Fixed income savers who have invested in balanced funds for monthly or regular returns are heading for tough times. Balanced funds is a good category provided you have a 3- to 5-year horizon.
Picture this. An equity asset category, being around for nearly 25 years, goes up a remarkable 40x in 10 years and 4x over the last two years. The last 10 years are significant to keep in mind considering that markets collapsed in September 2008 after Lehman folded up. That’s the journey balanced funds have had since 2008 from a category size of `5,000 crore to more than Rs 2,00,000 crore now. More so, over the last two years, investors suddenly seem to have discovered this equity-oriented bunch of funds as a panacea for periodic or even monthly returns.
The 1% monthly dividend promise
Any seasoned investor will know that equity returns are difficult to predict. So, what’s causing this excitement in terms of flows? Performance? Not really, because the 10-year category returns are sub-10%. The culprits are some other factors. While tailwinds from a one-sided equity market for the last two years and falling interest rates aided outperformance, a big chunk of fresh inflows has come from savers, most of whom are retired or traditional fixed deposit type of investors who were influenced by recent period returns, as well as promise of 1% monthly dividend (mis-selling) by industry intermediaries.
Over the last two years, balanced funds —the exposure to a mix of equity and debt —have experienced a ‘Goldilocks kind of period’ for both equity and bond markets. If you break down the equity holdings in these funds, half the portfolio was into large caps and the rest into mid and small caps. Mid and small caps delivered their best performance in a decade in these two years. Added to this, interest rates were on the decline as the economy had not yet recovered leading to capital gains in bond holdings. These phases in the market where both equities and bonds are delivering, are far and few.
Returns will be lumpy and erratic
As debt instruments are subject to interest rate movements, in good market periods, you are likely to see returns getting normalised to about 10% per annum. Over the last 10 years, category returns have been lumpy and erratic which is the reality. Going forward, you can expect many periods of low or negative returns as equities are bound to be volatile.
Return of capital or return on capital?
The problems are getting bigger as fixed deposit type savers are likely to be hugely disappointed once the market returns get normalised. Over the last few months, the sentiment in the stock market has been broken and upsides on returns are no longer easy to make. If you look at the allocation within the equity basket for balanced funds, the mid-cap allocation has been increasing in the last two years.
On the back of higher inflows, exposure to mid-caps got added and would be difficult to unwind as liquidity is relatively low in such stocks. If you look at the debt side of the balanced funds, exposure to long-term bonds may not work out as the interest rate cycle has turned and chances of capital gains from falling interest rates are quite low.
By Ramesh Bukka