FUND FLAVOUR

October 2020

 

Balanced Funds

 

Balanced mutual funds/Hybrid funds invest in both debt and equity instruments, and investors enjoy the benefit of realising maximum returns from both segments. The main intention of hybrid funds is to balance the ratio of risk-reward and optimising the return on investment. Top hybrid mutual funds invest about 50% to 70% of the portfolio in equities and the rest in debt instruments. Hybrid funds ensure capital appreciation and fight against the potential risk. These funds balance out the risk and returns of both Equity and Debt funds through diversification in different asset classes. The risk exposure of a Hybrid Fund depends on its investment stance and asset allocation amongst equity and debt. The primary focus of hybrid funds is to invest in a portfolio as balanced as it is diverse, by channeling investments proportionally into equity and debt instruments. This is done in order to create long-term capital appreciation at lower risk/ with lower volatility. Hybrid funds bridge the gap between long-term capital appreciation and short-term income requirements of investors. As such, they are popular among new investors and experienced conservative investors alike. Balanced or hybrid mutual funds are a one-stop investment option offering exposure to both equity and debt segments.

The many hues of Balanced Funds

 

Balanced funds are essentially divided into two types:

1.      Equity-Oriented Balanced Funds: The portfolio of equity-oriented balanced funds usually invests majority of the money into equities and equity derivatives. Most of the capital in such a scheme is invested in several different money market and debt instruments. The capital appreciation in equity-oriented balanced funds is aggressive as it is the main focus of these funds, with interest income from debt instruments taking the back seat. Despite the fact that regular equity mutual funds and equity-oriented balanced funds offer similar returns, the risk associated with equity-oriented balanced funds is relatively lower, thereby making them attractive options.

2.      Debt-Oriented Balanced Funds: Debt-oriented balanced funds are ideal investment options for conservative investors. A large part of the money in the portfolio of debt-oriented balanced funds is put into debt and money market instruments. The risk involved with these funds is relatively low, and they have the potential to provide consistent long-term returns. In addition, the portfolio’s equity part can aid the fund in making the most of the increasing equity capital markets whilst protecting the debt instruments from inflationary and interest rate risks.

 

Securities and Exchange Board of India has categorized Hybrid funds into 6 classes:

1.      Conservative Hybrid Fund: This type of fund invests majority (at least 75% of total assets) in debt securities and the rest in equity. Since it invests primarily in debt instruments, it is relatively risk free.

2.      Balanced Hybrid Fund: This kind of hybrid fund allocates its assets in equity/equity related instruments and debt securities in equal halves.

3.      Aggressive Hybrid Fund: This fund predominantly invests in equities (at least 65% of total assets) and the rest in equity.

4.      Dynamic Asset Allocation: When the fund manager invests in equity and debt securities depending on the current market conditions with no specific percentage being allocated to debt and equity securities, it is called Dynamic Asset Allocation.

5.      Multi-Asset Allocation: This fund also has a dynamically managed investment portfolio, with assets invested in three or more asset classes. Investment in foreign securities is not counted as separate asset class.

6.      Arbitrage Fund and Equity Savings: This fund uses arbitrage strategy to make profits. They make use of the price difference in various markets and capitalize on the imbalance. Minimum investment in equities or equity related instruments is 65% of total assets.

 

Taxation of Balanced Funds

Equity-oriented balanced funds and debt-oriented balanced funds are subject to different taxation laws based on portfolio composition. Laws applicable to equity mutual funds shall apply to equity-oriented mutual funds, while debt-oriented balanced funds will be subject to non-equity investment laws.

a. For equity-oriented balanced funds

Mutual funds with an exposure of more than 65% are treated as an equity asset for taxation. Hence, there is a 15% tax on short-term capital gains (STCG), i.e. the gains booked with one year of the equity-oriented balance. If you hold these funds for more than 12 months, then a tax at the rate of 10% on long-term capital gains (LTCG) is applicable if the gains exceed Rs 1 lakh a year.

b. For debt-oriented balanced funds

Debt-oriented hybrid funds come under the family of debt funds for taxation purpose. The LTCG tax is applicable if the funds are held for more than 36 months. The STCG is taxed at 20% with indexation benefits. In other words, equity-oriented balanced funds have a clear tax advantage over debt funds.

 

Power and leverage of Balanced Funds

 

Diversification: As hybrid funds invest in different asset classes they provide diversification benefits to a portfolio.

Dual benefits: Hybrid funds provide dual benefits of long-term growth from equity and stability from debt.

Risk Mitigation: The debt allocation of the fund helps in effectively mitigating market risk and balances out the risk arising from equity investment.

Suitable for all types of investors: Hybrid funds suit a new investor scared of the equity market, a retiree looking for regular income or an aggressive investor looking for high returns.

 

Balanced funds can be considered by the following kind of investors:

·         New investors: Investors who are putting their money into mutual funds for the very first time tend to turn to balanced funds which are ideal investment options for new investors. This is because both equity and debt instruments are balanced in their portfolio, thereby ensuring that investors can watch their investment record reasonable growth whilst keeping their principal investment amount protected.

·         Conservative investors: Balanced funds are great options for conservative investors like retired people and those who want a long-term safe haven investment instrument. The reason why a large number of such investors consider balanced funds is due to the fact that they follow a balanced strategy which enables them to get the best possible outcome regardless of whether or not bond or equity markets are affected.

·         Investors who want better returns than investments in debt funds: Debt funds tend to provide returns of around 10% on an average, but some investors do not mind taking on some additional risk, albeit marginal, to earn considerably higher returns. If you are one of these investors, balanced funds can work out to be very profitable.

 

The Modus Operandi…

 

You can invest in balanced funds through either of the following ways-

·         Offline mode of investing– If you are not confident of your knowledge, you may choose to invest through a broker. However, investing in a fund through a broker will make you eligible for investments through regular plans that offer slightly lower returns and varied expense ratios in investment. If you wish to invest in the fund independently, you must visit the nearest branch of the AMC of your fund with the following documents-

·         Identity Proof (Aadhar Card)

·         Canceled cheque

·         Passport size photos (around 4-5)

·         PAN Card

·         KYC documents (for KYC verification)

·         Online mode of investing– If you do not wish to add on to your expense of commissions or brokerage, you may visit online investment platforms wherein you can choose from and compare more than 1,700 funds - all in one place, instead of following the long procedure of visiting the website of each AMC and then choosing from them. Here, you can select the fund in which you want to invest, look at the details and compare similar schemes as well as use SIP calculator or Lumpsum Calculator to estimate the future value of your investment. 

The Bottomline…

Best balanced mutual funds have offered better risk-adjusted returns in the long run compared to equity returns. The five-year rolling return and risk-based standard deviation of balanced funds are 13.2% and 2.9% respectively whereas it is 12.9% and 3.47%, 13.96% and 3.82%, and 14.91% and 3.96% for large-cap funds, mid and large-cap funds and diversified funds respectively.

Before you decide to invest in a balanced mutual fund, it is necessary that you set your investment objectives straight. Considering the risk involved and the returns that these funds may generate, you may choose to invest either in equity-oriented balanced mutual funds or debt-oriented balanced mutual funds. A balanced mutual fund which has a heavy investment in mid caps and long duration bonds may be a less suitable option for risk-averse investors. Additionally, you are advised to compare the funds on the basis of their past returns and carefully study whether they have delivered a consistent performance over the long term, especially in market fluctuations. Hybrid funds are considered ideal for investors with medium to long horizon. The past performance record of hybrid funds suggest that they are good to invest in with an investment horizon of five years or more. You also benefit from the power of compounding if you remain invested for the long term.