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Business News/ Money / Calculators/  Are balanced funds better than pure equity?
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Are balanced funds better than pure equity?

The IDFC Balanced Fund is proposed in a 60-40 proportion, where 60% of the assets will get invested in equity and the rest in fixed income schemes

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IDFC Asset Management Co. Ltd earlier this week announced the launch of IDFC Balanced Fund.

IDFC is the latest asset management company (AMC) to foray into the balanced funds arena. There are currently 100 such funds in the mutual funds industry, of which five were launched in 2016.

A balanced fund, essentially, is a type of scheme that combines both equity- and debt-oriented securities in one portfolio. Their bias is tilted towards equities as the product primarily aims at growing the wealth. It tries to do so with lower volatility in returns.

However, the proportion of equity and debt can vary, depending on the mandate of specific funds. The earlier balanced funds came with 65-75% equity and the rest in debt securities, which were passively managed. These days, they also have combinations of equity, equity derivatives for hedging, and debt instruments.

Balanced funds have gained momentum among investors in recent times as the long-term returns for this category, on a risk-adjusted basis, have been better than those of pure large-cap equity funds: 1-year rolling returns taken every month-end for the last 2 years show that in only one out of 24 observations did the balanced funds, as a category, underperform large-cap equity funds. Moreover, the standard deviation (a measure of volatility) of the returns for balanced funds is lower than that of large-cap funds. Hence, at a lower risk, these funds are able to outperform pure equity funds. They are taxed as per equity taxation, which means there is no long term capital gains tax to be paid if you hold them for at least 12 months.

Features

The IDFC Balanced Fund is proposed in a 60-40 proportion, where 60% of the assets will get invested in equity and the rest in fixed income schemes. The fund can also invest 5-35% in equity derivatives for arbitrage exposure or hedging. The rest of the equity portion will be managed actively.

According to Anoop Bhaskar, head equity, IDFC Asset Management Company Ltd, “We would want to maintain around 70% of the equity exposure in large-cap stocks, for which we have identified a universe of around 140 stocks. While valuation on price-to-book-value basis is important, we will filter stocks through other metrics like cash flow generation, return on capital employed and debt levels; before looking at valuation." The portfolio will be constructed in a manner similar to IDFC’s existing Classic Equity Fund. Rather than creating and managing newer equity strategies, the idea is to optimally use what already works.

The debt portion too will be actively managed. This means, as interest rates in the economy move, the duration of the fund will be managed to generate returns. While adding credit opportunities or high-yielding corporate bonds to the portfolio is an option, primarily it is duration management that will drive the fixed-income portfolio at present. According to Suyash Choudhary, head fixed income, IDFC Asset Management Company Ltd, “We want to optimise returns from yield on securities and at the same time take advantage of any interest rate opportunities. Currently the skew is towards higher duration."

What works…

An asset allocation strategy, which is certain, means that the investor can benefit from diversification into asset classes. Given that equity- and fixed-income returns are often negatively correlated—if one is not doing so well, the other will most likely perform. This lowers the volatility in returns from a hybrid product, as compared to a pure-equity product. At the same time, being majorly exposed to equity means that returns have the ability to beat inflation and create wealth if you remain invested for the long term. IDFC has a good track record of performance in both equity and fixed income with highly experienced fund managers.

...What doesn’t

It’s another balanced fund in an already crowded category. Balanced funds come in different combinations of equity and debt. Nevertheless, the endeavor for the category itself is to minimise risk or volatility and maximise returns. So far, data shows that many of the funds that are available, have been able to achieve this successfully. Hence, there is no pressing need to add another balanced fund to your list. This fund will suit those investors who want a specific 60-40 equity-debt break-up within the balanced category. The strategy to have active management of debt, along with equity, can be the differentiator and the added benefit if it is successful.

While the risks could be lower than in a pure-equity fund, balanced funds are not always ideal for regular income or safety of capital. Give the fund at least a year to deliver performance before opting for it.

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Published: 07 Dec 2016, 05:59 PM IST
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