Build Portfolio with Balanced Funds

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If you are looking for low maintenance fund for your core portfolio, equity-oriented hybrid funds fit the bill to perfection

Build your core portfolio with balanced funds

Here we tell you about a type of fund that can constitute the core of your portfolio.The core serves as the anchor to the entire portfolio. Hence, one of the prerequisites for a fund that can be part of the core portfolio is that it should require minimum maintenance and should be able to adjust to market conditions. We believe equity-oriented hybrid funds, more commonly known as balanced funds, are ideal candidates for constituting the core.

In a hybrid fund, the fund manager balances the fund’s equity-debt allocation according to market conditions. This will leave you free to concentrate on the active portion of your portfolio that requires greater attention.

The disadvantage of having balanced funds in the core portfolio is that you cannot specify your equity-debt mix. This will be determined either by the law or by the fund house. A more conservative investor may, for instance, desire a lower allocation to equities, but by just owning balanced funds he will not be able to achieve this.

What is a hybrid fund?
Hybrid funds combine a stock component, a debt component and sometimes a money market component in a single portfolio. They generally stick to a relatively fixed asset allocation.

These funds are geared toward investors looking for a mixture of safety, income and modest capital appreciation. The amount that such a mutual fund invests in each asset class remains within a set minimum and maximum limit. The hybrid funds which we are talking about invest about 65 per cent in equity and 35 per cent in debt and money market instruments.

How balanced funds are different
The objective of these funds is to provide capital growth via a mix of equity and debt: blend of growth and safety. The unique proposition of spreading investments among two broad asset classes is hard to find in other types of funds. The higher equity allocation to the tune of 65 per cent gives these funds the opportunity for high growth, while the debt component provides a cushion when the equity component fails to perform. At the same time, the same debt allocation pulls the fund’s return lower during a bull run since these funds are not fully invested in equities.

Low downside risk
Among equity funds, hybrid equity funds have the lowest downside standard deviation. Standard deviation is a measure of volatility. It measures how much the data points are spread out in relation to the mean. Loss SD considers just the downward volatility since we are interested in knowing only the downside risk of equity oriented hybrid funds in relation to other types of funds.

Switching: Their key advantage is the ability to switch from a high equity allocation with more aggressive growth oriented stocks when the market is bullish to low equity allocation with more defensive stocks when the market turns bearish.

Diversification: These funds offer diversification in the true sense with a portfolio that contains stocks and bonds, thereby offering a blend of growth and safety.

Hassle-free. You do not have to take the trouble of managing an assortment of investments yourself. One fund does it all. Your overall cost of owning and managing your investments also comes down.

Active-management risk: The active-management risk can get amplified in these funds. The fund’s exposure to equity or debt is a function of the fund manager’s view about the direction of equity markets. A fund having a high exposure to equities during bear runs exposes investors to undue risks while going overweight on debt during bull runs results in a failure to reward investors adequately.

Objective mismatch: A hybrid equity fund may have bonds of lower tenure while what may ideally suit your portfolio objective is longer-term bonds. Long-term bonds earn significantly more than short-term bonds. Hence instead of complementing your portfolio objective, hybrid equity funds can potentially act contrary to it.

Tax incidence
Hybrid equity funds are treated as equity funds according to the income tax department’s definition. Currently they are subject to just short-term capital gains tax . Both dividend income and long-term capital gains from hybrid equity funds are tax-exempt.

The tax rules play to the strengths of hybrid equity funds. Investors need to rebalance their portfolio at the end of every year to maintain the desired asset allocation. But the short-term capital gains tax will make rebalancing before one year a tax-inefficient strategy.

In hybrid equity oriented funds, fund managers do the rebalancing. The current tax laws do not have provision for taxing the fund manager’s actions. In essence, the fund manager can rebalance the fund’s portfolio n-number of times and still attract no tax. Hence, the rate of return of these funds will not get eroded due to rebalancing.

How to buy a balanced fund
Your first step while selecting a fund in this category should be to check the ratings of hybrid equity funds at These funds are rated according to their five-year and three-year risk-adjusted returns. So a 5- or 4-star rated fund would mean that over the past five-year and three-year horizons these funds have given the best risk-adjusted returns in this category.

Remember, however, that rating is a quantitative measure. The way a particular 5-star fund generates returns may not suit everyone’s risk appetite. Hence you should dig deeper and try to gather more information about the fund. One should look at how active the fund manager has been in asset allocation. Check whether in the process of generating excess return he has allowed equity allocation to go way beyond 65 per cent. During a market rally, some funds allow their equity allocation to go very high which enables them to post high returns but this approach is contrary to the basic idea behind buying a balanced fund.

Opt for funds that have shown consistent results.

Finally, find out where the fund manager invests both in the equity and the debt portfolio. As an investor you need to decide which style suits your portfolio. Also find out where the fund manager puts the money in the debt portion.

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