Newsletter - march2014

Hybrid mutual funds schemes are a convenient option for those who want to diversify their investments across asset classes. These funds include both equity and debt schemes preferable for investors with a moderate risk profile. Thedebt component provides a steady income and cushions the portfolio returns from slipping (capital preservation) when the markets are down while the equity component accelerates the gains(capital appreciation) when the markets are in an upswing. There are two of hybrid mutual funds:

Monthly Income Plans (MIPs):These plans have a greater exposure to debt (70-100%) and a relatively lower exposure to equities (0-30%). Based on their equity cap, MIPs can be further divided into conservative and aggressive plans - investing up to 15% of the corpus into equities is considered as conservative and up to 30% as aggressive. MIPs are less risky than pure equity funds but slightly more risky than pure debt funds. Investors should however note that the schemes are not obliged to provide any ‘monthly income’; instead, the income is paid out as dividends purely dependent on the schemes. distributable income and other relevant factors

Balanced funds: These funds generally invest in the range of 65% to 75% in equity and the remaining in debt; investors with a slightly higher risk profile may find this more attractive. Equity component offers the potential for higher capital appreciation while the debt component is likely to act as a buffer at times when the equity market turns volatile.

Diversification– One of the major benefits of hybrid funds is diversification. These funds help tomoderate the effects of individual asset class performance on the portfolio’s value, especially during uncertain times.

Asset allocation is automatic and tactical– Holding equity and debt portfolios separately can be operationally tedious, and involve costs and tax implications. Further, one may not be able to tactically adjust equity allocation as per market movement. Hybrid funds offer a solution in a single structure.The fund managers in charge of these funds are well-equipped to take a tactical call based on market movements.

Tax benefits- Most balanced funds in India have an average 65% exposure to equities which allow them to be taxed like equity funds (no long term capital gains tax; 15% short term capital gains tax plus applicable surcharge and cess). For those funds where the average equity exposure drops below 65%, the tax treatment is similar to debt funds (income tax slabs to be used for short term capital gains tax and long term capital gains tax). A dividend distribution tax is deducted if investors opt for the dividend plan of MIPs. Compare this with bank fixed deposits (FDs) which are taxed at individual income tax slab rates for all time periods.

Bernstein continues, "There is no greater cause of mischief to the small investor than the confusion between the health of the economy and stock returns. It's natural for people to assume that when the economy is in good shape, future stock returns will be high, and vice versa. The exact opposite is in fact true: Market history shows that when there's economic blue sky, future returns are low, and when the economy is on the skids, future returns are high."There is also the related paradox that the more enthusiastic people are about stocks, the worse that stocks tend to perform. Bernstein relates the story of Joseph Kennedy Sr., who claimed to have exited the stock market when the shoeshine boys started giving him stock tips. Conversely, BusinessWeek's famed The Death of Equities cover was printed three years before the beginning of a 30-year bull market.Bernstein reminds us how in the late 1990s, people thought that the internet would change everything. It did, but it didn’t help the economy that much, and over the next decade stocks suffered not one, but two bone-crushing bear markets that resulted in more than a decade of negative real returns.The message is that novice investors fare best when wax is stuffed in their ears. The sooner they learn to ignore what they hear, and just let the portfolio run its course, the better off they will be.

Hybrid mutual funds offer a mix of growth and income and come with a plethora of advantages. But do remember, that like any other financial instrument, they are subject to market risks. Investors are thus advised to invest in funds that suit their investment objective, risk profile and returns expectations.