MF Maze To Matrix


January 2019

A Balanced Fund is a mutual fund which provides a one-stop investment mix by investing its portfolio in a mix of debt and equity investments with an aim to balance the risk-reward ratio and ensure to provide a return which over time provides a perfect blend of equity and debt exposure. In this, the fund manager allocates your money in both debt and equity as an asset class in a certain proportion. The equity: debt proportion depends solely on the orientation of the fund. In India, Balanced Mutual Funds typically invest 50% to 70% of their portfolio in stocks and the remainder of their resources in bonds and other debt instruments. Balanced funds help you to ride the equity wave while still maintaining a low-risk profile. They invest the fund’s assets in equity shares as well as debt instruments in a specific ratio according to the investment mandate of the fund. 
Balanced funds, the most popular type of hybrid funds, are essentially divided into two types – Equity-Oriented Balanced Fundand Debt-Oriented Balanced Funds. Until a few months ago, Balanced Funds were synonymous with equity-oriented Hybrid Funds that invested over 65% of their assets in equity. Clearly, Balanced Funds were not true to their name. But there was a reason for this lopsided allocation. In order to qualify as an equity scheme, a minimum equity allocation of 65% is required. Since, equity schemes enjoy a tax advantage over debt schemes, an additional 15% exposure did not seem to do much harm. At the end of the day, investors would benefit. However, most schemes classified as Balanced Funds were free to vary their exposure to equity, ranging from a minimum 65% to as much as 80%. This drew a lot of flak from the regulator. After years of deliberation, the regulator had its way by coming out with the Categorisation and Rationalisation of Mutual Fund Schemes. This reform has the sole objective to create uniformity among the different categories of schemes managed by various fund houses.
As per the new norms of SEBI on recategorisation of mutual funds, there are 7 categories of hybrid funds.

  •  Conservative hybrid – These schemes invest around 75-90% of the total assets in debt instruments and 10-25% in equity instruments.
  •   Balanced hybrid – True to its name,Balanced Hybrid Funds are pure balanced funds that invest around 50% of their assets in equity and the balance in debt. Here, hedged equity positions or arbitrage exposure is not allowed. While these funds offer investors an equal exposure to equity and debt, they are not very tax efficient. In terms of performance, schemes investing according to such an assetallocation have been virtually non-existent, as fund houses preferred keeping the exposure in excess of 65%, so as to avail of tax benefits. Hence, there are no funds with a reliable track record of performance.
  •  Aggressive hybrid – The composition of these funds includes investments of around 65-80% of total assets in equity related instruments and the remaining in debt instruments, a minimum of 20% debt allocation is specified. These funds have the flexibility to include an arbitrage exposure.
  •  Multi asset allocation –This category invests in at least three asset classes with a minimum allocation of at least 10% each in all three asset classes.
  •  Arbitrage funds – These schemes, as the name suggests, follow arbitrage strategy and invest at least 65% of total assets in equity related instruments.
  •  Equity savings funds – These are open ended schemes investing a minimum of 65% of the total assets in equity and a  minimum of 10% of the total assets in debt.
  •  Dynamic asset Allocation – These are also known as Balanced Advantage funds. As the name suggests, the funds under this category can dynamically manage the asset allocation with no restriction on the minimum or maximum exposure. The fund can choose to be fully allocated either to equity or debt instruments depending on the fund manager’s view of the market. CertainDynamic Funds have a formula driven approach that takes into consideration market valuations and other factors. The allocation is pre-decided based on the formula that defines the equity exposure based on the different variables. Though Balanced Advantage funds also set their asset allocation as per the direction of the market, they tend to keep a minimum 65% exposure to equity at all times.

As an investor, you need to take a closer look at the asset allocation strategy of such funds. If the fund chooses to continue with the investment strategy as before, you need not worry. However, if there is a change in investment attributes, it will warrant a closerlook – the past performance of such schemes cannot be considered. Such funds suit moderate-to-high risk profile investors, given that the funds would invest predominantly in equity assets. While the fund may try to reduce volatility by dynamically managing the unhedged equity exposure, very few funds have been successful in doing so. Hence, it will be pertinent to have a look at the historical performance of the fund before investing. How well such funds perform is highly dependent on the fund managers’ skill and experience, as well as the formula adopted to set the asset allocation.Which of these fund categories is a better option? The Aggressive Hybrid Fund category is the most promising of the lot. The asset allocation will be stable and the returns tax-efficient, hence, you will be able to fit in such funds seamlessly into your financial plans.


