Balanced Funds

 

WHAT ARE BALANCED FUNDS/HYBRID FUNDS?

Balanced funds also known as hybrid funds are mutual fund products that comprise a mix of debt and equity instruments. Hence, as the name suggests, balanced funds maintain the balance between the debt and equity components of a portfolio.

It contains a stock component, a bond component and to an extent money market component in a single portfolio.

The equity component helps boost the overall performance of the scheme in the long term. This ensures that it generates returns good enough to beat inflation and take care of the investor’s current and future financial needs.

The bond component of a balanced fund serves two purposes:

1. Creating an income stream for its investors and
2. Reducing portfolio volatility.

Highly rated bonds such as AAA corporate bonds and U.S. treasuries bills provide interest income while large company stocks offer quarterly dividend payouts to enhance yield.

 

 

VARIANTS OF BALANCED FUNDS

1. Equity oriented balanced funds – All mutual funds with an equity exposure of 65% or more will be treated as equity funds for taxation purposes.

 

2. Debt oriented balanced funds – All mutual funds with an equity exposure of less than 65% will be treated as debt funds for taxation purposes.

 

 

IMPORTANT POINTS TO NOTE ABOUT BALANCED FUNDS

The following are some of the important features of the BALANCED FUNDS that every investor must know.

1. Investor’s profile – These funds invest in the combination of debt and equity instruments. Hence, it is best suited to investors who do not have an appetite to take risks involved in pure equities however, at the same time want to earn returns good enough to beat inflation.

 

2. Risk – Balanced funds are considered to be the moderate risk-moderate returns investment. It is comparatively safer than equity funds but more volatile than debt funds due to the inclusion of the equity component.

 

3. Liquidity – Balanced funds are not meant for short term investing due to its volatility however, they do not have any lock-in and can be liquidated in times of emergencies.

 

4. Taxation – Income from most of the balanced funds comes under debt taxation and is considered as “Income from capital gains” and if held for more than 36 months, it qualifies for indexation benefits. However, it does not provide tax benefits.

 

5. Volatile – Returns from balanced funds are market-linked which makes them volatile. However, being a combination of debt and equity component, it involves higher volatility as compared to pure debt-oriented products.

 

5. Time horizon – Investors investing in balanced funds must have a minimum time horizon of 3 to 5 years.

 

6. Regular Income – Some balanced funds offer dividend payouts which can help investors generate cash flow however, they are not guaranteed and subject to dividends being declared by companies they have invested money in.

 

7. Returns are not guaranteed – Since it is market-linked, its returns are not fixed. However, one can expect the average returns in the range of 8% to 15% depending on the composition of the fund and its debt-equity ratio.

 

8. Asset class – Balanced mutual funds are treated as debt instruments for taxation. However, some balanced funds take higher exposure to equities to boost returns which makes them equity-oriented balanced funds.

 

9. Cost – Fund houses charge expense ratio to facilitate mutual fund investments.

 

10. Loan facility – In case of emergencies, investors can pledge their mutual funds units as collateral to avail loan facility.

 

 

WHO CAN INVEST IN BALANCED FUNDS?

Any Indian resident, NRI, HUF or Institutional investor can invest in this scheme.

 

 

MINIMUM AND MAXIMUM INVESTMENT ALLOWED IN BALANCED FUNDS

One can start investing in debt funds with as low as 500/- a month.

 

 

WHERE DOES BALANCED FUNDS INVEST YOUR MONEY?

The funds accumulated in balanced mutual funds scheme is diversified across debt and equity instruments and are used to purchase stocks and bonds of companies with different credit rating and market capitalization.

Since balanced funds also take exposure to the debt market, they also invest funds in government securities, corporate bonds, and deposits of various tenures issued by companies. Investors get returns in the form of fixed interest however, they are not guaranteed and completely determined by the performance of the company.

 

 

WHAT KIND OF RETURNS CAN BALANCED FUNDS GENERATE?

