Monday, January 07, 2013


January 2013


Traditionally, Indians are great savers but are very conservative and rather reluctant investors too. As per the data released by the Reserve Bank of India (RBI), about 47% of the household savings in India lay in deposits with banks. Contribution of equity assets, in the total financial assets of the household sector is very low - about 12%, which is much lower when compared against the global standards (especially the developed markets). The primary reason for this is, the element of uncertainty involved in equity, which makes many investors uncomfortable and stay away from it. The mighty bull phase of 2002-08, however, had changed the perception of many investors towards investing in equity assets. But only a few early movers, who invested at the onset of the bull market, reaped the benefits. Having witnessed their success, others too started looking upon equity asset class as a hot cake. Unfortunately, some entered during the fag end of a multi-year bull phase and they felt the blow when the negative ripples of the U.S. sub-prime mortgage crisis had adverse repercussions on the Indian equity market. At present, although markets have recovered from the slump, they have generated no real returns for many investors over the last five years. Memories of the bear market are yet to fade from the minds of investors. Having burnt their fingers, retail participation in equity markets, not to mention equity mutual funds, recently fell to a seven year low.
Start off on a good note…

If you are one of those who have not yet invested in equity mutual funds, although risk profile allows you to invest, fearing the topsy-turvy rides of equity markets, then you ought to rethink to obtain effective real returns over the long-term. While your proclivity to be invested only in fixed income investment avenues may help you safeguard against the implied volatility of equity markets, you may not be able to generate the desired wealth over the long-term by secluding equities. If you find yourself confused in choosing between safety and returns then you could find solace in "balanced funds". 

The buzz was "balance" in 2012, and the term as it applies to mutual funds is just as it sounds, holding both stock and bond positions in one convenient wrapper. The theory is reduced volatility, and the attendant reduced return, but investors do not mind too much if it smoothes out the ride. Today we are facing considerable headwinds on the global and domestic front. High interest rates, geopolitical tensions, fears of a resurgence of inflation are some of the red flags and balanced funds could be a relatively safer haven for new entrants into the stock market.

What exactly is a Balanced Fund? 

Balanced Fund is a category of mutual funds which invests both in fixed income instruments as well as equities in different proportions. Allocation to debt and equity depends on factors such as the outlook for equities, valuations, inflationary pressure, and interest rate scenario among others. But generally, in order to qualify as equity oriented funds (which make their tax treatment favourable), balanced funds allocate 65% of their total assets towards equity and 35% towards debt. 

Facts in favour…

The first benefit which balanced funds offer is a set asset allocation - generally ranging between 65% and 75% in equity and the rest in debt and cash. However, extraordinary market conditions would not deter the fund manager to go beyond these limits or reduce the exposure to a particular asset class. 

In addition, balanced funds provide the benefit of diversification within each asset classes i.e. equity and debt. So, within equity you benefit from wide diversification across stocks and sectors, while in debt, across fixed instruments and maturity of papers. Moreover, the hybrid nature of the product allows the fund manager of a balanced fund to increase exposure towards debt investments when outlook appears favourable to do the same, thereby, facilitating in mitigating the risk (associated with equities) and rewarding investors with appealing returns. More often than not, balanced funds are more conservative in their approach than a plain vanilla equity fund which runs with a sole objective of profit maximisation. A balanced fund, as the name suggests, tries to strike a balance between risk and returns by taking optimum exposure to debt as well as equity and they are less risky and volatile than pure equity funds. This conservative approach helps balanced funds deliver steady returns to investors across market cycles. This may, to an extent, boil down your concerns about investing in mutual funds. 


Balanced funds can also be the ideal vehicle to help meet critical financial goals. Given the stability offered by these schemes, you can invest in them to fund short- to medium-term goals without worrying about market risk. Running a SIP in these schemes will enable you to safely build a sizeable corpus over three to five years and meet your financial targets.

