Monday, January 01, 2018

FUND FLAVOUR
January 2018

Risk is the main quotient in the investment world. A favourable risk-reward balance attracts most of the investment from the public. As investing in large cap, midcap, small cap, multi-cap has different degrees of risk involved in it people tend to give a second thought before investing. Investing in Balanced Funds reduces the risk of downside to the fund to some extent as it has a good composition of fixed income securities and equity. The fund’s ability to give handsome returns in the long term is most suitable for a risk-averse investor.

Balanced Funds – the Modus Operandi

The balanced fund achieves the target of maintaining the balance because when the stocks fall, the bonds hold their value. When the stocks rise, the bonds yield lower value. Assume you have a Rs. 1,00,000 portfolio. The balanced fund allocation ratio that you have set is 75% stocks and 25% bonds. So now Rs. 75,000 is in stocks and Rs. 25,000 is in bonds. Due to market run, the stocks appreciated to 80,000. Now the fund manager sells some stocks worth Rs. 1,250 and puts them in bonds so that Rs. 78,750 (Rs. 1,05,000*.75 = 78,750) is in stocks and remaining in bonds. This brings your portfolio back to 75% stocks (Rs. 78,750) and 25% bonds (Rs. 6,250) ratio. This is done on a regular basis. The illustration may look simple but as your portfolio fluctuates wildly, this re-allocation brings stability. So when one asset class shoots up in value, it is sold and other is bought. This structural combination offers enhanced flexibility, ensures that the investment of the investor is safe, and returns good profits in the end.  That is why balanced mutual funds are one of best investment options. The division of the funds differs according to various mandates and the program offered by the respective investing agency. For example, equity hybrid funds from Birla Sun Life Mutual Fund invest 65% to the equity and the remaining in the debt. The debt hybrid funds see an investment of 75% in debt and the remaining in equity. Therefore, an investor should consider the options available to him or her to plan according to their requirements and the amount they want to invest in mutual funds.

A safer bet

If you are an investor seeking good returns with little tension of market volatility and the associated risks, balanced funds are a perfect fit to your portfolio. Shorn of jargon, balanced funds are mixed or hybrid investment schemes that bridge the gap between the riskier equity market and the relatively safer debt market. Depending on the nature and aim of investment, as well as the disposition of the investor, balanced funds can come in different shades in between the two extremes. Equity hybrid schemes, for instance, invest more in equities than debt. Debt hybrid funds, on the other hand, invest a minimum 75% of the funds in debt, and the remaining in equity.

Equity-Oriented Balanced Fund: In case of an equity-oriented balanced fund, a majority of the portfolio of the scheme would be invested in equities and equity derivatives. The minority portion of the scheme’s capital would therefore be invested in various debt and money market investments. The key characteristic of this fund is their aggressive capital appreciation, while interest income from debt investments is often the secondary goal of these schemes. That said an equity-oriented balanced fund is still a lower risk investment option than a plain vanilla equity mutual fund even though the returns offered by these two different fund types are often comparable.

Debt-Oriented Balanced Fund: For the conservative investor, a debt oriented balanced fund is just what the doctor ordered. With a major portion of its portfolio invested in debt and money market investments, these funds are potentially low risk investments with the capacity to deliver consistent returns in the long term. Moreover, the equity portion of the portfolio would help the fund benefit from rising equity capital markets and hedge the debt investments from interest rate and inflationary risks. With a risk level that is only marginally higher than the average debt mutual fund and proportionately higher ROI, a debt-oriented balanced fund is often considered to be an ideal investment for risk-averse investors.

Tax Considerations of Balanced Funds

Depending on the composition of the portfolio, separate taxation rules exist with respect to debt-oriented balanced funds and equity-oriented balanced funds. In case of debt-oriented balanced funds, non-equity investment taxation rules will apply, while in case of equity-oriented balanced funds, the rules regarding equity mutual funds will apply.

Taxation Rules of Debt-Oriented Balanced Funds:
In case of debt-oriented balanced fund investments, short term capital gains refer to profits generated through redemption or switch of fund units prior to completion of 3 years from the date of allotment, in case the units have been held for over 3 years, the profits from a redemption/switch transaction would be subject to long term capital gains. Short term capital gains tax rate in case of debt-oriented balanced funds is the same as the income tax slab of the investor. Moreover, as no TDS is deducted in case of unit redemption, the short term capital gains thus generated would be classified as “income from other sources” on the ITR. Long term capital gains obtained from debt-oriented balanced funds are subject to 20% tax on profits if indexation benefits are availed, while the applicable tax rate is 10% in case indexation benefits are not availed.

Taxation Rules of Equity-Oriented Balanced Funds:
For the purposes of equity-oriented balanced fund, current tax rules consider investments made in the fund for up to 1 year from the date units are allocated as a short term investment, while units held for longer periods are classified as long term investments. In case of short term capital gains obtained through redemption or switching of units prior to 1 year from date of allotments, 15% tax needs to be paid on the profits. As per current equity-oriented balanced fund taxation rules, long term capital gains incur nil tax and are thus tax free.