Assuming, you invest Rs. 10,000/- per month until retirement (60 years) @ average rate of 9% per annum, the corpus you will create (approximately) on your retirement i.e. at the age of 60 at various age groups will be as follows:

 

Returns generated by some of the aggressive balanced funds in the last 10 years

 

Returns generated by some of the conservative balanced funds in the last 10 years

 

 

FUND ACCESSIBILITY AND LOCK-IN APPLICABLE FOR BALANCED FUNDS

Balanced or hybrid funds are usually open-ended mutual funds and do not have any lock-in due to which investors can liquidate their investment very easily. However, they should check if the exit load is applicable in any of the funds they have invested in.

Also, hybrid funds are the mix of debt and equity instruments hence, due to the presence of equity component, redeeming it in the short term may dent your returns.

 

 

WHAT ARE THE BENEFITS OF INVESTING IN BALANCED FUNDS?

BALANCED FUNDS offer the following benefits to its investors.

1. Diversified hence less risky – Balanced funds offer a mix of debt and equity investments in a single product. Hence, money invested in balanced funds gets diversified across both asset classes by itself offering higher stability as compared to equity funds.

 

2. Better returns with lower risk – Balanced funds offer higher and inflation-adjusted returns as compared to debt funds due to the inclusion of equity component in their overall investment portfolio. At the same time, participation in the debt market makes it less risky as compared to equity mutual funds.

 

3. No TDS – Debt oriented balanced funds do not attract TDS which marginally increases their earnings. The tax is deducted only on returns it earns at the time of redemption.

 

4. Low cost – Low expense ratio with high growth potential as compared to other insurance products makes mutual funds the most favorite among the long term investors.

 

5. Easy access to funds during difficult times – Mutual funds are highly liquid. During emergencies, the money can be withdrawn without any hassle whenever needed. However, withdrawing funds during unfavorable market situations may result in losses. Hence, one should refrain from investing in balanced funds if they anticipate any expenses which may trigger redemptions.

 

6. SIP – Systematic investment plan is available in mutual funds investments which is one of the best ways of investing to take benefit of rupee cost averaging.

 

7. Tax-efficient – If compared with fixed return instruments like fixed deposits, balanced funds are more tax-efficient if held for more than 36 months as the returns it generates will be taxed at 20% with indexation benefit.

 

8. SEBI Regulated – Mutual funds in India are regulated by SEBI as their governing body. They restrict fund houses with their strict rules and regulations to keep their code of conduct and ethics in place and often protect investor's interests.

 

9. Professional Management – Most of the investors who have newly started investing may lack expertise in selecting the right investments. Hence, fund houses appoint a qualified individual to make such sensitive calls. Also, investments in these funds are being managed by professional fund managers who invest in the mix of equity and debt assets promising highest returns at a particular risk level which might not be easy for individual investors.

 

 

WHAT ARE THE LIMITATIONS OF INVESTING IN BALANCED FUNDS?

BALANCED FUNDS has the following limitations.

1. Not 100% safe – Though balanced funds offer a comparatively higher level of safety as compared to equity funds, it is not 100% safe as it is exposed to credit risk, interest rate risk and some amount of volatility risk also due to participation in equity markets. In case, the company they have invested money in defaults in making interest or principal payments, the NAV falls which directly impacts the value of your investment. Also, its returns are not as stable as fixed deposits.

 

2. Moderate or Low returns – Since balanced funds invest heavily in debt-oriented products, they offer low returns. Also, due to low participation in equities, the returns it generates are comparatively low as compared to any equity mutual funds.

 

3. Opportunity Loss – Since its exposure to equity is low, the opportunity to earn more in the flourishing market also reduces.

 

4. No control over the choice of stocks – Since actively managed balanced mutual funds are completely controlled by the fund manager who places his bets in shortlisting stocks of various companies, the investors have no control over selecting his favorite stocks. To take exposure to their favorite stocks, one can invest directly or go for PMS.

 

5. No guaranteed returns – Returns in balanced are market-linked which makes it unpredictable and risky.

 

6. Difficulty in selecting the right fund – With the number of fund houses and options of funds that exist in the current scenario, investors are left confused with where to invest and how to choose the best fund and sometimes end up picking up the fund with very poor growth prospects. Hence, one should always take advice and use the knowledge of financial advisors.

