How often do Balanced Funds Rebalance?

I have two questions on hybrid equity funds. How often do these funds actually re-balance their portfolios? I want to find out if regular rebalancing is indeed happening. For an individual investor, as there is no tax on the debt portion of hybrid equity funds, what is the tax treatment at the fund-house level for the debt part? In other words, is there any tax (for the debt portion) that an individual investor in a hybrid equity fund ends up paying?
- Anand Vardhan

Rebalancing
Hybrid equity funds (or balanced funds) may follow a daily, monthly or dynamic system to rebalance their portfolios between equity and debt. Therefore, you will need to find out the frequency based on the fund you are investing in. Basically, all balanced funds have a pre-set range for both their equity and debt investments, which they disclose in their offer documents. Having set this range, funds may follow two different methods to decide when they should book profits on one asset and invest in the other.

One, they may follow a steady-state allocation, where the equity and debt portion are always fixed. Therefore, whenever the equity portion exceeds a specified limit, they will book profits and switch the funds into debt. The reverse can happen too. Two, they may follow a dynamic or tactical allocation. Here, the fund manager takes a call on whether equity or debt will generate better returns based on market conditions and decides to alter his portfolio mix accordingly. Here is how these two strategies work.

HDFC Balanced Fund follows a steady state allocation, with equities usually at 70-72 per cent of the portfolio and debt making up the rest. When the equity allocation reaches the higher end of this band (due to market gains), the fund cuts exposure to invest the excess sum in debt. Therefore, rebalancing is done whenever the limits are hit.

ICICI Pru Balanced Advantage Fund follows a dynamic or tactical asset allocation. The fund's equity allocation can vary between 30 and 80 per cent, while debt allocations can range from 0 to 35 per cent. The equity portion is typically made up of both stocks and derivatives. Now, this fund decides on its allocations to equity based on whether the equity market looks overvalued or not as on a particular date. The fund tracks the price-to-book- value ratio of the index to decide whether the market is overvalued or undervalued. This fund follows a daily rebalancing, i.e, the indicator is tracked daily to assess the portfolio mix.

Some funds may, however, not change their allocations so often but may base them on a medium-term view of the market. Take Birla Sun Life 95, which has a 65-75 per cent equity allocation, with the rest in debt. The level of equity allocation (whether at the lower or upper end of the band) is based on equity market valuations and its medium-term outlook. The fund had low equity allocation in 2001 but hiked it steadily until it hit the upper limit by November 2013, as valuations became more attractive.

This article was originally published on July 21, 2015.