A Balanced Approach To Mutual Fund Investing

As a category, Equity Oriented Balanced funds have grown by an average of 11.5 per cent per annum over a 10 year period as of 7th July, 2016. Factor in the tax efficiency of this return (returns from Equity Oriented Balanced Funds are tax free after a year), and this actually works out to quite an impressive growth rate for a moderate risk investor. To put it in perspective, an 11.5 per cent return would have nearly tripled the value of Rs. 1 Lac to nearly 3 Lacs over the past decade - which has seen its fair share of turmoil; what with subprime mortgages, government changes and more recently, the prospects of a divided EU creating bouts of volatility on more than one occasion!

Balanced Funds invest between 65 per cent and 80 per cent into equities, with the remainder getting allocated to debt instruments. The specifics of the equity and debt investments - for instance, whether to opt for a large cap tilt or a midcap tilt, or whether to follow more of an accrual strategy for the debt portfolio or a dynamic strategy, is the prerogative of the fund management team. Usually, a balanced fund will employ separate fund managers for the equity and debt portions of the portfolio.

Balanced Funds are ideally suited for moderate risk investors, or even low risk investors with a sufficiently long time horizon (as risk tolerance along cannot be the key determinant of asset selection). The debt portion acts as a cushion during market corrections, but also prevents Balanced Funds from racing ahead when markets pick up pace.

Automatic Rebalancing
Because a Balanced Fund needs to stick to a predefined range of asset allocation between equity and debt, the Fund Manager is constrained to reduce exposure to equities if a market run up throws the portfolio balance out of kilter. Similarly, the Fund Manager needs to purchase more equities in case a market correction leads to a drop in the percentage of equity holdings. In this manner, Balanced Funds automatically ensure the application of a disciplined technique of buying low and selling high in volatile markets. For this reason, Balanced Funds are an ideal component of the core of your portfolio - the part which you'd ideally like to buy and hold for the long haul.

Surprise! Your debt investment gets taxed as an equity investment
If you were to create your own portfolio with separate equity and debt mutual funds, the overall tax efficiency of your portfolio would be negatively impacted by the debt funds. However, the returns from a Balanced Fund allocating more than 65 per cent of its assets to Indian equities are taxed entirely as equity, offering the unique advantage of tax efficient returns in spite of having a fairly sizeable allocation to fixed income instruments. It seems that in this instance, you can actually have your cake and eat it too!

They're lower risk, but not 'low risk'
Although they tend to be less volatile than equity funds, Balanced Funds must not be misconstrued as 'low risk' funds. They are exposed to risks that prevail both in equity as well as debt markets, and their volatility can end up catching you off-guard. For instance - HDFC Balanced Fund (which has close to Rs. 6000 Crores in assets) fell by close to 40 per cent in 2008, only to recover by an eye popping 100 per cent between March 2009 and March 2010. There may be phases when equity and debt markets underperform in tandem, leading to a double blow to the portfolio returns. A case in point is the two month phase in July and August 2013, when the Rupee's unprecedented fall prompted a bond market correction wherein the yield on the 10 year G-Sec soared almost 50 bps in a single day, and the NIFTY delivered a negative 5.3 per cent return in August. In this period, HDFC Balanced Fund dropped by 6 per cent in just two months.

In Focus: Two bellwether Balanced Funds
If you've made up your mind to invest into Balanced Funds, you may want to consider ICICI Prudential Balanced Fund or DSP BlackRock Balanced Fund - two funds in this space that have stood the test of time and will in all likelihood, continue to create long term wealth for investors.
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ICICI Prudential Balanced Fund
(with inputs from Sankaran Naren, Executive Director and CIO, ICICI Prudential AMC)
Launched in 1999 amidst turbulent times, the fund now has a track record spanning 17 years. In the past 5 years, it has delivered annualized returns in excess of 15 per cent and has a 10 year return track record of 13 per cent per annum.

