Why does my wife invest only in a couple of Aggressive Hybrid funds and nothing else? 

I, being an enthusiast of mutual funds, tried to introduce my wife to the world of investments and mutual funds. I used to keep on watching mutual fund-related videos, hearing audiobooks and reading articles, and books wherever and whatever my eyes could lay on at times in front of her. I tried to discuss my new learnings with my wife during long drives or at bedtime but she used to get irritated by my latest obsession. And, she had a problem too – lack of disposable money. After leaving her job and choosing to be a full-time “housewife”, the only money she had is some old savings and the monthly money that I give her mostly to run the house. The monthly money that she receives is a paltry sum for many. And she is addicted to Nykaa, Myntra, and the likes. So, I doubted if she has a “Saving” mentality at all!

However, to my shock, one day she proclaimed that she started two “SIP”s for an unknown goal and for an unspecified time horizon most likely to be long-term. She planned to invest a few lump sums too along the way at opportune moments in the same funds. I was apprehensive about her selection as I thought she must be lured towards funds that gave unreal recent returns. I was pleasantly surprised when I realized that she chose two “Aggressive Hybrid Mutual Funds”.

I couldn’t resist asking her why she chose Aggressive Hybrid among the all categories. She asked me instead, “You tell me what few common traits of a good long-term portfolio are?” I silently started to prepare a checklist for a thought experiment:

a) It should be a diversified portfolio of Stocks and Bonds – it should have multiple asset classes.

b) If the portfolio is long-term, then it should have a large equity allocation as that is historically the most rewarding asset class.

c) The equity part of the portfolio should be broad market-based. There should be stocks from Large, Mid and Small cap companies and various industries and sectors. It should have a Flexi-cap/ Multi-cap structure.

d) The portfolio should not only focus on return rather it should give better “risk-adjusted return”. It should manage the downside well.

e) The debt part of the portfolio should have optimum “Credit Quality” without compromising yield, should not have “Liquidity Risk” and should be somewhat in the middle when it comes to “Interest Rate Risk”.

f)  Systematic rebalancing is a must to maintain the risk profile of the portfolio and to optimize the return. Systematic rebalancing entails periodic profit booking when the equity market is high and periodic investment when the market is low.

g) Portfolio must be low effort and cost to maintain.

h) Portfolio should provide an optimum tax-adjusted return as that is the real rate of return.

      Overall Portfolio composition: 

      I remembered something that I read a long time ago – Modern Portfolio Theory (MPT). It was advocated by economist Harry Markowitz in 1950. MPT advocates the diversification of securities and asset classes. It believes in not putting all the eggs in one basket. MPT says stocks may be most rewarding but face both systemic risks - market-related risks such as interest rates and recessions, as well as un-systemic risks—issues that are specific to individual stocks. MPT helps to design an ideal portfolio that will provide the investor with maximum returns by taking on the optimal amount of risk.

Notice that the 100% bond portfolio and 50% bond-50% stock portfolio have very comparable volatility but contrary to popular belief, the latter is more rewarding in terms of Returns. So, according to MPT, a 100% bond portfolio is risky and provides a sub-optimal return. And 100% stock portfolio may be most rewarding but very volatile. So they are both non-ideal. An efficient frontier of better risk-adjusted return lies somewhere between the 40% bond 60% stock, 30% bond 70% stock, or 20% bond 80% stock area. The ideal mix for an individual though depends on the risk tolerance of the given individual. 

Let us look at the asset class mix of the few aggressive funds of some renowned asset management companies (AMC). In light of MPT, we notice they are very similar and they all fall in the Efficient Frontier area. Allocations slightly differ based on their opinion of the market based on their market research.

	28-Feb-2023			31-May-2023
	ICICI Pru Equity & Debt Fund(G)	DSP Equity & Bond Fund (G)	Mirae Asset Hybrid Equity (G)	ICICI Pru Equity & Debt Fund(G)	DSP Equity & Bond Fund (G)	Mirae Asset Hybrid Equity (G)
Equity or Equivalent	75.50%	73.70%	73.30%	71.90%	74.35%	70.50%
Debt or Equivalent	22.20%	25.20%	23.50%	19.80%	24.75%	25.20%
Cash Equivalent	02.30%	01.10%	03.20%	08.30%	0.90%	04.30%

    

The Nifty 50 was at 17,304 on 28 Feb 2023 and at 18,534 on 31 May 2023. We notice most of the AMCs did profit booking when the equity market rose. This is a clear sign of rebalancing.

       Let us now update the checklist with what we have seen so far:

SL#	Items	Verdict
a	Diversified portfolio across multiple asset classes – stocks (equity) and bonds(debt)	☑
b	Large equity allocation based on Efficient Frontier	☑
c	Diversified equity portfolio
d	Optimum risk-adjusted portfolio return with optimum volatility	☑
e	Debt portfolio should provide optimal yield by managing the risks - “Credit Risk”, “Liquidity Risk”, and “Interest Rate Risk”
f	Periodic rebalancing	☑
g	Low cost and low effort to maintain
h	The optimum tax-adjusted real rate of return on the overall portfolio

 Equity Investment

Now let us dig deep into the Equity portfolio of a few aggressive hybrid funds:

Market cap split (%)

	Percentage as part of whole Equity & Debt Portfolio			Percentage as part of only Equity Portfolio
	ICICI Pru Equity & Debt Fund(G)	DSP Equity & Bond Fund (G)	Mirae Asset Hybrid Equity (G)	ICICI Pru Equity & Debt Fund(G)	DSP Equity & Bond Fund (G)	Mirae Asset Hybrid Equity (G)
Large Cap	63.43%	43.62%	54.79%	88.20%	58.68%	77.72%
Mid Cap	04.71%	19.11%	08.18%	06.55%	25.70%	11.60%
Small Cap	03.77%	11.62%	07.52%	05.25%	15.62%	10.66%
Total Equity	71.91%	74.35%	70.49%	100%	100%	100%

As on 31-May-2023

Top 10 sector holding (%)

Now I realized that equity parts of the Aggressive Hybrid funds are diversified across market caps and sectors.

