Balanced Mutual Funds

 

 

As the name suggests, this category of funds invests in two asset classes — equity and debt, with the majority (minimum 60%) finding its way into the former. Such funds are simplicity at its best. You get a ready-made portfolio that allocates between two asset classes, with the actual allocation depending on the fund manager's call on the state of the markets. But do note, the fund managers are restricted by the mandated equity allocation. So you won't find them going 95 per cent into equity, they will operate within the stated band.

 

For instance, just before the market crashed in January 2008, these funds held 74 per cent of their portfolio in equity (December 2007). By February 2009, it stood at 63 per cent but moved up to 71 per cent (May 2009) as the stock market began to rally.

 

The higher debt exposure does tend to hit returns. This category delivered 61 per cent in 2009 as compared to 84 per cent, which was the average of equity diversified funds. However, this is precisely what you should expect from such funds. They are a more tamed version of pure equity plays. The debt component makes these funds less volatile providing better downside protection. In 2008, this category of funds shed just 43 per cent against a 56 per cent fall experienced by equity diversified funds.

 

So what should investors expect here?

 

The prime advantage of such funds is that one doesn't have to worry about the rebalancing of the portfolio. The fund manager takes care of that. Every portfolio must have elements of both asset classes. And we, at Value Research, have consistently been advising our readers to rebalance their portfolio at the end of specific time periods to maintain their predetermined ratio.

 

With such a fund, this issue is dealt with. As equity outperforms, the fund manager will book profits in stocks and transfer the gains to debt to maintain his equity:debt ratio. Or vice versa.

 

Investing in these funds is also tax efficient. As far as the tax man goes, these are treated as equity funds. They don't attract any dividend distribution tax and no long-term capital gains tax is levied if investments are sold after one year (short-term capital gains tax is applicable). However, if an investor holds a debt fund, long- and short-term capital gains are applicable.

 

If one takes a look at the Direct Tax Code, gains from all funds will be taxed. So your gain in an equity fund will be added to your income and taxed, though a deduction will be available depending on the tenure for which the units are held. So an investor will be penalised for rebalancing. Hence the convenience of letting the fund manager rebalance on his own gains all the more significance.

 

On the debt side these funds invest in all sorts of paper though most of them don't take aggressive maturity bets and prefer playing it safe.

 

These funds are yet to gain in popularity. They make great investments for those who are new in the investment arena. The asset base of this category of funds is just 9,985 crore (July 31, 2010). This is just 6 per cent of the assets of equity funds. Interestingly, the biggest fund of this category — HDFC Prudence, accounts for around half of the assets of the category.