Your Money: Know how balanced mutual funds operate

September 30, 2020 1:45 AM

Whenever you invest in a balanced fund, your money is invested by the fund manager in a variety of market securities. These include equity instruments (stocks), debt instruments (bonds), and money market instruments (cash or equivalents).

These include equity instruments (stocks), debt instruments (bonds), and money market instruments (cash or equivalents).

By Hemanth Gorur

Balanced mutual funds, or balanced funds, usually are the “go to” option for most small investors. Apart from the ease of investing, a common belief is that they are safe and provide decent returns.

However, both these aspects may not be true of all balanced funds to the same extent. The safety and performance of these funds depends a lot on their composition, and how their components behave in the market.
Equity and debt components

Whenever you invest in a balanced fund, your money is invested by the fund manager in a variety of market securities. These include equity instruments (stocks), debt instruments (bonds), and money market instruments (cash or equivalents).

Suppose you invest Rs 1 lakh in a balance fund which invests in equity and debt in the ratio of 60:40. Ignore the cash component for now. Then Rs 60,000 will get invested in equity and another Rs 40,000 in debt. In return, you get allocated a certain number of units of the balanced fund at a certain per unit price. This per unit price is called the

Net Asset Value (NAV).
How Net Asset Value is arrived at
As per SEBI guidelines, equity-oriented balanced funds need to invest at least 65% of the money collected, or Assets Under Management (AUM) in equity, while debt-oriented balanced funds need to invest at least 40%. Suppose an AMC has AUM of Rs 5 crore in an equity-oriented fund and has issued ten lakh units of the mutual fund to its investors.

Then the NAV per unit is Rs 50. Your investment of Rs 1 lakh would fetch you 2000 units of the mutual fund. If you had invested in a debt-oriented fund which would allocate your money into equity and debt in a ratio of 60:40, the way to look at the NAV is that each unit of `50 gets allocated into equity and debt in the same ratio. So Rs 30 goes into equity and Rs 20 goes into debt.

Performance of balanced funds
The performance of your balanced fund, therefore, would depend on how the NAV of your fund reacts to market developments and sentiment. The NAV itself, as demonstrated earlier, is composed partly of equity and partly of debt.

When your fund manager invests part of your investment into equity, it basically represents ownership of the companies whose shares he is buying on your behalf. On the other hand, when the other part of your investment goes into buying debt, essentially you are getting a claim on the assets of the company whose bonds you are buying.

In case the company is liquidated or goes bankrupt, debtors of the company are given higher preference over shareholders of the company in claiming the salvageable assets of the company. Hence, debt is seen as a safer instrument than equity. Thus, when the markets go down, the debt component of your NAV or your balanced fund protects against your investment taking a proportionate loss and reduces your downside.

However, when the markets go up, the equity component of your NAV or your balanced fund tries to keep up and appreciates more in value compared to the debt component, assuming a positive correlation between the stock markets and the shares of your invested companies. This ensures that you get higher-than-normal returns on part of your investment.

When investing in a balanced fund, study its historical NAV performance, its fund composition, and the fund manager’s track record. Invest only after understanding the type of investment you are getting into.

The writer is founder, Hermoneytalks.com

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