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.
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
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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