Advantages of Balanced Mutual Funds

Best of Both Worlds
Balanced funds are suitable for investors who want to enjoy the returns from equity investments but with a safety cushion. Normally this is true for first time investors or investors who have low to moderate risk appetite. Since balanced funds are a mix of Equity and Debt, they have lower volatility than the Equity Funds and their returns are higher than the Debt funds. Though in a bull market these funds will not give you as much return as pure equity funds, the loss would be lower than those funds in a downward moving market.
The Balanced funds have to maintain the portfolio according to their mandate. For example, debt oriented balanced funds have to keep at least 65% of their investments in Debt instruments hence whenever Equity portfolio of the fund crosses 35%, the Fund Manager will book profit from equities and rebalance the portfolio. The fund manager rebalances the portfolio based on market conditions and asset allocation limits periodically and maintains the asset allocation without any tax implications or exit load. This will reduce the volatility and also preserve the gains. This obviates the need for manual re-balancing.
Tax Efficiency
For taxation purpose, equity-oriented balanced funds are treated as equity funds. Hence, even though such funds have a certain portion of debt portfolio, the debt portfolio will also be tax-free.This seems to be the biggest advantage to many. In case you separate your assetallocation between debt and equity by investing separately in debt funds or equity funds, then for debt part, whether in short term or long term, you have to pay the tax (based on tax rules shared above). However, with equity-oriented balanced funds, such debt part is completely tax-free.
Balanced Mutual Funds provide the convenience of diversification in the form of a single docket of a mutual fund. An investor thus need not go through the hassle of analyzing and selecting a bouquet of funds. A professionally trained and experienced fund manager does this job for the investor. A calculated combination of debt and equity components makes the funds less vulnerable to market volatility. The equity components of the fund are aimed at generating capital appreciation and their debt components serve as securities to shield the investment from unforeseen market corrections.Better risk-based returns

Balanced Mutual Funds have given better risk-adjusted returns in the long run compared to equity returns. The 5-year rolling return of balanced funds is 13.2% as against 12.9%, 13.96% and 14.91% in the case of large cap, mid cap and diversified funds respectively. The Standard deviation of balanced funds is 2.9% as against 3.47%, 3.82% and 3.96% in the case of large cap, mid cap and diversified funds respectively.


Disadvantages of Balanced Mutual Funds


While it might seem that balanced funds are virtually risk-free, it is not entirely the case. Balanced Mutual Funds have their own share of risk. In the case of a direct investment across a number of stocks and debt instruments, one can relocate the resources among different funds as diversification for tax planning or wealth creation. However, in balanced funds, since the decision of resource allocation is with the fund manager, customised diversification is not possible.
Myopic viewDue to the advantages, many investors, in fact, many advisors are recommending equity-oriented balanced funds for short-term goals which may be even less than 5 years. They completely neglect the equity exposure of such funds.
Poor understanding of the portfolio
Many investors are of the opinion that debt part of the portfolio is totally safe. But they fail to understand the type of debt instruments they are investing. Even in case of the equity portfolio, analysis of the stocks the fund is holding is of paramount importance. If the fund has higher exposure towards mid and small cap stocks, then it is riskier than holding a pure large cap fund.

Selection Factors for investment in Balanced Mutual Funds

  • You should consider the following factors for selecting balanced funds:
  •  Asset size of a fund should be a reasonable threshold level. A minimum asset size of Rs.500 crore can be considered.
  •   Past performance is one more indicator for the selection of the right mutual funds. Past five years’ fund performance history can be considered.
  •  Fund manager profile is a key factor. Fund manager should be experienced and capable of generating good returns.
  •  Asset allocation by balanced funds that allocates properly between equity and debt helps the investor to diversify. If your risk appetite is low, it is better to choose funds which do not have more 70% exposure to equity.
  • Consistent performance of the funds is one of the key parameters
  • As per latest categorization balanced fund category is renamed as Hybrid Fund. This includes conservative hybrid fund, balanced hybrid fund, aggressive hybrid fund and dynamic asset allocation fund. You should select fund category carefully.
  •  Another factor to consider while selecting a mutual fund is the reputation of the fund house. A fund house should be renowned and should be at least 5-10 years old.
  • Mutual fund rating is another important factor for consideration. You should select a mutual fund with a higher rating. Consider rating given by CRISIL and Value research for the selection.
  • Expense Ratio plays a major role in deciding fund performance. The expense ratio is a fee charged by the investment company to manage the funds of investors. Lower the expense ratio, better the fund performance.

