In the previous article we discussed how a first time investor in market-linked financial products should put money in liquid funds to test waters. Liquid funds can be used to park funds for durations. The next logical step is to get to know other categories of mutual funds, which protect the down side and also in times of upward movement in the equity markets, generates the equity returns in the equity part of the portfolio.
Hybrid funds are slowly gaining attention in the investor’s portfolio. There are various types of funds such as capital protection funds, monthly income plans, asset allocation funds and balanced funds.
Balanced funds can add value to the portfolio with three to five years of investing tenor. Time horizon is an important element in the investing process.
What are balanced funds?
Balanced funds typically invest in both equity and debt in a pre-determined ratio There are two types of balanced funds – equity-oriented and debt-oriented. In the former with minimum equity allocation is 65% and in debt-oriented balanced funds, the equity allocation below of 65%.
Typically, the fund manager of a balanced fund, based on the scheme mandate, invests in a mix of equity and debt instruments. The equity part of the investment is allocated in large –cap stocks. For the debt component of the portfolio, the fund manager invests in government securities and corporate debt paper.
The standard deviation is not as low as that of a liquid fund and based on the scheme allocation can be up to one. As the allocation is also into equity, the volatility in the equity markets does have an impact on the Net Asset Value (NAV) of the scheme. That is where time horizon is an important element, while deciding upon the suitability of the scheme.
When we talk about liquidity, redemptions in balanced funds are processed on T+3 business days. What it means is that when you place a redemption request before 2 pm on Monday, the redemption proceeds are credited on Thursday, before noon.
As the equity market return was reflecting a continuously upward graph, it was no surprise that AUM of the balanced funds, especially the equity-oriented schemes also grew. Again, history repeated and the one year return performance are in the red.
Many of the schemes also started distributing monthly/ quarterly dividends to the investors. This again resulted in investors assuming that the quantum of dividend will be constant, going forward. However, as the equity markets, started its downward journey, the dividends either ceased or the divided distributed got lower.
While investing do not ignore the size of the fund, credit quality of the portfolio, equity allocation in the scheme and track record of the fund house, across time horizons and cycles.
Based on the asset allocation, the profits in the balanced funds are taxed. If the asset allocation in the equity component is in over 65%, the taxation laws as per the equity mutual funds are effected. For investments held for over one year, there will be no tax.
If the asset allocation in the equity component below 65%, the tax laws as per the debt mutual funds are applicable. So, for investments held for over three year, long term capital gains will be levied and the investor can the benefits of indexation. The tax rate is 20% with indexation benefits. Investments held for less than three years, short term capital gains is applicable.
Balanced funds popular with retail investor. The simplicity of the investment, liquidity and the ease of investment need to be looked at while investing.
The author is founder & managing partner of BellWether Advisors LLP