In terms of taxation, the balanced funds that invest at least 65% in equity are treated at par with equity investments and attract no tax liability on capital gains if held for more than a year. The debt-oriented funds come under the debt fund category, where capital gains are taxable. This means that even the equity portion of the fund gets taxed. However, these are eligible for indexation benefits (capital gains adjusted for inflated cost of purchase), attracting a lower taxation (10% without indexation, 20% with it) if held for more than a year.

On the flip side…

Fund managers have limited freedom as 65% in equity is the minimum requirement to take benefits of taxation. So even if the fund manager feels that minimum equity exposure is beneficial for the portfolio he cannot do it.

Partial withdrawal is a big problem with balanced funds – think of a situation when you need some amount for your emergency need but you have parked your whole amount in balanced funds. As you do not have any choice you will redeem from balanced funds and that means, for every redemption of Rs 100 you are actually redeeming Rs 65 from equity and Rs 35 from debt. Even if you are long term investor in equity, automatically your equity gets redeemed. In case of proper asset allocation, you could have avoided this.

You have limited choices. If you want to have exposure to midcaps or only large caps, this is not possible with balanced funds as you cannot dictate your terms to fund managers.

How have they fared? 

Balanced funds as a category have generated decent returns across time periods. Although they have not outperformed the category of pure equity funds or broader market indices in absolute terms, they have not trailed by a big margin either. On the contrary, they have been a lot more stable (in terms of the risk as revealed by the Standard Deviation of 3.88%) than the pure equity funds (standard Deviation of 5.16%). Thus the risk-adjusted returns too have been superior in case of balanced funds, and they have also managed to outperform some of the key indices. Balanced funds have delivered superior risk-adjusted returns, outperforming pure equity funds over three- and five-year time frames. Balanced funds typically outperform the markets during downturns, but that they lag behind during rallies. It underscores the fact that you need to be invested in a balanced fund for a long period of time in order to benefit from its asset rebalancing structure.

Best of both worlds

When you invest in an equity fund, your equity risk is diversified. This is because numerous investors like you invest in the same fund. When the investment call is taken by the appointed fund manager he uses his market knowledge to select and invests only in cherry picked equity stocks. The principal objective of a debt fund is preservation of capital followed by generation of income on the capital invested by you. Now if you want to get the best of both worlds, you may choose the third option of mutual funds i.e. balanced funds. These are built out of a combination of both worlds, viz., equity world as well as debt world. Both are generally combined in the ratio of 65:35, where 65% is allotted to equity portfolio (shares) and remaining is debt (fixed return investments like bonds). Conventionally, certified financial planners have usually suggested that first-time investors use balanced funds as their preferred vehicle. Such funds, which straddle the equity as well as debt space, are viewed as a compromise solution suitable to those who are gingerly approaching the stock market. They are in particular a good starting point for novice investors because they tend to be a lot more consistent during the bearish market phases but still generate decent returns in market upswings. However, not all balanced funds are similar in performance. As mentioned earlier, very few manage to beat broader equity markets or give satisfactory performance in bull market cycles. This entails that you have to be careful while choosing a fund for investments, because as an investor you may not be satisfied only with your fund falling by lesser margin. You would want your fund to generate decent, positive returns during the market upswings. Assessment of available options would make your journey smoother.

 …to end on a good note!


The stock market has delivered single-digit returns in the past five years. The BSE Sensex has given 2.74% annualised returns amidst bouts of volatility. But what if you had mixed some bonds (or fixed income instruments in market parlance) with your equity investments? Well, you have fared a little better. According to Morningstar India, a mutual fund tracking entity, balanced funds as a category delivered annualised return of 5.02% in the five-year ended December 31, 2011, leaving behind large-cap equity funds (3.16%) and small- & mid-cap equity funds' category (2.97%). Those capable of stomaching the volatility prevalent in the market can still look at equity funds, though the performance of equity funds may remain clouded in the near term. But balanced funds offer a judicious mix of debt and equity. As equities are attractively valued with limited downside and interest rates almost peaking, you can now expect healthy risk-adjusted returns from balanced funds.

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