Equity Vs Hybrid Funds

With two years of weak markets, it’s a good time to ask a simple question: did hybrid funds that promise a smoother ride protect investors better than pure equity funds? Let’s find out.

Know The Categories First

Large-cap funds put at least 80 per cent of their money in the top 100 companies by market capitalisation. These are the biggest and most established names. They are widely researched and easy to trade, so they are usually the least volatile among equity funds, but not always. Large companies fall too.

Mid-cap funds invest in companies ranked 101 to 250. These may be tomorrow’s large caps. Some will graduate to the top league. Some will stumble on the way. Growth potential is higher, and so are the falls when markets turn.

Small-cap funds go beyond the top 250 companies. This gives the fund manager a wide canvas. Many of these companies are thinly traded and lightly researched. A right call can pay handsomely. A wrong call can hurt just as much. Higher return expectations come packaged with higher volatility.

Multi-asset allocation funds (MAAFs) must invest in at least three asset classes, with a minimum of 10 per cent in each, as per the Securities and Exchange Board of India (Sebi). Typically, these are equity, debt, and gold. Different assets rarely fall together, so this is the most diversified portfolio on the list.

Aggressive hybrid funds hold 65 per cent to 80 per cent in equity, and the remaining in debt. It is mostly an equity fund with a cushion to soften the fall, but does not remove the risk.

Balanced advantage funds (BAFs) are mostly equity, but the manager hedges part of the equity exposure dynamically. The idea is to cut risk when markets look expensive and add it back when they look cheap. The promise is lower volatility than pure equity.

2-Year Performance

A quick look at the numbers show that MAAFs performed the best in the 2-year period (see 2-Year and 8-Year Return Till September 2026).

• While the market gave negative returns over the last two years, at the Nifty/Sensex level, small-cap funds have given better results.

• Large-cap funds have given negative returns, but relatively better than the Nifty/Sensex.

• Mid-cap fund performance is somewhere between large and small-cap fund performance.

• The performance of MAAFs proves the age-old point of portfolio allocation.

• BAFs have given marginally negative returns. Though it is better than large-cap funds, it has not outperformed mid- or small-cap funds. Hence, over the last two years, the concept of actively hedging a part of the equity portfolio has not really played out.

8-Year Performance

Two years is a short window to judge any fund. It is just one market phase. Let us stretch the lens to eight years.

The reason: Sebi issued its fund categorisation circular in October 2017, and it was implemented in early 2018. Before that, funds’ composition with the same label could look very different. So comparisons would not be like-for-like.

When considering 8-years performance (see 2-Year and 8-Year Return Till September 2026), the order flips. Small caps lead, mid caps follow, and large caps sit near the bottom. Small caps beat large caps by more than 8 percentage points a year. Over time, the risk was rewarded.

That is not a licence to load up on small-cap funds. We covered this earlier in Outlook Money (https://bit.ly/4BvPvKY). Eight good years do not cancel the bad stretches you must sit through along the way.

Among hybrids, MAAFs again came on top. They beat aggressive hybrid and BAF. But note that they did not beat mid- or small-cap funds. They offer a decent return with less drama. That is a different but a valid promise.

BAFs finished last of all six. Over a long period, the hedging gave up more upside than it saved on the downside. BAFs lower the volatility and deliver moderate returns. If that is what you want, it is fine, but do not expect them to compete with equity over the long run.

The Fund Manager Risk

Everything so far is category averages. Averages hide a lot. Look at the gap between the best and worst fund in each category (see Annualised Returns And Category Dispersion Over 2 Years).

In small caps, the best fund returned 9.63 per cent a year and the worst lost 5.00 per cent. In large caps, even the best fund was negative. In BAFs, the worst fund lost 8.42 per cent a year, worse than the average large cap fund. Same category, same market, but very different outcomes. The difference is the fund manager. Pick the wrong fund and the category label will not save you. That is the fund manager risk.

The Passive Answer

Index funds and exchange-traded funds (ETFs) remove that risk. They simply follow the index. You give up the chance of beating the market or lagging behind by a wide margin. Given the spreads above, that is a trade worth thinking about.

Not every category has a passive option. BAFs are by definition actively managed, so there is no index to track. But for the core equity portion of your portfolio, an index allocation deserves a place in your plan. One caution: an index fund falls with the market. It reduces manager risk, not market risk.

The Takeaway

Three things stand out from the data. Hybrids helped under weak markets, but not all hybrids. MAAFs delivered, but BAFs did not. The longer view can favour mid and small caps, for those who can stomach the volatility. Choosing the fund matters as much as choosing the category.

So, check the track record, not just the label. Then pick the category, the fund, or the index, in that order.

By Joydeep Sen Corporate Trainer and Author