Time and again the media keeps putting balanced funds under the scanner to see how they have fared. On the occasions when balanced funds haven't done well, you have journalists questioning the very existence of the category and how they can be replaced seamlessly by investing in a combination of equity funds and debt funds.
In our view, fashionable as it has become, no amount of balanced-fund-bashing can hide the fact that the product has multiple roles to play in the risk-taking investor's portfolio.
In our view, balanced funds present a unique investment proposition for the following reasons:
1. They can be potent asset allocation tools that allow investors (as also fund managers) to move across two asset classes (equities and debt) depending on opportunities in those markets.
2. Any financial planner will tell you that diversification is the cornerstone of a successful investment strategy. In recent times, you will have heard considerable noise about the fantastic investment opportunities in gold and real estate. More important than the investment opportunities they offer, these asset classes present a unique diversification opportunity. Since all asset classes have their own cycles, which at times run in opposite directions, it pays to invest across several assets so as to de-risk the portfolio.
From that standpoint, equity and debt are two asset classes that help investors diversify so that no single asset has an unduly high allocation in the portfolio.
3. Balanced funds are more 'disciplined' than equity funds; they are compelled to maintain a pre-determined asset allocation plan. Equities usually, account for a minimum of 65% of net assets (to qualify as equity-oriented funds). If the balanced fund is managed in a disciplined manner, the fund manager will book profits at regular intervals (in a rising market) to keep the equity allocation hovering around 65%. This is unlike an equity fund, where the fund manager might be forced to ride the bull run without being able to book profits even if markets have run up perilously, like they did before the crash in May 2006.
4. According to the latest budget guidelines, balanced funds with a minimum 65% equity allocation qualify as equity-oriented funds. So balanced funds attract the same tax benefits as equity funds; dividends are tax-free and investors pay STT (Securities Transaction Tax) on redemption.
To pitch balanced funds against diversified equity funds, please click here
5. We don't understand how balanced funds can be considered as unnecessary and pointless, when you have some balanced funds that have done far better than their diversified equity fund counterparts. Balanced funds like HDFC Prudence have done exceedingly well vis-à-vis some diversified equity funds over the long term (3-5 years).
6. Experts believe that since on occasions balanced funds have been outperformed by the benchmark index (CRISIL Balanced Index), they are no good. We disagree with that assessment. To begin with, given their present asset allocation structure (minimum 65% in equity) balanced funds cannot be compared accurately with their benchmark index since CRISIL Balanced Index has a 60% equity allocation.
Moreover, if underperformance to benchmark index is the reason for banishing a mutual fund category, then this process must begin with equity funds. We have already seen diversified equity funds in the domestic market struggling to match their benchmark peers, especially during the market crash over the last few months. In developed markets, it's an even bigger struggle for equity funds to best their benchmarks.
Now let's evaluate what is being advanced as a solution to the problem. 'Experts' encourage investors to invest in a debt fund and an equity fund in a pre-determined allocation to replace balanced funds. We don't think this is the right 'solution', if anything; the solution is more complicated than the problem for the following reasons:
1. Investor will have to invest in two investment avenues, as opposed to one balanced fund. When we talk of diversification in a positive way, we are not referring to cramming your portfolio with several funds when a simpler option stares you in the face. If you have a single investment that can achieve an investment objective, it makes little sense to reject that in favour of its underlying components (in this case equity funds and debt funds). Else, equity fund investors should abandon equity funds and take to investing directly in the stock markets.
2. Even if you choose to invest in equity funds and debt funds to replace balanced funds remember it's only a start, there is a lot more to follow. For one there is rebalancing to be done at regular intervals. For all their clamour against balanced funds, critics forget that the fund manager of a balanced fund administers a very important task continuous rebalancing of the equity and debt allocations to ensure that they stay in line with the pre-determined asset allocation. On your own, you will have to mirror his efforts and competence, which is easier said than done given how dynamic equity and debt markets can be.
3. An even more demanding task is to take active calls on debt and equity markets. Remember a balanced fund deals with two assets, which means to succeed on your own you have to get it right with two investments. You have to track events related to equity markets as well as debt markets. To do that successfully, you might as well resign from your present job and take up investing as a full time activity and even then your hands may be a little too full for comfort. You think we are kidding, not for nothing are there two fund managers in most balanced funds, one each for equity and debt components. So you may actually be attempting something that is best achieved by a team of fund managers.
By now it's clear that balanced funds for all their 'so-called flaws' are irreplaceable. There is no investment to replace them and more importantly there is no investment team to replace the fund managers. So the next time you read something about how balanced funds are losers, make a note of the journalist who wrote that article so you can skip his/her articles the next time.
For a Free download of the latest issue of 'Money Simplified -- The definitive guide to planning for your child's future,' click here!
