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Why Balanced Funds Are Good For Investors

These funds work when markets are choppy or steady, and suit both seasoned as well as newbie conservative to moderately aggressive investors

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In times of dynamic stock movements, investors have to be cued to the markets and in sync with its ever-changing moods. Any misstep could lead to a loss. Warren Buffett famously uttered that investors should have two rules — first, never lose money; second, always follow rule number one. In fact, market gurus also point out that investors tend to chase equities when they are climbing higher, while avoiding stocks when they are falling. When stocks are at elevated levels, investors are unnecessarily putting their portfolios at risk by buying more. On the other hand, when stocks are falling investors make the cardinal mistake of avoiding equities, when in fact that is a good time to buy. So, which strategy counters these mistakes and works better in many market situations? Here’s where a simple asset-allocation strategy comes into play. It not only, by default, buys stocks when markets are falling, but also takes out money from equities when markets are rising. Here’s how it works. By default, balanced funds have an in-built asset allocation strategy that allocates a portfolio between equity and debt in a 65-35 ratio, i.e. 65 per cent of it is invested in equity, the rest in debt. Whenever markets rise, the equity portfolio in a balanced fund also rises. For example, equities could expand from levels of 65 per cent to around 70 per cent. But as the fund is a balanced one, the fund manager will again tilt the ratio back to the specified 65:35. How? By selling some equities, booking profits, and re-investing the proceeds to debt. Here, the fund manager would sell 5 per cent of the equity portfolio and buy some debt. As the markets are going higher this automatically ensures that an investor is booking some profit invariably — and not chasing high-priced stocks. Says S. Naren, CIO, ICICI Prudential Mutual Fund: “Balanced funds are a suitable way to beat volatility and benefit from reasonable risk-adjusted returns as they have a pre-determined allocation towards debt and equity, thus offering the benefit of both worlds — growth of equity and relative stability of debt.” Naren further elaborates that such type of funds tend to do well in different types of market cycles when one holds for the long term. “With the benefits of asset allocation and tax efficiency, these products could form part of investor’s core portfolio,” says Naren. Certified financial planner Mukesh Dedhia reckons that balanced funds work well in two of three market conditions. First, when markets are bad, balanced funds do better than markets or other equity funds. When markets are flat, balanced funds do as well. Only when markets are rising do balanced funds slightly lag behind equity funds because of the debt component. Thus, Dedhia, also a director at Ghalla and Bhansali Stockbrokers, says that investors are better off with balanced funds.

Balanced funds have been around for some time now, but investors have recently warmed up to them. Data from ValueResearchOnline show that investors pumped in Rs 28,484 crore into balanced funds in FY16, compared to Rs 15,417 crore in FY15, a whopping 84 per cent increase. And, given that its popularity is waxing, this category is only likely to balloon in coming years. Says Naren, “Largely, the increase in assets of balanced funds is on account of incremental allocation by investors who have been underweight on equity asset class over the past few years. There have been bouts of volatility from the beginning of the year, due to which we have been recommending our investors to invest in balanced advantage funds to benefit from volatility.” In fact, investors have a number of balanced funds to choose from. Equity-oriented balanced funds are those that have a higher equity component, while debt-oriented balanced funds have a higher debt component. So, if an equity-oriented balanced fund invests 65 per cent in equity, a debt-oriented balanced fund would invest 65 per cent of its portfolio in debt.

While an equity-oriented balanced fund suits a moderate to aggressive risk-taker, a debt-oriented balanced fund suits a highly conservative investor because of the low equity component. Dedhia reckons that investors could invest without much fuss in equity-oriented balanced funds if s/he has a higher risk appetite.

There is another kind of balanced funds that is dynamic, where the equity proportion can swing from 35 to 70 per cent depending on market conditions. Also, known as dynamic asset-allocation funds, these funds invest according to valuations in the market. If equity prices are too high, dynamic asset-allocation funds drop the equity exposure to as low as 35 per cent. On the other hand, if equity valuations are too low, such funds increase the equity component to as much as 75 per cent.

In this kind of balanced funds, investors need not take on the stress of timing the market and when to make that switch between equity and debt. This takes the strategy of an investor to a higher level, where one can actually market full-on when equity prices are very low, and ensures that the fund continuously books profits when equities are rising in value. When equity prices are very high, as these funds have a very low equity component, investors can aim to make better returns than normal balanced funds.

Says Naren: “These funds are structured to invest in equities when markets are cheap and book profits when markets are rising, thus minimizing risk and aiming to provide good long-term returns. These funds have the ability to incline the portfolio towards the more favorable asset class depending by using valuation yardstick such as price-to-book value and comparing it with the mean in order to arrive at the asset allocation break up.”

For investors, as balanced funds combine both debt and equity in a single investment structure, it leaves the hassle of asset allocation to the fund manager. If investors try to balance their asset allocation through separate funds or individual strategies, they may have to pay short-term capital gains tax or a higher exit load, and so on. Says Dedhia: “There is a continuous process of buying low and selling high, and if investors want to do this regularly on their own, taxes can kick in.” But balanced funds offer switching benefits without these additional levies. Besides, the risk-adjusted return can be better than in equity funds in some balanced funds because of the steady debt component of the portfolio. The debt component helps iron out equity volatility, and keeps steadies a portfolio when too much choppiness prevails. Data from ValueResearchOnline show that this category has given returns of 15.2 per cent in the last three-year period. Besides, when markets have been around the same levels in the last one-year period, these funds have given returns of around 1.44 per cent. So, this shows that they preserve gains when markets are falling, and the equity component gives the kicker to returns when markets rise.

In a three-year period, the best-performing balanced fund returned over 22 per cent to investors, while the worst-performing ones returned just 7.9 per cent. This shows that balanced funds have actually made money for investors. Besides, balanced funds come with tax advantages. As most balanced funds have 65 per cent exposure to equity, they are taxed like equity funds. Therefore, if the holding period is greater than a year, the applicable long-term capital-gains tax is nil. Dedhia, however, recommends that, as there are a myriad strategies that balanced funds follow, investors would do well to follow the advice of a financial planner. All balanced funds do not have the same equity component; and some follow a dynamic asset-allocation strategy. Besides, each individual’s needs and risk levels are different; hence investors need to know their risk appetite and which balanced-fund category suits them best.

However, investors have to come into the market with a long-term outlook. Balanced funds require at least three to five years for a cycle to be complete. But, if you want to take a moderate risk and make investment planning and asset allocation a lot easier, then balanced funds should be your route.

The Benefits Of Balanced Funds
* Balanced funds invest in both equity and debt and, therefore, their preset asset allocation works for the moderately aggressive investor

* The debt component in these funds helps stabilise the portfolio which, in turn, reduces volatility in the fund

* Balanced funds automatically rebalance to pre-determined ratios, hence they help stay ahead of the market conditions

* When equities go up, balanced funds help book profits out of equities and vice versa due to rebalancing

* Dynamic balanced funds follow a more conservative approach to equity exposure by investing in equity according to its valuations

* Balanced funds are taxed as equity funds, hence investors get the benefit of long-term capital gains if held for over a year

* There are various types of balanced funds; some come with an aggressive equity exposure, while others have lower equity exposures

* Investors could choose between different balanced funds according to their risk evaluation and how much equity exposure they want

* Balanced funds work better when equity markets are volatile or flat, but investors need to maintain a three-year investment horizon