Balanced funds: The benefits of both worlds

By Nimesh Shah
Managing Director & CEO
September 17, 2014
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The equity markets have soared to new heights and a certain segment of investors must be waking up to realize that they have been bereft of the upside so far. In fact, a general tendency of Indian investors is to invest in equity when the markets are surging high, while pull out money when the markets are underperforming- which may not necessarily lead to a good investing experience.

It may be a prudent strategy, thus, to add flavor of balanced funds in a portfolio which seek to capture upside by increasing allocation to equity when the markets are declining, and aim to limit downside by reducing exposure to equities when markets are rising- completely reverse of what retail investors normally do.

Also, in times of market volatility some investors either don’t invest at all or panic-sell their investments. This lack of confidence could arise out of their bleak understanding of equity as an asset class. It is apt to mention here, that equities is a suitable investment for long term wealth creation. One should ride the short-term volatility with patience in order to benefit from the potential capital appreciation in the long-term.

Yet, if you do not wish to take too much risk, but wish to have exposure into equities, balanced funds are a good way forward. These funds are less volatile, and when the markets fall, they are hurt less than others.

Asset allocation is might

We believe investors should constantly adhere to the asset allocation model depending on their risk profile. Adhering to asset allocation, instils discipline in investing and helps avoid the tendency to redeem at market bottoms and invest at market tops. Also, spreading investments across more than one asset class reduces risks and moderates the effect of an individual asset class on the overall portfolio returns. However, managing separate debt and equity portfolios could be a tedious task and would involve churning costs and tax implications. Further, one may not be able to tactically adjust allocations to market movements.

Balanced funds offer benefits of asset allocation model in a single structure. These funds offer the benefits of both worlds as equity has the potential to deliver superior long-term returns while debt seeks to provide stability to the portfolio. This diversification limits the portfolio from downside risks if either equity or debt enters a bearish phase.

Tax efficiency

Having an average exposure of 65% to equities, allow balanced funds to be taxed like equity funds. Therefore, these funds enjoy tax-free returns if the holding period is greater than a year; otherwise, they are subject to short-term capital gains tax. For dividend option in such schemes, dividends are tax-free (without any dividend distribution tax). For funds with an average exposure lower than 65%, the tax treatment is similar to that of debt funds.

In summary

Balanced funds are suitable for investors with a moderate risk profile and investment horizon of over three years. On the equity side the fund is managed actively based on valuations in the market, as the portfolio is constructed keeping in mind the conservative risk profile of investors. This could also be a product for maiden investors to start off with, owing to lower volatility and tax benefits. Being a product that works across market cycles, and aims to offer the benefits of asset allocation, this product could form part of investor’s core portfolio.

This article was published in Afternoon DC newspaper on September 8 2014