Investors with shorter horizon of three-five years can also look at balanced funds and also those looking to invest lump sum money.
The current volatility in the equity markets can be a cause of concern for retail investors, who have been pouring money into stocks.
In a scenario where the Sensex corrects one day and gains on the next, balanced funds, also called as equity-oriented hybrid funds, can be a good investment option.
On an average, these schemes maintain at least 65 per cent allocation to equity and rest is in debt.
The diversification between the two asset classes protects the portfolio from downside risk if either of the two starts correcting.
While equity has the potential to deliver superior long-term returns, debt provides stability to the portfolio.
While the BSE benchmark Sensex has seen an overall correction of around 10 per cent in the past one month, it has been highly volatile on a day-to-day basis.
For example, on September 4 and 5, the market corrected 871 points and in the next two trading sessions, gained 826 points. In this one month, balanced funds have fared better with -5.21 per cent average returns.
In fact, schemes in this category have contained downside better than large cap funds, which have average returns of -8.46 per cent, and large- and mid-cap fund categories that have -8.74 per cent returns.
Balanced funds have also fared better than most equity-oriented schemes since the large single-day correction of 1,624.5 on August 24.
"On the equity side, these funds have a mix of blue chip and mid-cap stocks just like a diversified scheme," says Atul Bhole, fund manager at Tata Mutual Fund.
He says when markets correct and equity portion goes down, the fund manager sells debt instruments to rebalance the portfolio and maintain the allocation.
"This helps a fund manager to always buy on correction. In case of a diversified fund, they don't have the same liquidity as they maintain high equity allocation," says Bhole.
The strategy has managed to beat Sensex and large-cap funds in the past one year. Balanced funds have average returns of 6.89 per cent.
The Sensex dropped -5.67 per cent and large-cap funds are down -0.25 per cent.
Vidya Bala, head - mutual funds research, FundsIndia says while these funds are suited for all investors looking to contain volatility, those with limited money should also look at them.
"Portfolios of these investors are automatically balanced saving them hassle of doing it manually and there's cost attached to it," says Bala.
Bhole says investors with shorter horizon of three-five years can also look at balanced funds and also those looking to invest lump sum money.
However, for long-term wealth creation, one should invest in diversified funds through a systematic investment plan.
These funds are also tax-efficient. As they maintain at least 65 per cent exposure to equities, they get the same treatment as equity schemes.
If an investor holds these for more than one year, the returns are tax-free and so are the dividends.
