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Asset Allocation

The Surging Balanced Funds – The Good, Bad and the Ugly

The choices we make are based on choices that we would rather make but are denied – passively or actively.

Most investors would want nothing better than a simple investment products that can provide them the comfort of long term returns that can match inflation. But there is no simple magic wand that can provide the mental comfort that reality requires.

Fear is the starting point for many a investment but once you over-come that, you have Greed that shall let you take decisions that you wouldn’t have taken just a few years ago.

I love movies and some movie dialogues have such a impact that it never bores me to watch it again and again. One such which in the context of his post would be from one of my all time favorite movies – V for Vendetta


I was reminded of this speech when thinking of why there has been a swell of money that is flowing into Balanced Funds. While I can understand Equity Inflows and Debt Inflows, why the sudden surge into Balanced is a question that has been not answered.

For long, Fixed Deposits in Banks / NBFC’s (for those who were willing to take a bit more risk for a bit more reward) were the key places to invest. Stock markets have been there for Decades and we even had a Quasi Mutual Fund that invested in Equity but gave returns and volatility similar to Debt for Decades [US-64 scheme of Unit Trust of India].

With Interest rates on Deposits falling to low’s not seen in a long time, investors are caught between the Devil and the Deep sea. Rising costs, which seem to have very little correlation with the inflation numbers released by the government.

Debt funds make sense for those who are paying taxes on their Interest, but for those who don’t, there is little to differ in returns. This squeeze kind of forces investors who won’t want to take risks to start taking risks many are unprepared for.

Enter, Hybrid Mutual Funds aka Balanced Funds

Balanced funds themselves have been here for long and yet for a long time it was like the unwanted child. Equity lovers didn’t love that it held Debt and those looking at Debt did not want the volatility that came with the Equity exposure of Balanced.

Balanced is a wrong way to define the current genre of funds in the first place. When we use the word balanced, the thought is that its equally weighted towards Debt and Equity. But look at the portfolio of any Balanced Fund and you shall see that most have a Equity Exposure of 70% while Debt and Cash completes the rest.

The reason for that peculiar spread comes down to the Tax advantage gained from having equity at minimum of 65% which makes the fund qualify as a Equity fund. This means, Zero Tax on Long Term Gains and no Dividend Distribution Tax on Dividends.

If a fund had a ratio of 50 : 50, it would be qualified as a Debt fund wherein Short Term gains (Sale within 3 years of Acquisition) is added to one’s Income and hence treated similar to a Fixed Deposit. Post 3 years, it gets a little better since you qualify for Long Term wherein Tax is levied at 20% with Indexation benefits.

To this, add the fact that Debt funds have very little commission payable to advisers versus Balanced where the commission is similar to Equity Funds. Added to this potent mix are funds which are willing to pay Regular Dividends making it seems like there is little or no risk in going for Balanced versus Debt Funds.

With markets on a roll, all the above factors have meant a strong inflow into Balanced Funds. The chart below plots monthly inflow into Balanced Funds (in Rupees Crore).

Balanced funds are good in terms of the investor getting a bit of exposure to Debt along with Equity. But the sale narrative is that these are good funds and comparable to Fixed Deposits with the additional advantage of higher returns thanks to Equity exposure.

“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett 

The disadvantage of Balanced funds comes to the fore if and when the markets crack. While we may or may not see a fall similar to the one seen in 2008, its important to see how the funds held up during the 2008 crisis with a much lower Asset Under Management to get a better understanding of the Risks that a Investor is assuming.

Look at the draw-downs from the peak they had suffered by October 2008. 50% seems par for the course at a time when Nifty was down 60%. So much so for calling themselves Balanced. More importantly, at the end of 2007, Balanced Funds together had assets under management of just 20K Crores versus nearly 190K for Equity.

Today, Balanced funds account for 135K Crores versus 588K Crores in Equity Funds. The ratio has gone from close to 10% to 23%. This growth is good if the investor is looking at risk and returns that are closer to equity funds. But if the investor is looking at this as a Regular Income Scheme, will he be in for a surprise.

A new category of Balanced Funds that have hit the market lately are Dynamic Balanced Funds or Asset Allocation Funds. These funds too hold more than 65% in Equities to qualify as Equity funds but differ in Net Exposure to Equity by holding Short positions (using Futures) thus reducing their Exposure from long positions. In other words, these are comparable to Long-Short funds.

Take the Motilal Oswal Focussed Dynamic Fund for example. Their Long Exposure in stocks is equal to 79.50% as of September 2017. But using Short Futures, they are able to set off 34.75% of the above exposure giving them a Net exposure of just 44.75%.

But since shorts require margins which are kept in Cash, their exposure to Debt comes to just 10%. While the advantage is that the fund can based on its MOVI index (created using a amalgamation of Nifty Price to Earnings Ratio, Nifty Book Value and Nifty 50 Dividend Yield) add or decrease exposure to markets, its low Debt exposure means that any gains will need to accrue from markets.

Balanced funds are good if you want to divest yourself of the responsibility to allocate assets between Debt and Equities to the fund. But if you ratio doesn’t match the ratio used by the fund, you shall end up having a unhappy experience even though the fund would have performed as it should have.

If you are going through a Advisor route, its his responsibility to ensure that your Net allocation to Equity and Debt matches your needs and risk taking abilities. Asset Allocation is much easier and cheaper if you can model it outside.

Investment objectives and Risks of both Equity funds and Debt funds are clear – WYSIWYG , with Balanced though, its neither here nor there.



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