FUND FLAVOUR
January 2011

Balanced is better

What matters in long term investing is identifying consistent funds with balanced risk-adjusted returns and not what is “in” or “out” of fashion.

Almost all of us want to achieve a fine balance in everything we do in life. It is difficult for most people to dispassionately act on their investments. This is where balanced funds pitch in.

The USP

The unique proposition of spreading investments among two broad asset classes is hard to find in other types of funds. The higher equity allocation gives these funds the opportunity for high growth, while the debt component provides a cushion when the equity component fails to perform. At the same time, the same debt allocation pulls the fund's return lower during a bull run, since these funds are not fully invested in equities. The best balanced funds keep allocation flexible and open to changes as demanded by market conditions (but subject to regulations).

Right side of the balance…

Advantages abound in balanced funds.

Switching: Their key advantage is the ability to switch from a high equity allocation when the market is bullish to low equity allocation when the market turns bearish.

Diversification: These funds offer diversification in the true sense, with a portfolio of stocks and bonds, thereby, offering a blend of growth and safety.

Less volatility: Balanced funds have the lowest downside standard deviation, a measure of volatility.

Hassle-free: You do not have to take the trouble of managing an assortment of investments yourself. One fund does it all.

…and the left

But, is there any downside to balanced fund investing? Yes, there is.

Uncertainty in asset allocation: Since there is both the equity and debt component in the portfolio, and their performance is not disclosed separately, you are not sure about the performance of the equity and debt portions. It can be that the equity portion is doing well but the debt portion may give a mediocre performance. One can never be sure of this. One cannot specify the equity-debt mix. This will be determined either by the law or the fund house.

Active-management risk: The active-management risk can get amplified because the fund's exposure to equity or debt is a function of the fund manager's view about the direction of equity markets.

Objective mismatch: Such funds may have bonds of lower tenure. Long-term bonds earn significantly more than short-term ones.

Scintillating secular growth

Between December 2007 and 2010, the average equity-oriented balanced fund posted 4.76% returns compared to the 1.72% earned by the equity diversified category. Astute stock picking was certainly behind this stellar performance. An aggressive exposure to small- and mid-cap stocks helped HDFC Prudence grow by 29.98% in the past one year, which is better than what the average equity fund earned during the period. But much of the credit also goes to the asset allocation mix that balanced funds have to follow. Equity funds have to mandatorily invest up to 80% of their corpus in stocks. On the other hand, equity-oriented balanced funds can reduce their exposure to stocks to as low as 40% of their portfolio. This flexibility of asset allocation allowed balanced funds to pare their equity allocation during the 2008 meltdown and protect themselves against the downside. Reliance Regular Savings Balanced, the best performing hybrid fund in the past three years, has churned its portfolio considerably.

An analysis of the top three funds in the balanced fund category and returns in the last five years shows that Rs 100 invested five years ago in HDFC Prudence Fund (G) would have become Rs 281 now, Rs 100 invested five years ago in Canara Robeco Balance (G) would have become Rs 265 now, and Rs 100 invested five years ago in DSP BlackRock Balanced Fund (G) would have become Rs 261 now. HDFC Prudence Fund (G) has invested 71.40 % in equity, Canara Robeco Balance (G) has invested 69.33 % in equity, and DSP BlackRock Balanced Fund (G) has invested 71.18 % in equity. How much can they fall in full fledged bear market? Between Jan 1, 2008 and Nov 1, 2008, HDFC Prudence Fund (G) lost 45 percent in NAV, Canara Robeco Balance (G) lost 43.3 percent in NAV and, DSP BlackRock Balanced Fund (G) lost 39.3 percent in NAV. But still they have given a return of more than 160% (absolute in last 5 years).

Cushion for the core

The Sensex is running like a speeding train and you want to take full advantage of the bullrun while avoiding the risks. You cannot totally avoid the risk but you can go for medium risk options like balanced funds. For conservative investors, balanced funds are a sensible balancing act that lets them sleep better in turbulent times. A balanced fund is best as a core investment for investors who want exposure to equities but have some lingering concerns about them. With a typical mix of around 60 percent stocks and 40 percent fixed income, balanced funds split the difference between growth from stocks and income from bonds. Each portion has different managers, providing an investment that functions like two separate funds in one. Investing in this product helps to achieve your goals safely. There is cushion from investing in debt which creates minimum return for investors. For some investors, this risk-reducing hybrid provides one less thing to worry about. For others, however, it represents just half a loaf because it will never supply the euphoric results of a rousing stock market rally. Being cautious is smart!