Balanced Funds

A simple yet efficient approach to investing is through investment in balanced funds. It is also an asset allocation approach to investing where investments are done in two asset classes, namely equities and debt, under the same portfolio. Hence, instead of investing in separate debt and equity funds, balanced funds combine both asset classes in a common scheme. This unique combination also offers the best of both worlds to investors.

Balanced funds invest around 65% in equity stocks, and the remainder in debt instruments. On average around 70% of assets were invested in the equity market by balanced funds. When interest rates are high, a fund manager may increase the allocation to debt securities to take advantage of higher bond yields. Similarly when equity valuations drop fund managers reduce exposure to debt, and may increase the fund’s exposure to equity. Thus, balanced funds provide investors a hassle free way of asset allocation.

Every investor is unique in terms of expectation of returns, risk preferences, investment horizon, liquidity requirements, and so on. An asset allocation decision is ideally made only after considering all these parameters. Strategic or tactical asset allocation among different asset classes by itself can account in large part for a portfolio’s overall performance. Generally speaking, risk averse or conservative investors lean towards products that given steady returns and have a negligible probability of capital loss. On the other hand, aggressive investors with a high risk appetite expect higher returns, albeit with the possibility of capital loss. Risk preference and returns expectation is subjective and dynamic factors. Balanced funds therefore aim to provide investors with the return potential of equity, along with the safety of debt.

Tax efficiency is a major advantage of balanced funds, as they are considered equity oriented funds for tax purposes. So if the investor receives dividends from a balanced fund, it is entirely tax-free. The same goes for long term capital gains in balanced funds, while short term capital gains are taxed at the rate of 10%. In a debt fund, on the other hand, short term capital gains are taxed at the rate of 30% and long term ones at 10%. This means that the debt component of a balanced fund is taxed like an equity fund.

Balanced funds are amongst the oldest categories of mutual fund offering in India. The total corpus of balanced funds stood at Rs 6795 crore divided among 16 schemes currently in 2007. Although assets under management in balanced funds have tripled in the past three years, one needs to take a closer look at these numbers. A major portion of the jump in corpus is due to the strong performance of the equity indices, which resulted in significant mark to market gains for all balanced funds. For instance, the NAVs of balanced funds jumped 147% over the past three years, which means that just over one-fourth of the jump in the corpus is due to fresh investments. Balanced funds have failed to attain popularity despite their long existence and the continuing bull run in the Indian equity markets. This is not surprising as most savvy investors tend to invest directly in diversified equity funds rather than balanced funds, to maximize gains in bullish markets.

Balanced funds have fared well, outperforming their benchmark, the Crisil Balanced Fund Index, by a considerable margin. The recent performance of balanced funds is also notable, with 35% returns on an average in the past year, as against a 33% rise in the benchmark. The long term performance of most balanced funds has been superlative, too, with average returns of 147% and 375% on a three and five year basis, against returns of 116% and 239% returns on the Crisil index.

A common criticism of balanced funds is that they are not really necessary, as investors can do their own asset allocation by putting a certain portion of their money in equity funds, and the rest in debt funds. So, the question arises: why should people invest in a balanced fund and pay a load on the debt component? A balanced fund is therefore more expensive than doing your own asset allocation. Besides, balanced funds tend to under perform the broad indices during bullish phases.

Balanced funds are a safe refuge for investors who are conservative in their expectations of both risk and return. With the BSE Sensex crossing several important peaks in a short period and touching an index level of 19,000, the risk of a rapid fall remains in the system. Those already invested in balanced funds should stay put, if they are more comfortable n a lower risk zone than a diversified equity fund. Relatively young investors with a high risk profile and a long term investing horizon would probably do better to invest in diversified equity funds.