Taxation Rules of Dividend in Case of Balanced Funds:
Irrespective of whether you have invested in an equity-oriented or debt-oriented balanced fund, the dividend taxation rules are the same. Any dividends received by the investor from a balanced fund are completely tax exempt in the hands of the investor. However, these are subject to dividend distribution tax of around 30%, which is payable directly by the AMC to the relevant government taxation agency. This tax cost is transferred to the investor of the dividend plan as part of the scheme’s expense ratio.

Performance of Balanced Funds

Over the past one year, the net inflows into balanced mutual fund schemes have more than doubled. From around Rs 3,000 crore a year ago, the net inflow nearly tripled to Rs 9,000 crore in August 2017, before moderating to about Rs 6,000 crore in October 2017. In March 2017, net inflows into balanced funds even outpaced equity diversified funds. Clearly, investor participation has grown multi-fold. Several balanced schemes have burgeoned in size. As many as 6 schemes have crossed assets of over Rs 10,000 crore each. The CRISIL Balanced Fund - Aggressive Index generated a return of 19% over a 1-year period ending on November 24, 2017. Out of the 30 schemes on the list, 17 schemes delivered a return in excess of 20%. Those who had invested in the best balanced funds of the past 1-year could be sitting on gains in excess of 30%. The compounded returns over the past 3 years have not disappointed either. In the 3-year period ending on November 24, 2017, the CRISIL Balanced Fund - Aggressive Index delivered a compounded return of 8%. Over the same period, nearly 20 balanced fund schemes successfully generated more than 10% returns. The balanced fund schemes with the best performance leads the list with compounded returns ranging between 13%-15%. Clearly, balanced funds made the best use of the recently market rally and rewarded investors handsomely.
How have balanced funds managed to score such massive returns?
This is because balanced funds most often are not be balanced in the true sense. Most schemes, currently classified as balanced funds, invest about 65%-70% of their assets in equity. Some schemes have taken a quantum leap by investing in mid-cap stocks as well. With this aggressive equity allocation, balanced funds are able to score massive returns in a bull market. At times, some schemes even outperform many equity-diversified funds. Unfortunately, investors consider only returns and pay little heed to the high-risk asset allocation.

Who should consider investing in Balanced Funds?

Following are some key types of investors who should consider investing in balanced mutual funds:

Conservative Investors: A majority of conservative investors such as retired individuals as well as investors who are seeking a safe haven investment in the long term find balance funds as an ideal choice. This is obviously because the balanced strategy of the mutual funds ensures that the investor gets the best outcome no matter what occurs in the equities or bond market.
New Investors: For new mutual fund investors, their first investment more often than not is an ELSS i.e. a tax saver mutual fund. However, if you take away the tax benefit, balanced fund is probably a better starting point for new investors. With the balance of equity and debt instruments in its portfolio, the investor can look forward to reasonable growth of their investment while protecting the principal amount investments.
Investors Seeking Higher Returns than Debt Funds: On an average, debt funds have historically offered returns in the ball park of 10%. However, some investors might be willing to take marginally more risk to earn suitably higher returns. For such investors, a balanced fund is definitely the preferred investment route due to unique balance of risk and return that is available from this class of mutual funds.
Investment in Bull Markets: Bull markets, such as the one we are witnessing right now is a dream for those who are already invested, but a bane for those planning to make their investments. During market highs, equity mutual funds are priced at high levels which can significantly impact the returns in the long term especially in case of almost inevitable market correction. In such situations, a balanced fund with its conservative strategy is more reasonably priced and it can help protect the investor’s money when a correction eventually happens.

Why Balanced Funds are a must for retail investors

3 compelling arguments on why Balanced Funds are best for retail investors.

1) Inflation – Equities form major portion of balanced funds. This is a major shield in battling against inflation which will erode your purchasing power in later years. So, balanced funds protect your purchasing power and help fight inflation.
2) Income tax – Do you know that you need to pay income tax on all debt instruments. The interest from debt will be taxed as per your income tax slab. Balanced funds have this unique proportion where you can invest 35% in debt but still pay no tax on the interest earned from these debt products.
3) Volatility and asset allocation – The equity market always goes through ups and downs. There are periods of bull and bear phases. Nobody can predict with precision the beginning and end of each phase.
Balanced funds protect your money by proper asset allocation and timely rebalancing which determines major part of returns over long term for retail investors.
You should definitely look at investing in balanced funds if you do not want to maintain separate funds for equity and debt. It is also suitable if you do not like to invest directly in stock market. You can choose if you want the style to be aggressive or conservative when you sign the policy document.

Balanced mutual funds are the unsung hero in the stock market. It gives you peace of mind and optimum portfolio allocation. So what are you waiting for? Invest in the best balanced funds and reap the benefits. If you are a retail investor looking to avoid undue risk, look no further than the best balanced mutual funds.

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