 

7. Regulations and restrictions – Since SEBI is a governing body of mutual funds in India, their strict rules and regulations sometimes acts as a barrier for the fund manager in taking higher risk or independent calls to exploit available opportunities in the market.

 

 

WHO SHOULD CONSIDER INVESTING IN BALANCED FUNDS?

BALANCED FUNDS is most suited to the following investors:

1/ Moderate risk-takers – These funds are most suited to investors who are nearing retirement and have a moderate risk appetite, who can take some level of risk to earn decent returns that beats inflation to manage their current and future financial needs.

 

2. Investors in higher tax slab – Investors who fall under a higher tax slab of 20% or more, who are considering a fixed deposit to invest for 3-5 years can consider investing in balanced funds for stable and better post-tax returns.

 

3. Senior Citizens – Individuals above 60 years of age with moderate risk appetite can consider investing partially in balanced funds for the long term to earn decent returns out of their retirement fund to beat inflation.

 

4. Investors looking forward to diversifying their portfolio – Investors with low liquidity needs, having enough exposure to equities and looking forward to diversifying their investment portfolio to earn inflation-adjusted returns must consider investing in balanced funds.

 

5. Investors having a horizon of 3-5 years – Individuals investing for the medium to long term goals including retirement planning, children education, etc. who would not require those funds for at least 3 to 5 years or more can consider investing in such avenues.

 

 

WHO SHOULD AVOID INVESTING IN BALANCED FUNDS?

BALANCED FUNDS may not be the best investment for the following investors:

1. High-Risk-takers – Young investors especially below 35 years of age, who have age by their side and can take higher risk to earn much better returns in equity mutual funds or direct equities. However, they can still invest in balanced funds to diversify their portfolio.

 

2. Investors with high liquidity needs – Inclusion of equity component in balanced funds make it more volatile as compared to other pure debt instruments and frequent withdrawal at regular interval may or may not be possible. Hence investors with high liquidity needs should consider investing in liquid funds instead.

 

3. Investors with long time horizon – Individuals having an investment horizon of 5 to 7 years or more can invest in equity mutual funds or direct equities as this period is fairly long enough to take exposure to equity funds to earn better post-tax returns.

 

4. Investors looking for regular income – A BALANCED MUTUAL FUNDS do not guarantee regular income to its investors. Any price appreciation in the value of the fund is added to its NAV and paid at the time of redemption.

Also, in case of dividend payout option, the dividend payout is subject to many conditions and paid to its investors only as and when declared.

 

 

A PIECE OF ADVICE

THINGS YOU SHOULD DO WHILE INVESTING IN BALANCED FUNDS

BALANCED FUNDS investors must follow the below suggestions while investing to maximize the value of their investment.

1. Perform due diligence – Never invest in mutual funds before verifying the credentials of the company and checking their credit rating. Usually, companies with low ratings try to lure investors with attractive rates. But don’t fall into the trap as they are very risky. One should thoroughly study the risks involved in such instruments.

Also, investors should be aware that though balanced funds in a way are considered as safer instruments as compared to equities, they do not guarantee returns. Thus, returns it generates completely depends on the performance of the company they have lent money to and various macroeconomic factors.

 

2. Assess your risk appetite – One should always assess their risk appetite before investing in equities oriented products. Equities are considered as a high risk – high return investment avenue. Though the equity participation in balanced funds is minimal, someone with moderate income, sole bread earner of the family, low on savings, high on liabilities tend to have a very low-risk appetite and even a minor loss may derail their entire financial life. Such individuals should be very careful while investing in this option.

 

3. Know your investment goal – One should bear in mind all pros and cons of investing in balanced mutual funds. Investment in these funds are mainly meant for medium to long term financial goals having a horizon of 3 to 5 years or more.

 

4. Always diversify – The safest way of investing is to diversify your risk across various asset classes and other schemes of similar profile. Concentration in one particular scheme or asset class can be very risky and may result in loss of capital. Similarly, refrain from over diversifying the portfolio as it may dilute your overall gains.

