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Target returns that are between equity & debt

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It has been proven that maintaining asset allocation based on one's risk appetite is one of the optimum ways of wealth creation in the long run. To maintain the asset allocation, the investor must continuously monitor his/her portfolio and rebalance whenever the asset allocation shifts, which can be due to differential performance of the debt and equity portfolios or fresh investments.


Balanced funds can help you to get an exposure in the equity market and at the same time cushion your portfolio with debt. These schemes are equity-oriented funds with the portfolio comprising of debt securities and equities. Assets in these funds are generally held in a predefined proportion of debt securities and equities, that is 65-70% in equities and the balance in debt.


In a typical balanced fund, the equity portion is managed like a diversified equity portfolio while the debt portion is usually managed like a short-term debt fund based on accrual strategy. However, certain balanced funds could also look at managing the debt more actively.


A balanced fund by design maintains its asset allocation and rebalances based on market conditions. For an example, let's take a balanced fund with 70% exposure to equity and 30% to debt. If the stock markets are down, the fund's equity exposure will drop to the extent of the fall, and the fund manager will then invest more in equity to maintain the 70% equity level. This way, the fund will buy more equity when the markets are down and hence optimize returns.


Similarly, in a rising market, if the equity allocation moves up to 80%, the fund manager will sell 10% of the equity portfolio and buy debt, thus automatically booking profits.


How does it compare with other funds?


Broadly, balanced funds target returns that are between equity and debt funds. Volatility in a balanced fund is less than that in a pure diversified equity fund but greater than that of a debt product.


Balanced funds tend to outperform equity funds in cycles when stock markets are volatile or bearish as they have a cushion of debt. When stock markets are in a secular bull phase, they will tend to underperform funds with 100% equity component.


However, for a long-term investor where the investment goes through various market cycles, balanced funds have the potential to outperform even equity funds and are a great tool to achieve long-term goals.


Due to the equity-oriented structure of a balanced fund, it qualifies for the same tax treatment as equity funds as they have more than 65% of their assets in equities, that is, short-term capital gains are taxed at 15%, while there is no dividend distribution tax and long-term capital gains tax.


Hence, for investors looking at long-term wealth creation either through SIP or otherwise, a balanced fund provides a great tool to create wealth. It is also a great investment option in volatile market conditions as it helps cushion the down side and gives reasonable upside of equity.

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