Balanced funds pack the advantages of both equity and debt funds and are fast gaining popularity among investors
22-Nov-2017 •Aarati Krishnan
Balanced funds were supposed to be a one-stop-solution for investors who were not savvy enough to juggle multiple equity and debt funds. But lately, the balanced-fund category has become quite complex, too, with the conventional 65-35 balanced fund now complemented by many new sub-breeds. So here's your ready reckoner on choosing the right scheme.
Decide on your objective
What's the risk-return mix that you are comfortable with for your investments? This question has now become critical to selecting the right kind of balanced fund for your portfolio. If your objective is to beat debt returns by a big margin and you don't mind taking capital losses or poor returns in some years, the conventional balanced fund which invests a minimum 65 per cent of its portfolio in equities and the rest in debt is a good fit.
But if you are wary of equity volatility and are only looking for slightly better returns than debt, the new breed of balanced-advantage funds or equity-savings funds should suit you well. These funds park about 30 to 35 per cent of their portfolio in stocks, another 30 to 35 per cent in equity arbitrage opportunities (for low-risk, liquid-fund-like returns) and the remaining in bonds. In effect, while two-thirds of their portfolios are in debt-like investments, they still fetch you the tax benefits of an equity-oriented fund.
Old-style balanced funds are also better suited to earning capital gains over a five-year plus horizon and are bad choices to earn regular income. Balanced-advantage and equity-savings funds are better suited to delivering income than capital gains.
While tax laws require balanced funds to maintain a minimum 65 per cent equity allocation, there's no maximum limit specified. In practice, balanced funds maintain anywhere between 65 and 75 per cent allocation to equities. Here, apart from looking at the current equity-debt mix, it is also important to check out a fund's past allocation to know how far it takes its equity exposures if bullish on the market.
Funds with a propensity to take a 70 per cent plus equity allocation are obviously more risky than those that stay near the floor value of 60 or 65 per cent.
What's the allocation strategy?
You also need to understand whether the fund follows a tactical or steady-state allocation strategy to rebalance between the two assets. Tactical balanced funds try to time the market by owning more equities when they are bullish about stocks. They reduce the equity portion when they fear downside. This strategy can pay off through higher returns in bull markets and lower losses in falling markets if the fund gets its calls right. But that's a big 'if.' Steady-state balanced funds stick to a preset mix of equity and debt, no matter what the market conditions. They strictly rebalance their portfolios when the equity or debt portions hit limits.
Tactical allocators expose investors to more risk because the fund manager, apart from choosing the right stocks and bonds, has to make the right calls on market timing.
How much risk?
Balanced funds are supposed to be lower-risk products than pure equity funds. But some balanced funds can turn out to be riskier than pure equity funds by virtue of their aggressive investing strategies, both on equity and debt.
In the equity portion, a big determinant of risk is the portfolio break-up between large, mid and small-cap stocks. The higher the weights in mid and small caps, the more the volatility and the possibility of losses are. Of course, a higher mid and small-cap allocation can also pay off in bull markets, as it has done in the last three years.
In the debt part of a balanced-fund portfolio, the manager can take both duration and credit risks to bump up returns. They can own very long-term bonds, betting on falling interest rates. If the rates rise, the strategy will yield losses. If the fund owns AA or lower-rated corporate bonds to improve yields, defaults or downgrades can cause sudden NAV blips.
Funds which combine a large-cap-oriented equity portfolio with a short maturity and high quality debt portfolio are the best fits for conservative folks.
Study the track record
As both debt and stock-market conditions can heavily influence balanced-fund performance, it is important for balanced-fund investors not to choose schemes based on recent returns alone. A scheme's ability to navigate both stock market and interest rate cycles over the long term is critical to your wealth-building plans.
Checking out a scheme's 10-year track record is your best bet to gauge how good it is at navigating multiple rate and market cycles. At this juncture, calendar year returns relative to the benchmark and category may be a far better measure of a balanced fund's consistency than trailing one, three or five-year returns.
To check on a balanced fund's propensity for risk, assess its best and worst one-year returns during its lifetime. The gap between the two equips you with a good understanding of the risk-return trade off in the fund.