 

5. Compare expense ratios – “Expense Ratio” refers to the charges involved in investing in mutual funds. Hence, always compare the expense ratio while investing, especially among the funds which are identical in all aspects. Hence, lower the expense ratio, higher the returns.

 

6. Check entry and exit load – It is important to study every aspect of the fund while investing in mutual funds. An entry load is a onetime fee that you pay while investing in a scheme. Similarly, exit load is a fee you pay for exiting from the scheme before one year. Hence, if you anticipate any possibility of liquidating your investment before a year, invest in a scheme without the exit load.

 

7. Know the pros and cons of investing in direct plans – Though investing in direct scheme is cost-effective due to lower expense ratio, it loses the edge in the form of expert advice and services of your financial planner. Their attention and expertise in the subject can help you achieve much better returns which may surpass the saving you would have had by investing in direct schemes. As it is rightly said, sometimes, saving pennies can cost you fortune. Hence, choose a regular plan provided your portfolio is being managed by a competent financial advisor.

Some broking houses also provide a user-friendly and robust online interface to help you keep track of your investments and manage them effectively. It not only gives you a single screen view of all your investments across different fund houses but also lets you carry out transactions at your ease. The only downside of having a middleman or a broker is higher expense by a very small margin to accommodate their commission payout but that is small enough to make a significant difference to your investment kitty.

 

8. Track your investments annually – It is very important to revisit your investment portfolio once in every 6 months or at least once a year to review its performance. Its performance should be in line with its benchmark and other funds of similar nature. In case of any deviation, a decision needs to be taken after thorough analysis, whether to stay invested or to exit and look for a better performing fund.

 

9. Opt for online Platform – Always opt for a fund house or a broker whose online interface is strong and user friendly. Investors should always use an online platform to better tracking mechanism.

 

10. Update nominee details – Updating nominee details with the respective fund houses is very important. In case of an investor’s death, the family members should not end up running from pillar to post when they need that money the most to claim your investment proceeds.

 

 

THINGS YOU SHOULD AVOID DOING WHILE INVESTING IN BALANCED FUNDS

BALANCED FUNDS investors must avoid indulging in following practices while investing to protect their investment from losing its value.

1. Investing in direct schemes – Though investing in direct scheme is cost-effective due to lower expense ratio, it loses the edge in the form of expert advice and services of your financial planner. Their attention and expertise in the subject can help you achieve much better returns which may surpass the savings that you may have by investing in direct schemes. As it is rightly said, sometimes, saving pennies can cost you fortune. Hence, choose a regular plan provided your portfolio is being managed by a competent financial advisor.

 

2. Selecting a fund only based on past returns – Though past performance is one of the key determinants of fund’s credibility, it should not be the only deciding factor as the glorious performance in the past can be a result of various factors which may or may not exist in future. Hence, one should make a note of sectors the fund is exposed to, the track record of the fund manager, etc should also be looked into while making a decision.

 

3. Investing during increasing interest rate scenario – Balanced funds take high exposure to bonds of various companies. Bond prices are inversely related to market interest rates. It means that the bond prices start to fall when market rates increases and vice-versa.  This happens because bonds issued at a coupon rate of 6% per annum loses its value if market rates go up to 7% per annum as new bonds are now available at a 1% higher coupon rate. This causes NAV of debt funds to fall which impacts its investor’s returns.

 

4. Borrowing money to invest – A lot of brokers or agents will lure you with attractive returns however, one should understand the risk involved in equity-linked products. How much ever promising the investment looks, one must be very careful about fundraising methods. Never borrow money to invest in mutual funds as these avenues are highly risky and there is a possibility where all your money can vanish if the investment fails.

 

5. Going heavy on small-cap or risky funds – Though small-cap and multi-cap funds are a very good vehicle to boost returns, one should not get over-enthusiastic and take heavy exposure to these funds as their performance is subject to various micro and macroeconomic factors. It lacks stability and hence should only be looked at as a booster to other blue-chip funds.

