Monday, January 07, 2008

FUND FLAVOUR Balanced Funds


Balanced Funds
Balanced Bet!

Does the fear of losing your money stop you from investing in the stock market? Then a mutual fund is a better bet. But by investing in both shares and fixed-return investments, balanced funds that seek the best of both worlds, is the best bet. They include the power of equities (shares) and the stability of debt market instruments (fixed return investments like bonds) and are most likely to take you to your goal safely. What makes balanced funds such a powerful investment tool is their inherent design, which allows them to maintain an effective balance between debt and equity.

Heroic Hybrids!

As the name suggests, hybrid funds are those funds whose portfolio includes a blend of equities, debts and money market securities. Balanced Funds, Growth-and-Income Funds and Asset Allocation Funds are the many flavours of hybrid funds. But balanced funds provide the most straightforward combination of exposure to both stocks and bonds. The balanced fund’s mandate is to generate conservative returns. These funds achieve this by parking 65 per cent (to enjoy the tax benefits of being an equity-oriented fund) to 80 per cent in equities (a slight deviation to take the maximum advantage of the performing asset class). Balanced funds are generally meant for a class of investors who are risk averse - returns from equities are veiled under the safety net provided by debt. This category of funds uses a balance of equity and debt investments to act as a hedge in the event of a downturn in either of the markets. They seldom fall at the battlefield!

The royal rebalancing act…
A rational investor needs to periodically review the performance of his portfolio and rebalance it as and when required and book profits, in tune with his risk appetite. Such an act of rebalancing may be required even if the original investment was made in accordance with a well-conceived plan and he does not deliberately increase his exposure to equities (equity investments appreciate over time). Tough as it might be (to redeem in a rising market), rebalancing imposes discipline and ensures that the portfolio remains diversified. Selling and buying equity funds at appropriate intervals attract transaction costs (STT and loads) and taxes reducing the returns. The crucial role of Balanced funds come into play - they continuously, cost-effectively, effortlessly (on your part!) and diligently (uncanny ability of the fund manager) rebalance the portfolio to ensure that the broad asset allocation is not disturbed. The balanced funds have 65% of their assets allocated to equity and so there is no tax on long-term capital gain as equity schemes are exempt from long-term capital gains tax and are subject to only 10% tax on short-term capital gains. You may rest assured that the profits earned from the stock markets are being encashed and invested in low risk instruments. Rebalancing is an effective way to increase the potential long-term return of a portfolio, while minimizing risk.

Retrogressing at times….

The following scenario is not atypical: A novice in the investment jungle with Rs. 5,000 to spend wants a stand-alone investment that spreads risk, protects capital and provides growth opportunities. Balanced funds score high on all counts, but are they as good in action as they are on paper?

  • Balanced funds tend to lag equity funds during a bull market.

  • While bonds give balanced funds more stability, they have their own risks. In general, the longer the bonds' maturities, the higher the interest-rate risk. Long-term bonds usually pay higher interest rates than short-term bonds, but if rates rise, a fund dominated by long-term bonds is locked in at a lower rate of return.

  • While balanced funds as a group are known for their stability, certain funds change the weightings in their portfolios radically and quickly. They indulge in over-exposure to equities with a view to earning superlative returns.
…but revered to this day

Balanced funds invest across equity and debt markets which leaves them well placed to serve three objectives:

  • Shift across asset classes based on the best available investment

  • Use the debt component intelligently to de-risk the equity portfolio during volatility in equity markets and salvage returns when the equities head south.

  • Book profits in equities regularly which again de-risks the equity portfolio by capping the level.

Balanced funds have proved their worth time and again and rewarded investors with reasonable returns and stability. The returns may not be as flashy as diversified equity funds, but balanced funds are the ultimate vehicle for long-term growth for the moderate risk taker. They will save you from bumpy rides and ensure a soft landing. In a falling market, when being fully invested in equities can prove perilous, a balanced fund with a 35% debt component might just be what the doctor ordered. Think of them as a good hedge against an overheated stock market or a global recession. They unrelentingly maintain composure of the riskiest asset class. History is on our side. Good old balanced funds!

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