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Balanced fund inflows: performance and incentives

Commissions and dividends aside, long-term performance and tax efficiency work favourably for balanced funds

Times are changing. These days when you walk into (usually) a private sector bank’s branch, you are likely to be sold not just an insurance policy but chances are that you would be told to put some money in a balanced fund as well.

Balanced funds have been in the news due to the growth in their inflows over the last 2 years or so. Since January 2015, the total assets under management (AUM) for the domestic mutual fund industry has grown 32%, and 2.1 times for balanced funds’ AUM. Along with consistent performance, many of these funds offer regular monthly dividends. “Relatively low-volatility products with potential for regular income cater to a unique psychological need in Indian investors. They are happy to receive this payout, which the growth options don’t cater to," said Manish Gadhvi, zonal head-NJ India Invest Pvt. Ltd, a pan-India mutual fund distributor.

Commissions

It may not be just the attraction of regular income among investors, but the increased commissions for distributors, that could also be driving sales.

Senior industry executives have indicated that a large bank-based distributor is giving its relationship managers incentives of 4-5% for selling the balanced fund of the bank-owned asset management company (AMC). The AMC does not pay higher commissions directly, but leaves its idle cash in the current account of the bank for a few days. This is enough to harvest the earnings from the float. This is then used to incentivise the relationship managers.

According to a senior executive from a national distributor, who requested not to be named, “If a mutual fund has an account with a bank, then the idle cash balance from that fund can be kept in a current account for a brief period."

Mint was not able to verify the existence of such alternate channels of compensation to distributors from AMCs.

Performance

Commissions and dividends aside, long-term performance and tax efficiency work favourably for balanced funds.

If you consider the 5-year performance (calculated every month-end for the last 3 years or rolling return) the average annualised return for both, balanced funds and large-cap equity funds, is 12.5%. The difference is in their volatility: balanced funds have a standard deviation—or volatility away from average return—of around 2.3%, whereas large-cap equity funds have a higher standard deviation of 3.5%.

According to Ajit Menon, head strategy, Tata Asset Management Co. Ltd, “The real advantage is the superior risk-adjusted return.... You get equity-like returns and a debt allocation with better tax efficiency and lower risk."

Dividends

Regular income with consistent long-term performance track record can be a dual benefit for many investors.

The dividend, however, is paid from the scheme’s distributable assets, which could otherwise be reinvested for further long-term growth. And the fall in net asset value, after the payout, neutralises the benefit of getting a dividend.

During prolonged bear markets, consistent payouts may become unsustainable when market value, and consequently the surplus in the scheme, falls.

According to D.P. Singh, executive director, SBI Asset Management Co. Ltd, “We are conservative when it comes to paying dividends in equity-oriented funds. We can’t be certain of distributable profits at all times, as market conditions have an impact."

Frequent withdrawals from equity-oriented funds, whether as dividends or systematic withdrawal plans, can erode long-term value.

What makes balanced funds appropriate for long-term investors is the combination of equity and debt in proportions such that the returns are closer to equity-like growth assets; at the same time debt securities reduce the overall price volatility. This is what investors should focus on. But let’s not forget the risks attached to market-linked products.

Caveat for investors: dividends are incidental, not assured or guaranteed. An investor needs to be disciplined and remain invested, rather than redeem and flee in turbulent times.

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