Fun Fact: When inspecting closure, one might find a startling resemblance between Flexi Cap of an AMC and the Aggressive Hybrid’s Equity portion of the respective AMC. Many AMCs have the same Fund Managers too for their Flexi Caps and Aggressive Hybrids (DSP/ Mirae/ Canara Robeco). However, this is not true for all. Say, ICICI’s Equity part of their Aggressive Hybrid looks more like a Large Cap fund.

Let us now update the checklist with what we have seen so far:

SL#	Items	Verdict
a	Diversified portfolio across multiple asset classes – stocks (equity) and bonds(debt)	☑
b	Large equity allocation based on Efficient Frontier	☑
c	Diversified equity portfolio - across market caps and sectors	☑
d	Optimum risk-adjusted portfolio return with optimum volatility	☑
e	Debt portfolio should provide optimal yield by managing the risks - “Credit Risk”, “Liquidity Risk”, and “Interest Rate Risk”
f	Systematic rebalancing – periodic profit booking and investment	☑
g	Low cost and low maintenance
h	The optimum tax-adjusted real rate of return on the overall portfolio

Debt investment:

Now let us examine the debt parts of the same three Aggressive Hybrid funds:

As on 31-May-2023

- The debt part of the portfolio should have a mix of papers in terms of Credit Quality. A large portion should be in the highest quality papers (AAA/AA+) but could also have upper medium grade papers (AA-, A+, A, A-) in strict moderation for better yield/ return.

- Debt part should also have a substantial amount of Government Securities (SOV) for Liquidity.

 

To calibrate the Duration Risk/ Interest Rate Risk, let us look at the below table:

	ICICI Pru Equity & Debt Fund(G)	DSP Equity & Bond Fund (G)	Mirae Asset Hybrid Equity (G)
Average Maturity	6.49 Years	2.62 Years	4.14 Years
Modified Duration	1.20 Years	2.22 Years	3.06 Years
Yield to Maturity	7.73%	7.38%	7.52%

As on 31-May-2023

- Debt part also should be somewhat in the middle when it comes to Interest Rate Risk. Liquid, ultra-short-term bonds carry low-interest rate risk but provide sub-par yield. Long-term papers give better yields but punishing during the rising interest regime. The debt part of the entire portfolio needs to be in the middle which will give an all-season bond flavour.

Here, Yield to Maturity is around 7.50% on average with middle-of-the-road - 2%-3% interest rate sensitivity. I can’t complain about such compositions.

Fun Fact: I realized that debt parts of the Aggressive Hybrid funds of any AMC have an uncanny resemblance with Short Duration Debt Fund or Medium Duration Debt Fund of the respective AMC. 

Let us now update the checklist with what we have seen so far:

SL#	Items	Verdict
a	Diversified portfolio across multiple asset classes – stocks (equity) and bonds(debt)	☑
b	Large equity allocation based on Efficient Frontier	☑
c	Diversified equity portfolio - across market caps and sectors	☑
d	Optimum risk-adjusted portfolio return with optimum volatility	☑
e	Debt portfolio should provide optimal yield by managing the risks - “Credit Risk”, “Liquidity Risk”, and “Interest Rate Risk”	☑
f	Systematic rebalancing – periodic profit booking and investment	☑
g	Low cost and low maintenance
h	Optimum tax-adjusted real rate of return on the overall portfolio

Cost and Maintenance:

Aggressive Hybrid funds automatically rebalance so they effectively require zero maintenance. Good aggressive hybrid funds are available in expense ratios between 0.50%-1.0% in direct plans. In India, even Nifty index funds cost between 0.20%-0.40% so the pricing of Aggressive Hybrids is super competitive. They are more attractive because of taxation though.

Tax-adjusted return:

Now, debt funds attract tax rates as per slab rate (as high as 30% for most) from 01-Apr-2023. Before that only if held for more than 3 years it used to get 20% taxation with indexation benefit. But now that is history.

Whereas Aggressive Hybrids get favourable tax treatment i.e. once held more than 1 year, taxation will be 10%  else if held less than a year, taxation will be at 15%. That is de facto equity taxation on the bond component which is a huge benefit. Penny saved is a penny earned. So, the real return on the portfolio will be boosted.

 

Let us now update the checklist for the final time:

SL#	Items	Verdict
a	Diversified portfolio across multiple asset classes – stocks (equity) and bonds(debt)	☑
b	Large equity allocation based on Efficient Frontier	☑
c	Diversified equity portfolio - across market caps and sectors	☑
d	Optimum risk-adjusted portfolio return with optimum volatility	☑
e	Debt portfolio should provide optimal yield by managing the risks - “Credit Risk”, “Liquidity Risk”, and “Interest Rate Risk”	☑
f	Systematic rebalancing – periodic profit booking and investment	☑
g	Low cost and low maintenance	☑
h	The optimum tax-adjusted real rate of return on the overall portfolio	☑

  

###############

I came back from my thought mode, and asked “What about Commodity allocation?” My wife casually replied: “I have enough gold ornaments”.  I asked “What about international allocation?” “What about index funds?” She nonchalantly replied, “Enough of your whataboutery, one cannot get every investment idea implemented in one’s portfolio”. She continued, “I can also ask what about favourable tax treatment on the entire portfolio”. I am speechless now. My whole life was a lie. I hid my face in the newspaper and concentrated on the hot tea instead.  

###############

Value Research Success Story: Bahubali Investor