Why Should You Invest in Balanced Mutual Fund?

Balanced Mutual Funds, as the name suggests, invest in a mix of equity and debt. It is an attempt to get the best of equity and debt as asset classes and to give investors an in-between solution that is not extreme in terms of risk and returns. But there is also a bigger purpose in balanced funds. Normally, the onus is on the investor to decide on the allocation between equity and debt. In the case of balanced fund, an expert fund manager does the job for you. So, it gives you the added benefit of professional fund management and professional asset selection.

Understanding the new structure of balanced funds as per SEBI

For a long time, balanced funds had an open definition. The asset mix ranged from 80:20 all the way down to 20:80 in terms of debt/equity mix. Also, the funds were using names and nomenclatures that were confusing for the investors at large. In 2018, SEBI asked all balanced funds to be reclassified into one of the 3 categories.

Aggressive Allocation Funds

These balanced funds are predominantly in equity and only a small portion in debt. The principal focus is wealth creation with the debt portion to give some conservatism to the portfolio. Here are the top performing aggressive allocation funds over last 5 years.

Data Source: Morning Star

Conservative Allocation Funds

These conservative funds are predominantly in debt and only a small portion in equity. The principal focus is stability with the equity portion to give some alpha to the portfolio. Here are the top performing conservative allocation funds over last 5 years.

Data Source: Morning Star

Arbitrage Funds

This third category of balanced funds as per SEBI definition are classified as equity funds for tax purposes but the returns are benchmarked to debt. Such funds buy equity and sell equivalent futures to lock in the spread.

Why should investors look at balanced funds as an asset class?

The debate on balanced funds is whether to do your asset allocation on your own or to leave it to your fund manager. From an overall financial plan point of view, it is always better to do your asset allocation based on your needs. However, some exposure to balanced funds is warranted as they are simple and efficient. Here is why you must look at balanced funds as an asset class.

1. The big advantage for investors is the tax benefits on the Aggressive Allocation Funds. Currently, a balanced fund with 65% exposure to equity is classified as an equity fund for taxation purpose. In such cases, the STCG is taxed at just 15% and LTCG at 10% above Rs.1 lakh per year of gains. The cut off period is 1 year to define LTCG.

2. Balanced funds can be extremely useful in restructuring your portfolio. For example, if your original debt/equity mix was 40:60 and if the equity mix has gone up sharply due to a bull market then you can rework the mix with Conservative funds. This is a smoother process of asset reallocation.

3. Balanced funds are transparent in the sense that the equity and debt portfolio are available to you on a monthly basis via the fact sheets. You can use the fact sheet to evaluate the portfolio and take your own call.

4. Balanced funds like the arbitrage funds can give you low risk like debt with the tax benefits of equity. This is a unique advantage that makes arbitrage funds attractive.

A word of caution on dynamic funds

One category of balanced funds that is gaining popularity among investors is the dynamic fund. Here the fund manager has the discretion to decide on the mix between debt and equity. For example, the fund manager can increase the equity exposure when the P/E of the Nifty goes below a threshold. Similarly, the fund manager can increase the exposure to long duration bonds if interest rates are expected to go down. At times, fund managers also add to their exposure to lower quality debt when they expect yields to converge. While all these are good ways of creating alpha, you must remember that it largely exposes you to the personal biases and views of the fund manager. That is a word of caution about dynamic funds.

Balanced funds have seen their collections grow quite impressively in the last few years although the FMP fiasco has tempered the demand to some extent. While there are merits and risks, balanced funds have surely emerged as an interesting alternative.