Smallcap rush pushes hybrid funds to sidelines, show slowest account growth

Hybrid mutual fund (MF) offers, expected to drive higher investor interest after the change in debt fund taxation, are set to end 2023 with the slowest account growth in the past three years.

Investment accounts in hybrid funds are up 5.7 per cent so far in 2023 compared with 7.6 per cent in 2022 and 20 per cent in 2021, shows the data from the Association of Mutual Funds in India (Amfi).

In 2020, the count had dipped 2.4 per cent.

While new account opening is showing sluggish growth, the flows have started picking up in some hybrid offers, especially those meant for institutional investors like arbitrage funds and equity savings schemes, and multi-asset funds, held up as the flavour of the season in 2023.

Net inflows into hybrid schemes in 2023 (as of November) stood at Rs 78,200 crore.

Arbitrage and equity savings accounted for 68 per cent of the total.

According to mutual fund executives, hybrid funds moved out of investors’ focus in 2023 because they were captivated by a red-hot equity market, especially the midcap and smallcap space.

“This year investors have been more comfortable putting money in equity funds, given the ongoing rally.

"This is evident in the record folio additions in smallcap funds.

"They are chasing returns and the market is also rewarding them,” said Niranjan Avasthi, senior vice-president and head, product, marketing and digital, Edelweiss MF.

Smallcap funds have added 5.9 million accounts, also known as folios, in 2023 so far as against 700,000 additions in hybrid schemes.

Balanced advantage funds (BAFs), the second-most popular hybrid offer, registered a 1 per cent drop in active folios to 4.4 million.

BAFs, along with aggressive hybrid funds, account for 77 per cent of the hybrid folios.

Multi-asset funds were the only bright spot as its folio count surged 68 per cent to 1.5 million.

Hybrid funds invest in equity and debt, with some categories even allowing exposure to commodities and arbitrage strategy.

These products, designed for investors who wanted to leave it to fund managers to do their asset allocation, gained a shot in the arm with the upward revision of debt fund taxation in March.

This made investing in hybrid funds more tax-efficient than investing separately in equity and debt funds.

Most hybrid funds qualify for equity taxation.

In anticipation of higher flows, MFs rushed to launch hybrid funds in 2023.

Fund houses have launched 11 schemes this year compared to five in 2022 and six in 2021.

The launches were largely in multi-asset and BAF categories with some fund houses coming up with balanced hybrid funds, a little-known category with no schemes until 2022.

Some fund managers have been recommending hybrid funds to investors in the present context, where equity valuations are above longer-term averages and at the same time bonds are attractive.

Investment advisors also concur with the view.

“We continue to believe that BAFs are a good option now.

"The automated rebalancing model between equity and debt helps with behavioural biases that could exist due to the recent outperformance of one asset class.

"Also, they are more tax-efficient than pure debt,” said Vishal Dhawan, founder and chief executive officer of Plan Ahead Wealth Advisors.

Hybrid schemes are expected to draw a greater interest once the market settles or the volatility goes up.

“Once the rally comes to an end and returns normalise, hybrid funds will likely see a surge in interest.

"Historically, hybrid funds have seen better flows when the market is volatile since their risk appetite goes down,” said Avasthi.