocate 65-80% of their portfolio to equities and the remaining 20-35% to debt instruments. The equity portion aims to provide higher returns through stock market growth, while the debt portion offers stability and mitigates risk, especially during market downturns.
An aggressive hybrid fund is designed to strike a balance between risk and reward. The equity component ensures that the fund can capitalise on market growth, while the debt allocation acts as a cushion against market volatility, making these funds a popular choice for investors with moderate to high-risk tolerance.
Why are aggressive hybrid funds good in a volatile market?
During times of market volatility, investors often become cautious about investing heavily in equities due to the uncertainty and risk involved. At the same time, they may not want to miss out on potential market gains. This is where an aggressive hybrid fund shines. Here are several reasons why they are an excellent option when the market is volatile:
1. Balanced allocation between equity and debt
The core strength of an aggressive hybrid fund lies in their diversified allocation between equity and debt. With 65-80% invested in equities, these funds can take advantage of market rallies, but the 20-35% in debt provides stability and reduces the impact of sudden market downturns. This balanced approach helps investors stay invested in the market while reducing the risks associated with full equity exposure.
In volatile markets, debt instruments in the portfolio act as a buffer, protecting the fund from significant losses. This allocation mix makes an aggressive hybrid fund more resilient during market corrections compared to pure equity funds.
2. Lower risk compared to pure equity funds
While aggressive hybrid funds still have a significant portion of their portfolio in equities, their risk is lower compared to pure equity funds. This is because the debt component adds a level of security. When the equity market experiences sharp declines, the debt portion of the fund generates steady returns, helping to stabilise the overall portfolio.
This reduced risk makes an aggressive hybrid fund a good option for investors who want to participate in market growth without exposing their entire portfolio to the high volatility of equity markets.
3. Steady returns during market downturns
One of the primary advantages of an aggressive hybrid fund is their ability to generate steady returns, even during market downturns. While equity funds may experience significant losses during volatile phases, the debt portion of an aggressive hybrid fund continues to provide stable income. This makes the overall return more consistent and less dependent on market fluctuations.
For example, during periods when the stock market is underperforming, debt instruments such as bonds and government securities can still generate returns, helping to offset any losses from the equity portion.
4. Flexibility in asset allocation
In addition to offering a balanced portfolio, aggressive hybrid funds allow fund managers the flexibility to adjust the equity and debt allocation within the predefined range (65-80% equity and 20-35% debt). This means that fund managers can reduce equity exposure when markets are highly volatile and increase debt allocation to reduce risk. Conversely, they can increase equity exposure when market conditions improve.
This flexibility in asset allocation allows the fund to adapt to changing market conditions, making it more resilient during volatile phases.
5. Tax benefits similar to equity funds
Aggressive hybrid funds are treated as equity-oriented funds for tax purposes, as they maintain more than 65% of their portfolio in equities. This means that long-term capital gains (gains on units held for more than one year) up to Rs. 1 lakh are tax-free, and gains above that threshold are taxed at 10%. Short-term capital gains (gains on units held for less than one year) are taxed at 15%.
The tax treatment of aggressive hybrid funds is more favourable than that of pure debt funds, making them an attractive option for investors seeking both growth and tax efficiency during volatile times.
Cost Inflation Index and its importance in mutual fund investments
When assessing the returns on any investment, it is crucial to factor in inflation. The Cost Inflation Index (CII) is a tool used to adjust the purchase price of an asset, such as mutual fund units, for inflation. This helps calculate the real value of returns and reduce the capital gains tax burden.
For instance, if you invest in an aggressive hybrid fund and sell your units after a few years, the Cost Inflation Index can be used to adjust the original purchase price of the units for inflation. This adjusted cost is then deducted from the sale price to calculate the capital gains. By using the CII, investors can reduce their taxable capital gains, which is especially beneficial when calculating long-term capital gains on mutual fund investments.
In the context of aggressive hybrid funds, factoring in the Cost Inflation Index helps investors understand the real growth of their investments, accounting for inflation’s impact on purchasing power over time.
Who should invest in aggressive hybrid funds?
An aggressive hybrid fund is well-suited for:
- Moderate-risk investors: These funds are ideal for investors who are comfortable with some exposure to equities but do not want to take on the full risk of equity markets. The debt component provides a safety net, making these funds less risky than pure equity funds.
- Long-term investors: Investors with a long-term horizon (5-7 years or more) can benefit from the growth potential of equities while mitigating risk with debt exposure. Aggressive hybrid funds are a good choice for those looking to build wealth steadily over the long term.
- Investors in volatile markets: During periods of market volatility, an aggressive hybrid fund offers the best of both worlds: exposure to market growth through equities and protection through debt instruments. This makes them a suitable option for investors seeking stability in uncertain market conditions.
- Tax-conscious investors: Since these funds are treated as equity funds for tax purposes, they offer a more tax-efficient way to invest in both equity and debt compared to pure debt funds. Investors looking for growth with tax benefits can benefit from an aggressive hybrid fund.
Conclusion
Aggressive hybrid funds are an excellent investment option for those looking to navigate the volatility of the stock market without exposing their entire portfolio to high risk. Their balanced allocation between equity and debt provides both growth potential and stability, making them a resilient choice during uncertain times. With tax benefits similar to equity funds and the ability to generate steady returns during market downturns, an aggressive hybrid fund stands out as a versatile and effective investment vehicle.
Additionally, factoring in the Cost Inflation Index when calculating returns ensures that investors account for inflation and maximise the tax efficiency of their investments. Whether you are a moderate-risk investor or someone seeking to balance risk and reward in a volatile market, aggressive hybrid funds can be a key component of your investment strategy.