 

6. Short term investing – If you see any possibility of redeeming your investment within 5 years of investing then avoid investing in this scheme, or take a small exposure. The reason is, to generate good returns, an investment involving equity component should be given sufficient time to cover multiple financial cycles involving market highs and lows and average out overall returns.

 

7. Do not get influenced by anyone but financial experts – A confused investor always has a tendency of reaching out to their friends and relatives for suggestions while making critical investment decisions. That happens irrespective of the knowledge and the level of understanding the friend has about the domain. It is as good as asking a truck driver, how to fly an airplane. Such advices in most cases are based on their individual experiences and hardly on calculations or facts and figures. Hence, instead of blindly following the financial advice of a random friend, investors must act wisely and take assistance of a well qualified financial planner who has sound knowledge about the domain.

 

 

WHAT ARE THE RISKS INVOLVED IN BALANCED FUNDS?

BALANCED FUNDS investors should be mindful of following risks involved in this investment:

1. Credit risk – Many investors expose themselves to a higher credit risk by investing their money in companies with low credit ratings. They take such risky calls to earn higher interest and returns on their investment as these companies are always willing to pay more due to the weak market reputation. Many times these companies start defaulting in making timely interest payments, sometimes even the principal. Hence before investing, one should always check the credit rating of the company with credit rating agencies like CARE, CRISIL, etc and select funds investing in companies with high credit ratings.

 

2. Interest rate risk – It refers to a risk where bond prices lose its value due to an increase in market interest rates. For example, a bond purchased at a coupon rate fixed at 6% will lose its value if the market rates go up to 7% and fresh bonds are available at a better rate. In such a scenario, the demand for bonds your funds are holding will fall as nobody would like to buy bonds offering a lower rate than current market rates.

With this, the price of the bond will fall causing the NAV of the to fall as well thus denting your investment.

 

3. Market Risk – Returns on equity and debts are market-driven and are largely influenced by various macro and microeconomic factors where we have almost no control. This makes this option highly volatile and risky.

 

4. Liquidity Risk – Though money invested in equities can be withdrawn anytime, sometimes financially it is not so viable to exit when the markets are on low. Doing so may lead to losses. Hence, one cannot rely on equity-linked instruments for their liquidity needs.

 

5. Concentration risk – Certain debt funds invest in bonds issued by companies of a particular sector or take a very high exposure to one particular sector. Due to this, the fate of investors is largely dependant on the performance of that particular sector. This increases their exposure to risk due to over-concentration in one particular sector.

Hence, the portfolio composition of the fund should be looked at very carefully while choosing the fund.

 

 

HOW TO SELECT THE BEST BALANCED FUNDS?

BALANCED FUNDS investors must follow the below instructions before signing up for the product to ensure the safety and growth of their investment.

1. Know what you are buying – Though returns are important, that should not be the only deciding factor. Investors should also know where the returns are coming from.

The credibility of the companies you have taken exposure to matters the most. Some low rated companies involving high risk may have given great returns in the past however, that may not be the case in the future and the same set of companies can result in heavy losses including the loss of principal. Hence, one should consider their risk appetite before investing and should not end up investing in high-risk instruments if their risk appetite is low.

Also, read its scheme information document carefully to understand the nature of the scheme and to check if its goals are in line with yours.

 

2. Get to the roots of the fund history – Before investing, find out as much information possible about the track record and the past performance of the fund. One should religiously study the portfolio composition of the fund. Then study the financial statements like Profit and Loss statement, cash flow statement and balance sheet along with the credit rating of the company they are investing in. The company which is low on debt and high on operating income is usually preferred. To find out more information, read the scheme information document of the scheme.

 

3. Know about the fund manager of that particular scheme – Fund manager is the key decision-maker of any scheme and they are the ones who run the show. It is very important to learn about their background like their qualifications, past performance, work experience, expertise in their line of business, a character like have they indulged in any unethical activity or do they have any criminal charge against them in the past and present, etc. Also, their financial health and investment intelligence should not be ignored.

 

4. Always prefer funds with a good track record – The track record of the fund is important not just from a returns point of view but also from its strong corporate governance and ethics. If the fund is found deviating from its investment goal in a few instances or has displayed poor performance consistently should be avoided.

