As their name suggests, aggressive funds target higher capital gain from the market by allocating more funds towards growth stocks. Usually, the higher risk of investing in these funds is offset by higher potential returns in the long run.
Aggressive mutual funds are hybrid funds located in the grey area between equity funds and debt funds, leveraging investment opportunities in both segments. Most hybrid funds vary in the percentages of allocating funds between debt and equity asset classes to meet the fund’s objective. However, to clearly distinguish between balanced hybrid and aggressive mutual funds, SEBI has identified the latter, where equity allocation can range up to 65 to 80% of the total corpus. Here we will discuss aggressive funds and the crucial factors you must know about these funds before investing.
What are aggressive hybrid mutual funds?
Aggressive mutual funds are hybrid funds, meaning these funds leverage investment opportunities in debt and equity asset classes. These funds invest 65-80% of the investable corpus in equities and equity-related instruments and 20-35% in debt securities and money market instruments. Usually, hybrid funds take a balanced approach and don’t take advantage of any arbitraging opportunities even if the fund manager is confident of making better returns. Aggressive mutual funds offer higher autonomy to fund managers in selecting investment avenues and instruments to earn higher capital gains. Hence, aggressive fund managers can take advantage of arbitraging options. Moreover, they can choose growth or value investing styles for selecting stocks and spread investment across securities with varying sensitivities as per changes in interest rates. It helps fund managers to disperse risk, which is why aggressive funds are less risky than pure equity funds, and at the same time, these funds have the potential to generate the same returns as equity funds in the long run.
Aggressive funds are growth investment schemes that are not risk-averse. In reality, these funds have higher betas and exhibit a strong correlation between price growth and volatility. Hence, these funds perform very well during market upswings and suffer significant losses during downturns.
Aggressive growth funds would invest in IPOs or initial public offerings, sell those for higher profit, and even explore investment options in the derivatives segment. If you plan to invest in aggressive growth funds, you must understand how these work.
How do aggressive funds work?
Aggressive growth funds invest in both asset classes together – equities and debt. These funds must invest at least 20% of the corpus in debt and FD-like securities to offer stability following SEBI rules. The major portion gets invested in equities and equity-related instruments. Hence, these are higher-risk funds than diversified funds.
As an asset class, equities can earn good returns and generate wealth for the investors in the long term. On the other hand, investing in debt instruments provides stability to the fund and generates regular income for the investors. Combining both, the aggressive hybrid mutual funds try to provide the best of both worlds through a single investment instrument. The equity component creates wealth for the investors when the equity market is booming, and the debt investments offer a cushion when the market is underperforming. However, one must be patient with their investment and have a long-term horizon to earn good returns.
Who should invest?
These funds are perfect for both new and experienced investors.
First-time investors: These funds suit investors who want to invest in equities for the first time but at the same time don’t want to assume the risk that comes with pure equity investment schemes. These funds combine debt investment to stabilize the portfolio and balance risks while generating returns from equity investment.
Investors with 3-5 years investment horizon: These funds are most volatile in the short run because of a high percentage of equity investment. Hence, investors must have a moderate to long investment horizon to see good returns. It will allow the fund to realize its full potential.
As retirement fund: Investors nearing retirement age can invest in aggressive funds to build a retirement corpus.
Aggressive hybrid funds aim to create regular income and long-term wealth generation by exposing the portfolio to debt and equity asset classes. Many investors consider these funds riskier than balanced hybrid funds. But, these funds can fit the investment goals of individual investors with a moderate risk appetite and an investment horizon of five years.
The risks associated with these funds are primarily arising from the selection of small and mid-cap stocks.
Common features of aggressive funds
All aggressive hybrid funds have some typical features.
High risk: These funds have high-risk exposure due to more weight given to equity investment. They are designed to perform when the market is rallying and may suffer significant losses when it corrects itself. Hence, risk-averse investors should avoid these funds.
Returns: The high risk of investing in these funds usually gets offset by the potential for higher returns. Allocating more funds to equity and equity-related instruments allows these funds to generate wealth in the long run. At the same time, the debt component offers stability and a cushion during a market downturn.
