FUND FLAVOUR

January 2016

Balanced Funds – Best of Both Worlds

Choosing between equity and debt is difficult in the best of times. To get over this problem, you must invest on the basis of your age and market conditions. However, if you are among those who do not want the hassle of investing in a basket of products that needs to be rebalanced at regular intervals, you can opt for hybrid funds. Hybrid funds allow you to invest in a combination of equity and debt. The category includes funds with different mandates. Equity hybrid funds, for instance, offer more than 65% exposure to equity, and the rest to debt. Debt hybrid funds invest at least 75% funds in debt and the rest in equity. 

Based on their objectives and strategy, hybrid funds, also called balanced funds, come in three forms - monthly income plans (MIPs), asset allocation funds, and capital protection funds. The main objective of these funds is to offer you the best of both worlds - equity and debt.

Hybrid funds do well when stock markets are going through a difficult phase as they have a cushion of debt. So, they are better equipped to withstand shocks in falling markets. However, when stock markets are rising, they may not do as well as funds with 100% equity component. Rebalancing based on market conditions also works for these funds. Take a balanced fund with 70% exposure to equity and 30% to debt. If the stock market falls, the fund's equity exposure will drop to the extent of the fall, leaving the fund manager with no option but to buy more shares to maintain the 70% equity level. Debt provides safety. Similarly, in a rising market, if the equity allocation moves up to 80%, the fund manager will sell 10% equity portfolio and buy debt, thus automatically booking profits. In fact, the debt component in balanced funds is managed in such a way that short-term debt funds, which are less volatile, comprise a big part of the portfolio. The idea is to lower the risk. Even the fund managers for equity and debt are different. The equity part is managed actively with exposure to companies across sectors and market capitalisation categories. The debt part is managed more passively.

Also in the pack

The other category within hybrid funds is debt-oriented MIPs, which allocate 5-25% funds to equity and the rest to debt. Their performance over the last three years has been noteworthy, with many delivering more than 10% returns. The good performance of these funds can be attributed to falling bond yields in the wake of the downward pressure on interest rates. As bond prices and interest rates are inversely related, the net asset value, or NAV, of any fund's debt component rises when interest rates start falling and vice versa. One can invest in MIPs for consistent returns, not capital appreciation. The idea of investing in these funds is that they give regular payouts. So, choose a fund with a consistent dividend record.

Then there are capital protection funds, a new category of close-ended funds whose aim is to offer consistent returns and protect wealth in a volatile market and yet gain from the upside offered by the equity markets. These funds invest up to 80% in debt (usually with a lock-in of three years), which generates a fixed return and ensures that the principal remains safe. The balance, that is, up to 20%, is invested in equity for wealth generation. However, these funds offer a psychological respite at a high cost. You can create your own capital protection plan by investing in a growth option of, say, an MIP, which has a similar composition of debt and equity, at a lower cost. These funds have low liquidity and tradability. 

These funds are for those who want to invest in the equity market but wish to stay protected on the downside, that is, do not want to risk the principal amount. These funds do not have much of a performance history to boast of, unlike their counterparts. Moreover, they do not guarantee capital. It is something that is stated implicitly; capital protection is inherent in the way the portfolio is constructed.

The right balance

Although equity and debt are more or less known to share an inverse relationship, there have been times when they have been positively correlated, especially when market cycles are turning. In 2003, when the cycle was turning, funds investing in government securities gave double-digit returns just like the equity markets. This went on till 2004. Similarly, after the 2008 global financial crisis, the stock markets picked up after early signs of recovery and debt, too, did well after the Reserve Bank of India cut interest rates to revive the economy. The purpose of investing in a hybrid fund is diversification, which can be achieved if both asset classes bear a low or negative correlation. The ideal investment is a hybrid fund that offers exposure to equity and gold considering they usually have a negative correlation. Gold's low or inverse correlation with other major asset classes like equity and debt can stabilise the fund's risk-return profile during periods of falling equity markets and challenging economic climate. For instance, in the last one year, the domestic equity market has given a negative return of 1%, short-term debt funds have returned 9%, while gold has been an outperformer, delivering 35% returns. There are a number of debt-oriented hybrid funds that offer a combination of equity, debt, and gold, such as Religare MIP Plus, Fidelity Children's Plan, Taurus MIP Advantage, Axis Triple Advantage, Canara Robeco Indigo Fund, and UTI Wealth Builder, an equity oriented hybrid fund.

