When they picked up the popular label of balanced funds, they lived up to it. Such funds would attempt to ensure that 50 per cent of their portfolio was in equity and 50 per cent in debt or cash and cash equivalents. That was before the Union Budget of 2006. The dynamics were changed that year. It was mandated that to get the tax treatment of an equity fund, such funds must up their equity exposure to at least 65 per cent from the then 50 per cent. Instantly, those who wished to retain their equity tax status became much more aggressive offerings.
A point in favour of such funds is the automatic rebalancing that they do.
It is not only convenient but also tax efficient. When a fund manager shifts between equity and debt to maintain the balance between both asset classes, he does it with no tax implication. On the other hand, if an individual had to venture to do this on his own, there would be a tax impact to consider. For example, let's say he invested Rs 1 lakh in Quantum Long Term Equity and Templeton India Short-term Income in March 2007 in the ratio of 65:35. In order to maintain the similar equity:debt ratio over the past five years, he would have had to pay a tax of Rs 2,338 over this period. This calculation has been done on the assumption that he rebalanced every six months. Had he done it every month, like the fund manager does, the tax incidence would be higher.
That's not all. If an individual has to sell his debt holdings, he pays capital gains tax, both long and short term. In such a fund, his gains on debt are also tax free because the entire fund is viewed as an equity product.
But there is a small catch. Being categorized as an equity fund attracts a Securities Transaction Tax (STT). So on the eventual redemption of units, STT at 0.25 per cent is charged on the entire transaction which includes a substantial debt portfolio along with equity. In a pure debt fund, STT is not levied.
Conversely, dividends in such a fund are not taxed either but in a pure debt fund, the fund house will have to pay Dividend Distribution Tax (DDT) before declaring the dividend.
Safer than an equity fund?
The debt component in these funds does help in limiting the downside while the price to be paid is on returns being on the lower side when compared to pure equity plays. So in 2007 and 2009, the returns were muted in comparison. But if we look at the recent past, we see that 2008 and 2011 were less painful for balanced fund investors compared to the other equity categories and the Sensex (see: A comparison with equity funds). In the long run, they do not disappoint. The 10-year returns of this category are close to the Sensex numbers.
What we have presented here is just an overall category view. If we look at individual performers, there are risky bets that may not work for you. In the race for high returns some of these funds adopt a slightly aggressive posture with regards to their equity allocation. By 2007 end, 15 (out of 23) funds were holding an allocation of over 70 per cent to equity. This has changed over time. Some like HDFC Prudence have consistently stuck to their maximum possible equity level.
The other criteria to consider is the exposure to mid- and small-cap stocks. By 2009 end, there were 10 funds (out of 27) which had more than half of their equity assets allocated to mid and small caps. In HDFC Prudence, this bias has added to the aggression of the fund. So though the returns are admirable, there has been a fair amount of risk undertaken to achieve that. The point we are making is that the top performer need not be suited for you. You have to look under the hood to see if it fits your risk profile.
By and large, most of the funds in this category have adopted a multi-cap strategy. Currently, there are six funds with at least 50 per cent of an allocation to mid and small caps; ICICI Prudential ChildCare-Gift topping the list with 71 per cent.
Making the right pick
This is an ideal product for a first-time equity investor. He gets acquainted with a market-oriented product with the debt component to act as a cushion against extreme market gyrations. It could also be valid for an investor who does not want a huge equity exposure but just a bit to aid capital appreciation of his portfolio. But once again we emphasise, do not blindly go for the best performers. If you are looking at lower volatility and steady returns, take a good look at the portfolios. The aggression may not suit you at all. Even if you find that your fund lags behind its peers in a bull run, it may still be a wise choice simply because it has stuck to a more conservative path that a balanced fund investor is seeking.
On a final note, we must mention the goal-oriented funds that also populate this space. We do not find them to be good value propositions. You can achieve the same goal of a child's education or marriage or your retirement by investing in regular funds. To add to it, some of these goal-oriented funds have put up a poor performance. LIC Nomura MF Children Fund lost 68 per cent in 2008 and was the worst performer in the category. ICICI Prudential ChildCare-Gift, on the other hand, lost 60 per cent in 2008 and delivered the second highest return of 84 per cent in 2009. Surprising amount of volatility from a balanced fund!