 

5. Check liquidity requirements – These funds are most suitable for an investment horizon of up to 5 years or beyond as they also invest in equities. Hence, one should avoid investing in balanced funds if they foresee any expenses coming up before that period.

 

6. Select technologically sound brokers – If you are investing through independent brokers then make sure they are well equipped with modern technology and systems. This will not only help you keep track of your investments online but also help you in making investments and redemptions yourself without depending on anyone.

 

7. Analyze performance – Where does the scheme stand against its competitors in terms of AUM size, market share, performance, etc. If the scheme has been in business for a while and still fails to build sizeable AUM or generate minimum returns against its benchmark and fellow competitors in similar schemes, then the reason for underperformance should not be ignored.

 

8. Study portfolio composition – When the scheme is focussed on a particular sector then the risk also gets concentrated on the performance of that particular sector. A slowdown in that particular sector can derail your overall investment. Hence, look for the fund that is evenly diversified across various companies and sectors.

 

 

TAXATION RULES FOR BALANCED FUNDS

Balanced funds are of 2 types –

• Equity oriented
• Debt oriented

Income earned from the sale of mutual fund units is termed as “Capital Gains”. These capital gains are taxable in your hands depending on how long you stayed invested.

Since balanced funds invest in both, equity and debt market, their tax treatment will differ depending on the type of fund are invested in.

If a fund takes equity exposure of 65% or more then it will be treated as equity fund otherwise it will be treated as a debt fund for taxation purposes. And the applicable tax rates will be as follows.

 

If the equity component is 65% or more

Capital gains earned on the holding period of less than 1 year are called “Short Term Capital Gains” (STCG). STCG is taxed at a rate of 15%.

Conversely, capital gains made on holding more than 1 year are called “Long Term Capital Gains” (LTCG). Owing to recent changes in budget 2019, LTCG up to Rs. 1,00,000/- is tax-free however, over Rs. 1,00,000/- will be taxed at 10% without the benefit of indexation.

 

If the equity component is less than 65%

Since the equity contribution is less than 65%, the investment will be termed as debt investment for taxation.

 If the investment in debt fund is held for less than 36 months then short term capital gains will be applicable and anything beyond 36 months will be termed as long term capital gains.

Tax applicable in case of short term capital gains will be added to your total taxable income and will be taxed as per applicable tax slab.

And in case of long term capital gains, the tax applicable will be 20% with indexation benefit.

Also, no TDS is applicable in case of investment in balanced funds.

 

 

DOES ANY OTHER PRODUCT OFFER BETTER PROSPECTS THAN BALANCED FUNDS?

BALANCED FUNDS can be beaten by the following products on various grounds.

1. From the returns point of view – Balanced funds invest in the mix of debt and equities due to which its returns are compromised due to low participation in equities. An investor looking for higher returns should consider investing either in equity mutual funds or direct equities like stocks or IPOs.

 

2. From a safety point of view – Balanced funds are considered moderately risky and not 100% safe especially in the short term due to participation in equities. Hence, to get a higher level of safety, one can consider investing in fixed deposits, liquid funds or short term debt funds or PPF if they do not require funds for at least 15 years.

 

3. From a liquidity point of view – Due to its participation in equities, withdrawal in the short term may not be feasible during unfavorable market conditions. Hence, fixed deposits and liquid funds will be the more appropriate options from a liquidity point of view.

 

 

HOW TO INVEST AND DOCUMENTS NEEDED

1. Update KYC – The first and the most important requirement is updating KYC details with the registrar. This can be done by submitting the KYC form with your PAN card and address proof to CAMS office or your investment advisor or AMC.

 

2. Create a profile with a broker or Fund House – A profile needs to be created by updating your details with the registered broker or a fund house to open your account.

 

3. Register Online – Once the account is opened, one needs to set up a user ID and password to register online or on mobile application and then start making transactions.

 

4. Offline Mode – One time transactions can also be executed offline by filling a form of the particular AMC and issuing a cheque. To start SIP, the investor needs to sign the SIP mandate which specifies the amount and period of investment to set up auto-debit on the account.