Core Philosophy
The fund maintains a minimum of 65 per cent to maximum of 80 per cent exposure to equity while the remaining in debt. The equity levels in the range of 65-80 per cent are determined using an in-house Price to Book Value (P/BV) model in which current market levels are compared to the fair value range to determine under or over valuation of the market. A lower P/BV than the fair value range triggers an increase in equity levels and vice versa. The rebalancing of equity portion takes place on a weekly basis.

Strategy
The Scheme looks at a blend of large and mid-cap stocks. While the large cap stocks represent established enterprises with track record, the midcaps are smaller businesses with long-term growth potential. It proposes to concentrate on business and economic fundamentals driven by in-depth fundamental research. The Scheme seeks to actively manage the debt portion based on the view of the debt market with an aim to benefit from changing interest rate cycles. The Scheme also invests in fixed income securities, which offer reasonable accrual with credit rating AA and above and tactical allocation to longer maturity papers.

Risk Management
The funds have a stock universe across market capitalizations. However, the conservative nature of investors is kept in mind while constructing the portfolio. Hence, they do not take any aggressive calls on any leveraged sector or companies. They tend to avoid companies with high valuations. Using bottom up, they pick up stocks with long term perspective. They also assign very high weightage to corporate governance standards of the companies where we are invested and how they treat minority shareholders.
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DSP BlackRock Balanced Fund
(with inputs from Atul Bhole, Vice President and Fund Manager and Pankaj Sharma, EVP and Head - Fixed Income, DSP BlackRock Investment Managers )
Another fund with a 17 year track record, DSP BlackRock Balanced Fund has delivered an impressive 13.7 per cent return per annum over the past 10 years.

Core Philosophy
The DSPBR Balanced Fund is managed with the core philosophy of long-term wealth creation and income distribution. The crucial aspect of this philosophy is to achieve these goals in a consistent manner while assuming risks to prudent and controllable levels. The Fund is mandated to invest in equities from 65 per cent to maximum of 75 per cent and the rest in debt. Where equity proportion is managed in a diversified style to generate returns over the long-term, the debt part helps in cushioning the volatility in equity market. While they don't believe in timing the markets and stay invested in equity of good quality and growing companies, this proportion is balanced frequently to benefit from the market volatility. On the debt side, the fund endeavors to deliver stable fixed income returns through coupons and capital appreciation. The fund invests in a mix of strong corporate credits and Government securities.

Strategy
On the equity side of the fund, as already mentioned above, they don't believe in timing the markets and stay invested in equity of good quality and growing companies. Hence equity portion of DSPBR Balanced Fund would stay invested on the higher side i.e. around 72-74 per cent most of the time. Secondly, to help achieve the goal of long-term wealth creation, the equity portion would have a large-cap to midcap exposure in ratio of around 60 to 35.

Though the fund will be managed with a bottom-up approach, pre-dominant style would be to buy and hold companies with compounding growth in revenues and in earnings run by good, competent managements. Limited part of the portfolio would be exposed to value or turnaround names depending on conviction levels about them. At the same time, the endeavor is to avoid apparent value picks or companies making severe capital allocation mistakes. Both the aspects means the fund can deviate from the broad market indices by a considerable degree. On the Debt side, the fund will maintain a medium term duration strategy. The fund will look to invest in the liquid segments of the curve.

Risk Management
For the equity portfolio, risks can be managed at two levels, at overall portfolio level and at individual stock level. At the portfolio level, the risk is managed by better diversification across sectors and stocks. DSPBR Balanced Fund intends to limit top 5/10 stock weight to the extent of roughly 20/30 per cent respectively. Secondly, to benefit from any particular sector or theme also, the Fund desires to create a basket of companies to spread the bets. At individual company level, they believe if one has invested in a good quality company with competent management and with long-term view, risks get reduced substantially. As far as fixed income is concerned, the mix of strong credit focus and government securities selection provides adequate liquidity while maintaining attractive yields.