Hybrid equity funds, commonly known as balanced funds, are ideal candidates for constituting the core of a portfolio. In a balanced fund, the fund manager balances the fund’s equity-debt allocation according to the market conditions.
The only drawback of having balanced funds is that one cannot specify the equity-debt mix. This will be determined either by the law or the fund house.
WHAT IS IT?
Balanced funds combine a stock component, a debt component and sometimes a money market component in a single portfolio. They generally stick to a relatively fixed asset allocation. It is geared toward investors looking for a mix of safety, income and modest capital appreciation. The amount such a mutual fund invests in each asset class remains within a set minimum and maximum limit.
The objective is to provide capital growth via a mix of equity and debt. The unique proposition of spreading investments among two broad asset classes is hard to find in other types of funds. The higher equity allocation gives these funds the opportunity for high growth, while the debt component provides a cushion when the equity component fails to perform. At the same time, the same debt allocation pulls the fund’s return lower during a bull run, since these funds are not fully invested in equities.
The best balanced funds keep allocation flexible and open to changes as demanded by market conditions (but subject to regulations). Balanced funds have the lowest downside standard deviation, a measure of volatility.
Switching: Their key advantage is the ability to switch from a high equity allocation when the market is bullish to low equity allocation when the market turns bearish.
Diversification: These funds offer diversification in the true sense, with a portfolio of stocks and bonds, thereby offering a blend of growth and safety.
Hassle-free: You do not have to take the trouble of managing an assortment of investments yourself. One fund does it all.
Active-management risk: The active-management risk can get amplified because the fund’s exposure to equity or debt is a function of the fund manager’s view about the direction of equity markets.
Objective mismatch: Such funds may have bonds of lower tenure. Long-term bonds earn significantly more than short-term ones.
Most balanced funds are treated as equity funds. Currently, they are subject to just short-term capital gains tax (at 15 per cent). Both dividend income and long-term capital gains are tax-exempt.
The tax rules play to the strengths of balanced funds. Investors need to rebalance their portfolio at the end of every year to maintain the desired asset allocation. But the short-term capital gains tax will make rebalancing before one year a tax-inefficient strategy.
In balanced funds, fund managers do the rebalancing. The current tax laws do not have a provision for taxing the fund manager’s actions.
HOW TO BUY IT
You can check for ratings of the fund before investing in them. However, these ratings are quantitative measures. The way one 5-star fund may have generated returns might not suit your risk appetite. Hence, you should dig deeper and try to gather more information about the fund. One should look at how active the fund manager has been in asset allocation. Check whether in the process of generating excess return, he has allowed equity allocation to go beyond 65 per cent.
Opt for funds that have shown consistent results. A fund like Escorts Balanced tops the chart during bull runs but finds itself at the bottom of the heap during bear runs. Such funds lack the consistency desired in a core portfolio fund.
Finally, find where the fund manager invests, both in the equity and the debt portfolio. Funds like HDFC Balanced and Escorts Balanced invest in mid- and small-cap stocks in their equity portion, while Magnum Balanced and UTI Balanced consistently invest in large-cap stocks. As an investor, you need to decide which style suits your portfolio. Also, find where the manager puts the money in the debt portion.