Factors an investor should consider


a. Risk

Even though they have a certain percentage of the fund’s assets allocated to debt instruments, balanced funds are not completely risk-free. The equity component of the balanced fund makes the fund vulnerable to market risks. Market risk causes the fund value to fluctuate in accordance with the movements of the underlying benchmark. Balanced funds are less risky as compared to pure equity funds; but in order to gain the maximum out of your investment, you need to exercise caution and rebalance your portfolio regularly.

b. Return

If you are a moderately aggressive investor, then you might think of investing in balanced funds. Historically, equity-oriented balanced funds have been found to deliver average returns in the range of 10%-12%.  In spite of having the debt component in its portfolio, balanced funds do not offer guaranteed returns. The performance of underlying securities affects Net Asset Value (NAV) of these funds and may fluctuate due to market movements. Moreover, these might not declare dividends during market downturns.

c. Cost

Balanced funds charge an annual fee for managing your portfolio which is known as expense ratio. It is shown as a percentage of fund’s average assets. It reflects the operating efficiency of the fund and becomes an important criterion at the time of fund selection.  Before investing in a balanced fund, you need to compare its expense ratio with that of competitive funds. Ensure that it has a low expense ratio as compared to peer funds. This will translate into higher take-home returns for the investor.

d. Investment Horizon

Balanced funds may be ideal for a conservative investor who is ready to invest his savings in 5-year bank fixed deposits (FDs). As compared to an FD, balanced funds may deliver higher returns over a medium-term investment horizon of say 5 years. In addition, you would get the benefit of indexation on long-term capital gains on the debt components. If you want to earn a risk-free rate of return, you may go for arbitrage funds which bet on price differentials of securities in different markets.

e. Financial Goals

Balanced funds may be used for intermediate financial goals which can be achieved in a period of 5-7 years. If you have goals like buying a car or funding higher education, you may consider balanced funds as a means to finance these goals. Even budding investors who are not opting to manage their portfolio actively but have a low-risk appetite may also invest in balanced funds. Retirees may invest in balanced funds and go for a dividend option to supplement their post-retirement income.

f. Tax on Gains

The capital gains on balanced funds are taxed based on the orientation of the fund. Equity-oriented balanced funds are taxed just like pure equity. If you hold your investment for more than a year, the capital gains are treated as long-term capital gains. Long term Capital Gains (LTCG) in excess of Rs 1 lakh on equity component are taxed at the rate of 10% without the benefit of indexation. Short-term capital gains on equity component are taxed at the rate of 15%. The debt component of balanced funds is taxed like debt funds. STCG from debt component is added to the investor’s income and taxed according to his income tax slab. LTCG from debt component is taxed at the rate of 20% after indexation and 10% without the benefit of indexation.

Why Balanced Mutual Fund is the Best Investment Option?

Balanced Funds are the most convenient investing option for the investors who want to gain good earnings on mutual funds, but do not wish to take the risk of stock market fluctuations. By making investments in equities and debts, they provide the benefits of both the worlds. The equity-oriented balanced fund offers capital growth in the medium to long run, while the debt-oriented fund aims to generate steady returns. Thus, the investors can gain substantial income on their investments.In balanced funds, equities provide the benefits of shielding the battle of inflation which if not managed can erode the purchasing power in the later years.The equity market faces many swings as things are never certain in the stock exchange market and investors wish to invest in the funds which provide greater benefits. The best balanced funds provide an advantage of asset allocation as per the market conditions. When the market performance is poor, the fund manager shifts the asset allotment in the debt instruments, and when the market is expected to rise, funds are parked in the equity stocks. This way, the returns are balanced, and investors do not face fluctuations in their earnings. The balanced fund is the vintage bicycle of investing. It may be old fashioned but it endures because of its sturdy simplicity and its sheer usefulness.