FUND FLAVOUR
January 2012

Balanced funds…sweet as ever

The fund industry never tires of concocting new products for investors looking for the perfect tradeoff between growth and stability. Absolute return, tactical allocation, target date ... those are just some of the impressive-sounding labels you are asked to decode. But if you are looking for a way to diversify across risky, uncertain and volatile equities and conservative assets, there is a simple solution that has been around for decades: the balanced fund.

Let us take a closer look at these balanced funds.

Balanced funds are also known as hybrid funds. They are a type of mutual funds that buys a combination of equity and debt instruments, to provide both income and capital appreciation while avoiding excessive risk. Such diversified holdings ensure that these funds will manage downturns in the stock market without too much of a loss as compared to an all equity fund. But on the flip side, balanced funds will usually increase less in value and provide lesser returns than an all equity fund during a bull market. Thus, these types of funds are meant to diversify away a little of your equity risk by exposure to debt, while maintaining decent returns as well. This one-stop-shop gives you adequate diversification without giving you the trouble of managing an assortment of investments yourself.

Under the microscope…

Though there is a vast difference in the strategy between a balanced fund and, say, a large-cap scheme within the same fund house, many fund houses model the equity portion of their balanced fund on the lines of one of their equity schemes. Balanced funds have to maintain their ratios of splitting between equity and debt by fixed percentage (a minimum of 65% equity to avail of the tax advantage). In order to do so, the fund has to keep on buying and selling from time to time, which leads to the concept of Asset Allocation. So, if a balanced fund has a ratio of 70:30 (equity: debt) and suppose it reached 77:23, the fund manager will make sure that he sells the excess part of equity to rebalance the fund back to 70:30. However in equity funds, if the ratio itself was 98:2 earlier, despite the big run in markets, the equity part will still remain around the same ratio and there is no question of asset allocation. So the conclusion is that the asset allocation is the internal advantage available to Balanced funds which leads to superior returns over longer term, but in short term, balanced funds will not out perform pure equity based funds in case there was a bull run. You always have to give balanced funds a long time to see the performance.

As balanced funds are lower on equity exposure, the fall in case of market crash is lower than pure diversified funds. For example, during the financial crisis of 2008, balanced funds lost only 42% as compared with 53% drop in returns by diversified equity funds. Balanced funds out performed pure equity funds by a considerable margin in the post crisis period also. A quick look at average returns of balanced schemes versus equity schemes shows that in the last six and 12-month periods, balanced funds have proved to be better than equity diversified funds. In the three-month period, the returns of both categories are similar at around 3%. Balanced schemes have given an average 6.8% gain in the last 12 months compared to 6% by equity diversified funds. In the six-month period, balanced schemes have fallen by 2.4% while its peers have fallen by 5.3% on an average. With debt instruments giving good returns, balanced funds give investors a cushion. It is true that equities have been volatile for quite sometime now but that is why balanced funds provide a slightly better platform. The sustained inflows into balanced schemes are borne out of the investors’ need to seek income as well as capital appreciation. Balanced funds returns are less risky than pure equity mutual funds.

Amid news of a slowdown in inflows that appears to have plagued the Indian mutual funds industry, there is one category in the equity space that seems to have consistently attracted money. In each of the past 12 months, balanced funds got net inflows (more money came in than went out) as per the data given by Association of Mutual Funds in India. Investors have pumped in around Rs 1,600 crore in the last eight months into balanced schemes. In the same period, for equity schemes, net inflows amount to around Rs 1,700 crore but with at least three times when net outflows were registered. The longest-running streak of net inflows into balanced schemes occurred in June 2007-2008 period when investors had pumped in Rs 6,100 crore in 13 months. The numbers are not significant, but these schemes—that invest across equity as well as debt markets—have matched performances given by equity funds. In the past three years, balanced funds returned 16% compared with 15% by large-cap funds and 17% by large- and mid-cap funds. However, only about 10% of the total equity inflows trickle down to balanced funds. Why are not distributors selling them enough? Do they still make sense?

Balanced funds to rule the roost in 2012

Balanced Funds are best placed to unleash a sustained rally in 2012. It is the best launch pad for novices to mutual fund investing. If you are looking at a time horizon of three to five years, moderate risk and decent returns, balanced fund is the answer.