Once upon a time, there used to be a type of mutual fund called a ‘balanced fund’. They were a very useful type of fund, which were generally the most suitable type for a large proportion of retail investors. Actually, balanced funds still exist. It’s just that Indian fund companies seem to be trying their best to sweep them under a carpet. If you depend on the marketing and sales efforts of mutual fund companies and distributors to get to know about funds, I’m sure that you haven’t invested a single paisa in a balanced fund in the last three years.
This becomes amply clear if we look at the track record of new fund offers, which are the only things that are intensely marketed anyway. Since the stock markets started rising in 2003, 12 new equity-oriented balanced funds have been launched. During the same period, 157 new equity funds have been launched. That’s 13 equity funds for every balanced fund. As things stood in 2002, the ratio was 20 balanced funds to 48 equity funds. That’s one balanced fund to 2.4 equity funds. Quite a drastic shift, no?
To figure out why balanced funds need more attention than they get, let’s recap what balanced funds (also called hybrid funds) are. Such funds maintain a balance of two types of investments-equity and fixed income. The fixed income part is generally corporate or government debt of various types. These funds are mandated to stick to a fairly well-defined ratio between these two types of assets. This simple structure is more conservative in returns than equity funds but it compensates with some great advantages.
Firstly, to maintain the ratio between debt and equity, the fund manager has to periodically sell whichever investment has done better. With the proceeds of the sale, he has to buy the other type of investment to regain the balance.
While this sounds counter-intuitive to the average investor, it ensures that the profits from equity are being regularly realised and then protected from vanishing by investing them in safe debt investments. When the equity markets are falling, it ensures that you are buying equities when they are cheap. Invariably, this is the best strategy to combine profits with safety in the long-term. However, individual investors rarely have the discipline to implement it, since it is always counter-intuitive to sell whatever is rising and buy whatever is falling.
Over a complete rise-and-fall market cycle, this invariably produces decent returns with far less volatility and heartburn. Over the last five years, the average equity diversified has given returns of about 31% p.a. and the average equity-oriented balanced fund has produced 23% but with lower volatility.
Not only does this balanced strategy get stable returns, it is also more tax-efficient than it would be if you executed it yourself. There are two reasons for this. One, every time you would sell you would pay capital gains tax. When funds buy and sell with their portfolio, there’s no tax liability to the end-investor.
Two, when you hold any kind of fixed income investment yourself, it is not liable for long-term capital gains tax since only equity income is exempt from that. However, if a balanced fund keeps its equity allocation above 65%, then the investor’s entire investment is treated as equity for tax purposes and thus becomes free from long-term capital gains tax.
Which brings us to the original puzzle-why aren’t fund companies and salesmen enthusiastic about balanced funds? I believe that’s because it’s difficult to package balanced funds in some kind of a returns-maximising trick story.
As the fund industry has gravitated towards consumer-goods type feature-driven products, simple and reliable ideas like balanced funds get side-tracked. But that doesn’t mean that the sensible investor has to ignore them too. There are a handful of excellent balanced funds with solid long-term available-you just have to seek them out.
Source:http://www.financialexpress.com/news/The-enigma-behind-balanced-funds/358293/2#
This becomes amply clear if we look at the track record of new fund offers, which are the only things that are intensely marketed anyway. Since the stock markets started rising in 2003, 12 new equity-oriented balanced funds have been launched. During the same period, 157 new equity funds have been launched. That’s 13 equity funds for every balanced fund. As things stood in 2002, the ratio was 20 balanced funds to 48 equity funds. That’s one balanced fund to 2.4 equity funds. Quite a drastic shift, no?
To figure out why balanced funds need more attention than they get, let’s recap what balanced funds (also called hybrid funds) are. Such funds maintain a balance of two types of investments-equity and fixed income. The fixed income part is generally corporate or government debt of various types. These funds are mandated to stick to a fairly well-defined ratio between these two types of assets. This simple structure is more conservative in returns than equity funds but it compensates with some great advantages.
Firstly, to maintain the ratio between debt and equity, the fund manager has to periodically sell whichever investment has done better. With the proceeds of the sale, he has to buy the other type of investment to regain the balance.
While this sounds counter-intuitive to the average investor, it ensures that the profits from equity are being regularly realised and then protected from vanishing by investing them in safe debt investments. When the equity markets are falling, it ensures that you are buying equities when they are cheap. Invariably, this is the best strategy to combine profits with safety in the long-term. However, individual investors rarely have the discipline to implement it, since it is always counter-intuitive to sell whatever is rising and buy whatever is falling.
Over a complete rise-and-fall market cycle, this invariably produces decent returns with far less volatility and heartburn. Over the last five years, the average equity diversified has given returns of about 31% p.a. and the average equity-oriented balanced fund has produced 23% but with lower volatility.
Not only does this balanced strategy get stable returns, it is also more tax-efficient than it would be if you executed it yourself. There are two reasons for this. One, every time you would sell you would pay capital gains tax. When funds buy and sell with their portfolio, there’s no tax liability to the end-investor.
Two, when you hold any kind of fixed income investment yourself, it is not liable for long-term capital gains tax since only equity income is exempt from that. However, if a balanced fund keeps its equity allocation above 65%, then the investor’s entire investment is treated as equity for tax purposes and thus becomes free from long-term capital gains tax.
Which brings us to the original puzzle-why aren’t fund companies and salesmen enthusiastic about balanced funds? I believe that’s because it’s difficult to package balanced funds in some kind of a returns-maximising trick story.
As the fund industry has gravitated towards consumer-goods type feature-driven products, simple and reliable ideas like balanced funds get side-tracked. But that doesn’t mean that the sensible investor has to ignore them too. There are a handful of excellent balanced funds with solid long-term available-you just have to seek them out.
Source:http://www.financialexpress.com/news/The-enigma-behind-balanced-funds/358293/2#
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