Balanced Funds are equity oriented hybrid mutual fund schemes. Hybrid funds invest in multiple asset classes like equity and debt. Balanced Funds have at least 65% asset allocation in equity or equity related securities and the remaining portion in debt securities. Debt as an asset class is subject to less price volatility relative to equity and therefore, balanced funds have a moderate risk profile compared to stocks or equity mutual funds.
Advantages of Balanced Funds
Superior risk adjusted returns with lower downside risks: We have discussed a number of times in our blog that, equity as an asset class has historically given higher long term returns compared to other asset classes. With more than 65% asset allocation to equity and equity related securities, balanced funds can give good capital appreciation to investors in the long term. The debt allocation of balanced funds serves to moderate the downside risks in volatile markets. While balanced fund managers maintain equity allocation above 65% (and fixed income below 35%), they can make asset allocation calls within a certain range based on their outlook for relative valuations of equity versus debt. If fund managers think that equity valuations are on the expensive side, they will reduce their exposure to equities and increase their debt allocation. If fund managers think that, equities are cheap then they will reduce debt exposure and increase allocation equities. Active asset allocation helps balanced funds deliver superior risk adjusted returns.
Dynamic Asset Rebalancing: Dynamic asset rebalancing is another benefit in balanced fund investments. Balanced fund managers aim to maintain equity and debt allocations within certain target ranges. A prolonged bull or bear market can cause equity or debt allocations exceed the target ranges and fund managers rebalance their asset allocation to bring it back within the target ranges. If stock prices run up substantially, then fund managers will book profits in stocks and re-invest in debt. When stock prices fall substantially, fund managers will invest in equity to bring asset allocations back within target ranges. Asset rebalancing results in greater returns stability for balanced funds compared to riskier asset categories like equity mutual funds.
Tax Advantage: Balanced funds enjoy a major tax advantage compared to many other investment products. Though Balanced Funds may have up to 35% allocation in lower risk debt assets, they are taxed as equity funds. Long term capital gains (units held for a period of more than 1 year) are tax free. Short term capital gains (units held for a period of less than 1 year) are taxed at 15%. Dividends paid by balanced funds are also tax free.
Smaller funds can generate better returns
In India, funds with relatively smaller Asset under Management (AUM) sizes can deliver superior returns to investors, because percentage of free float market capitalization in large segments of our equity market is low due to high promoter ownership. Though low free float results in less liquidity, over a sufficiently long period of time, these stocks can create wealth for investors through superior deployment of capital and returns thereof, economies of scale and valuation re-rating. However, fund with large AUM sizes are not able to take advantage of such opportunities because of liquidity consideration and they are forced to invest in highly liquid large cap stocks; over a period of time; the portfolio composition of very large sized funds begin to converge with the index composition. Small sized funds on the other hand can deviate substantially from the index and generate alphas for investors (superior risk adjusted returns) through bottom-up stock selection.
Good investment options for moderate risk and novice investors
Balanced Funds are good long term investment options for investors with moderate risk capacities. Balanced Funds are also good investment options for new investors who have no experience in equity investing and dealing with volatility of asset prices. Equity markets are intrinsically volatile in nature and volatility can stressful for many investors. The debt component of balanced funds limits downside volatility. Balanced funds can also be suitable for senior citizens as long term investments to beat inflation.
Though the primary objective of Balanced Funds is capital appreciation, they are also suitable for investors who like income from their investments, provided investors are ready for income volatility. If capital appreciation is the investment objective, then investors can choose for Growth Option in Balanced Funds. However, investors who want income can opt for Dividend Options. Investors should note that, dividends are paid at the discretion of the Asset Management Company (AMC), both in terms of the pay-out rate and the frequency of payment.
Some good balanced funds
ICICI Prudential Balanced Fund: This is one of the most popular schemes in the Balanced Fund category with more than Rs 9,100 Crores of AUM. The fund has given nearly 20% annualized returns in the last 3 years and over 27% returns in the last 1 year. The current asset allocation is 68% equity, 29% debt and 3% cash. SankaranNaren, Manish Banthia and Atul Patel are the fund managers of this scheme. The equity portion of the fund is primarily large cap oriented. The fund managers employ a blend of growth and value styles of investing. The interest rate sensitivity of the debt portion of ICICI Prudential Balance Fund is moderate.
DSP Black Rock Balanced Fund: This is medium sized balanced fund with around Rs 3,500 Crores of AUM. The fund has given nearly 27% annualized returns in the last 3 years and over 22% returns in the last 1 year. The current asset allocation is 74% equity, 24% debt and 2% cash. Atul Bhole, Vikram Chopra and Pankaj Sharma are the fund managers of this scheme. The equity portion of the fund is primarily large cap oriented and the fund managers employ growth style of investing. The interest rate sensitivity of the debt portion of DSP Black Rock Balanced Fund is moderate.
Principal Balanced Fund: This is small sized balanced fund and is a rising star in the balanced mutual fund category. Principal Balanced Fund gave one of the highest returns in the past one year with return of more than 31% (more than 18% CAGR in the last 3 years). The current asset allocation is 67% equity, 25% debt and 8% cash. The equity portion of the fund is primarily large cap oriented. PVK Mohan and BekxyKuriakose are the fund managers of this scheme. The fund managers employ a blend of growth and value styles of investing. The interest rate sensitivity of the debt portion of Principal Balanced Fund is limited. The relatively higher cash component of the portfolio will provide greater tactical flexibility to fund managers to take advantage of market opportunities, as and when they arise.
In this blog post, we have discussed what balanced funds are, how they work and their key advantages. We also discussed why investors should look beyond the most popular mutual fund schemes and the potential advantages of relatively smaller sized schemes. We also discussed three good mutual fund schemes that, investors may consider for their mutual fund portfolios. Investors should consult with their financial advisors, if Balanced Funds are suitable for their investment needs.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.