Financial goals: These funds are suitable for medium-term investment goals like buying cars or planning your dream vacation. However, higher exposure to equities also makes these funds volatile. You must note that your earning potential may suffer a blow while the market corrects itself or remain flat over a period. Hence, invest with a long-term investment plan to let the fund realize its full potential.
Cost: Investors need to consider the expense ratio of investing in the scheme to calculate absolute returns. Aggressive funds charge annual fees for providing fund management services. So, a higher expense ratio will cut into the profit earned from your investment. You can ensure a lower expense ratio by selecting direct investment plans.
Advantages of aggressive fund
There are a few advantages of investing in aggressive funds.
Diversification: These schemes offer proper diversification by selecting high-risk, high-return equities and low-risk, steady income debt funds. It ensures that returns do not solely depend on one asset class, like in pure equity funds. These funds let investors enjoy higher capital appreciation from equity investment while providing a cushion against market volatility through money market investment.
Ease: These funds eliminate the need for buying multiple stocks for diversification. It makes tracking portfolio performance easy. Professional fund managers manage your fund and move around to generate the best returns per market condition.
Automatic rebalancing: Aggressive funds allow rigorous rebalancing within the scopes of the funds. So, fund managers will allocate more funds towards equities for higher capital appreciation when the market rises. Similarly, they would rebalance the portfolio and increase debt investment in a bearish market.
Taxation: Aggressive funds are taxed like equity funds despite having debt exposure in the portfolio. It is because of more than 65% exposure in equities and equity-related instruments.
Lower volatility: Although we have said that aggressive mutual funds carry higher volatility due to their exposure to equity investment, these are still less risky when compared to pure equity investment. It is because of the debt investment component of the fund. When the market falls, the risk of the aggressive fund is limited to the equity portion. The debt component of the portfolio would provide a cushion and continue to earn income for investors.
Aggressive hybrid fund a taxation
Aggressive hybrid mutual funds are treated like pure equity funds in computing capital gain tax. Long-term capital gain is calculated if the investment period is more than one year. Any amount above the value of Rs 1 lakh is taxed at a 10% rate without indexation.
Short-term capital gain is realized on units sold before one year. The short-term capital gain tax rate is 15%.
Aggressive hybrid funds: Caveat applies
Aggressive hybrid funds are excellent for earning substantial returns from investing in equities and related instruments. When you select this scheme, the fund gets invested as per different market assumptions. These assumptions are further recalculated at various stages of the investment period. Hence, aggressive funds come with higher risks compared to the other growth funds. The primary objective of these funds is to leverage higher capital gains from equity investment. So, investors need to monitor the risk metrics of these funds regularly.
Mutual fund investors can learn about three risk metrics: standard deviation, Sharpe ratio, and Beta to compute various risk exposures of the funds.
Investors should note that these funds can perform very well or poorly depending on market conditions. In a bull market, aggressive funds can generate excellent returns while suffering significant losses during downtrends. It is because of high price instability. However, aggressive funds can generate superb returns, and hence, your portfolio should have limited exposure to these funds for wealth creation.
Where do the aggressive hybrid mutual funds invest?
Aggressive funds invest in stocks and debt instruments where the percentages for equity investment is between 65-80%, and debt investment is 20-35%.
Who should invest in aggressive mutual funds?
Aggressive funds should be a part of your portfolio because of their ability to generate superb returns from equity investment. These funds are suitable for investors who want to create wealth in the long run. It suits experienced investors and beginners alike who wish to gain exposure in the equity market.
Is there a lock-in period for investing in mutual funds?
Aggressive funds don’t come with a lock-in. You can redeem your units anytime you wish. However, if you withdraw it before one year, you will have to pay an exit load.
How much will I have to pay for the exit load?
An exit load is a fee the fund management company charges when investors redeem their units before one year. The rate varies between the companies but usually is around 1%.
How are these funds taxed?
Despite having exposure to deb instruments, aggressive funds are taxed as pure equity funds.
- Long-term capital gain tax: Applies at a rate of 10% on a capital gain amount above Rs 1 lakh for an investment period of over a year.
- Short-term capital gain tax: Applies at the rate of 15% on the capital gain for an investment period of fewer than 12 months.