Balancing act trumps pure debt, equity mutual fund

Despite positive returns from equity markets in the last few months, balanced funds have managed to give strong returns, held their own over debt and even large-cap equity peers last fiscal, riding on interest rate cuts and continued firmness in equities. The latest CRISIL report says that, CRISIL-AMFI Balance Fund Performance Index gave a return of 37.17% in 2014-15 compared with 12.47% by debt (CRISIL-AMFI Debt Fund Performance Index). Balanced funds usually invest in a mix of equity and debt and several funds even have aggressive equity component which can generate extra returns for the investors. Balanced category also outperformed the CRISIL-AMFI Large Cap Fund Performance Index in most time horizons considered. The CRISIL-AMFI Large Cap Fund Performance Index gave a return of 34.61% in 2014-15. The latest CRISIL report also says that, “These funds typically invest over 65% of their corpus in equity and the remaining in debt and cash, which allows them to tap run-ups in either category.” Many financial planners and distributors suggest that beginners start investing in mutual funds through balanced mutual funds as they are less volatile compared to other equity diversified equity schemes. In the last few months, having debt exposure has also helped balanced funds deliver positive returns. “On the debt side, the yield on the 10-year gilt securities fell over 100 basis points last fiscal. A portfolio analysis of CRISIL ranked balanced funds shows funds increased their gilt exposure to 13% on an average last fiscal, compared with 8% in FY14, thereby benefitting from interest rate fall,” concluded the report.

After a strong run in 2014 when top-performing balanced funds delivered upwards of 40% returns, these funds had to make do with a modest 5-6% return in 2015. But then, 2014 was an exceptional year when both equity and bond prices were on a breathless run. In 2015 though, both lost steam and delivered returns in fits and starts.

It is no surprise then that balanced funds have delivered lacklustre returns. The year-to-date returns of the top five balanced funds were almost 7%. But given that bellwethers such as the S&P BSE Sensex and the Nifty 50 registered losses of 5-6%, returns from these hybrid funds have been much higher.

Balanced funds that invest 65-70% in equity, and the rest in bonds and government securities, are less risky than pure equity schemes. So, while equities — particularly large-caps — slipped and impacted returns of diversified equity schemes, the bond portfolio of balanced funds supported performance.

Within equity, balanced funds that have increased their exposure to mid and small-caps have performed better, as Nifty Mid Cap and Small Cap indices managed to deliver positive returns of 5.7% and 4.9%, respectively.

Best bet in volatile times

Balanced funds can offer dual advantage of growth and safety in volatile times. In the present scenario where equity markets have exhibited quite a bit of volatility, balanced funds have emerged an attractive investment option both in terms of returns along with the safety of debt.

A little risk is the safest bet

Balanced funds are tailored for first-time investors and those looking for relative stability for their savings, rather than those eyeing pure equity exposure and high-risk capital accumulation. Shorn of jargon, balanced funds are mixed or hybrid investment schemes that bridge the gap between the riskier equity (or stock) market and the relatively safer debt (or bonds) market. Depending on the nature and objective of investment, as well as the disposition of the investor, balanced funds can come in different shades in between the two extremes. So how much of balanced funds should you have in your investment portfolio? About 20-25% is ideal. Choosing the right fund is imperative. If you are an investor seeking good returns with little tension of market volatility and the associated risks, balanced funds are what the doctor will order.