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Modern day balanced mutual fund approach

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In reality, most balanced funds have a strong tilt towards equity instead of a mix of equity and debt

THERE are various types of mutual funds available to investors with specific features. Often investors have a particular idea about a specific type of funds in terms of their features and risks, but that is not what is actually available.

Therefore, it is necessary for an investor to understand the actual position before picking up a fund. This requires some work on the part of the investor. One example can be the situation with balanced funds.

Name is not representative: One of the first things that an investor has to understand is that the name of the fund is often not representative of its investment pattern. The name often represents only the aim of the fund, and not what it actually is.

This is important because one has to understand the details of the fund before being able to judge what the investment is all about.

One of the best examples of this is balanced fund. The normal understanding of balanced funds is that they will invest equally in both debt and equity (allocation of around 45-55 per cent to debt and equity) so that there is a balance between the two asset classes and they provide mixed exposure to the investor. However when you look at the balanced funds operating in the country, you will find the situation completely different.

Balanced reality: In reality, most balanced funds have a strong tilt towards equity instead of comprising an equal mix of debt and equity.

It is not uncommon to find 70-75 per cent equity exposure in a balanced fund portfolio. This leaves just a small part of the portfolio to be invested in debt. This completely alters the nature of the investment as it is very near to becoming an equity-oriented fund in terms of its portfolio.

Some years back, the situation was better as around 60-65 per cent of assets of balanced funds was in equity and the remaining in debt. But the proportion has tilted further towards equity over the past few years.

Returns and tax: One of the main reasons why a balanced fund actually has this kind of exposure is due to taxation issues.

Under the tax rules, a fund will be an equity-oriented fund when the average exposure of its assets during the year is 65 per cent or more to equities in domestic companies.

In that sense, the 65 per cent limit becomes the floor for a fund to be categorised as equity-oriented and, hence, these funds try and meet this requirement.

The single biggest benefit of being classified, as an equity-oriented fund is that there will be no dividend distribution tax, which has to be paid when there is a dividend declared by the fund.

This will indirectly raise returns for investors, as they will not face the impact of dividend distribution tax when the fund pays a dividend.


Behaviour: Investors need to take a look at the portfolios of such funds and their actual performance in the market. There is likely to be a higher volatility in this type of funds thanks to their higher equity exposure. There will be a sharp rise in their values when equities do well but they will fall when the market turns weak.

One must ensure that the right expectations are built into the fund based on these conditions. In a rising market, the performance of this kind of funds will be better than a traditional 50-50 balanced fund, but in a falling market it will be worse.

The real challenge for a balanced fund is to ensure that it is able to protect the downside during tough times so that it achieves the desired goals.

 

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