Balanced funds

Balanced funds are a type of mutual fund that invests in both equity and debt instruments, aiming to balance risk and return. These funds are designed for investors with a low risk tolerance who seek modest capital appreciation and income generation. In this article, we will explore the features, benefits, and factors affecting balanced mutual funds and understand the process of investing in them.

What is a Balanced Fund?

A balanced fund, also known as an asset allocation fund, invests in a mix of equity and debt instruments. This dual investment objective allows balanced mutual funds to provide both growth and income, making them suitable for investors looking for a diversified portfolio. The equity component offers capital appreciation, while the debt portion fortifies the portfolio against market volatility.

Understanding the Asset Allocation in Balanced Funds

Balanced funds maintain a relatively fixed mix of equity and debt securities. The equity portion aims to offer capital appreciation and the benefits of stock market investments, while the debt portion helps protect the portfolio against excessive volatility, aiming to provide steady income and risk reduction.

Equity Allocation: The equity portion of a balanced fund seeks to generate long-term capital appreciation by investing in stocks. The fund manager selects stocks based on various factors such as company performance, industry outlook, and market trends.

Debt Allocation: The debt component provides a steady income stream through interest payments. Balanced funds typically invest in a mix of government securities, corporate bonds, and other debt instruments with varying maturity profiles.

Asset Allocation: The key to a balanced fund's performance is the careful management of the equity-debt ratio. This ratio determines the fund's overall risk profile. A higher equity allocation generally leads to higher potential returns but also increased volatility, while a higher debt allocation provides stability but lower expected returns.

How do Balanced Funds Work?

Balanced mutual funds aim to provide a blend of capital appreciation and regular income by investing in a mix of equity and debt funds.

Investment: Investors purchase units of a balanced fund.

Portfolio Construction: The fund manager allocates the pooled funds between equity and debt securities based on the fund's investment objective.

Income Generation: The debt portion of the portfolio generates regular income through interest payments. This regular income is distributed to investors as dividends.

Capital Appreciation: The equity portion aims to grow over time, and any capital gains realised are reflected in the net asset value (NAV) of the fund.

Risk Management: By combining equities and debt, balanced funds aim to reduce the overall portfolio risk. Debt securities can act as a buffer during market downturns.

The Role of Fund Managers in Balanced Funds

Fund managers play a crucial role in managing balanced funds. Their expertise in both the equity and debt markets enables them to navigate through different market phases effectively. The duties of fund managers involve:

• Selecting individual stocks and bonds for the fund after conducting in-depth research and analysis to identify promising investment opportunities.
• Monitoring market trends, economic indicators, and industry developments to make informed investment decisions.
• Employing risk management strategies to protect investors' capital and ensure the fund's stability during market fluctuations.
• Reviewing the fund's portfolio to maintain the desired equity-debt ratio and rebalance it as needed.

Types of Balanced Mutual Funds

Balanced funds in India, also known as Hybrid Funds, are primarily classified based on their equity exposure.

Equity-Oriented Balanced Funds: These funds invest a majority of their corpus (at least 65%) in equities and equity-related securities. The remaining portion is invested in debt and money market instruments. They are suitable for investors seeking moderate to high returns with moderate risk.

Debt-Oriented Balanced Funds: These funds invest a majority of their corpus (at least 65%) in debt securities. The equity component is relatively smaller. They are suitable for conservative investors looking for regular income with lower risk.

While the above classification is based on the overall fund composition, balanced funds can also be categorised based on their investment style:

Aggressive Hybrid Funds: These funds have a higher equity allocation (typically 65-80%) and aim for capital appreciation with moderate risk.

Conservative Hybrid Funds: A conservative hybrid fund has a lower equity allocation (typically 20-40%) and prioritises income generation with lower risk.

Dynamic Asset Allocation Funds: These funds dynamically adjust their equity and debt allocation based on market conditions.

Advantages of Investing in Balanced Funds

Balanced funds offer a compelling investment option due to their ability to balance risk and return. Here are some of the key advantages of balanced funds investments:

Diversification: By investing in both equities and debt, balanced funds spread investment risk across different asset classes.

Stability: The debt component acts as a buffer during market downturns, helping to protect investors from significant losses.

Income Generation: The debt portion of the portfolio generates regular income through interest payments, providing a steady cash flow.

Capital Appreciation: The equity component offers the potential for long-term capital appreciation, allowing investors to benefit from market upswings.

Professional Management: Balanced funds are managed by professional fund management experts who have expertise in both equity and debt markets.

Disadvantages of Investing in Balanced Funds

While balanced funds offer several benefits, there are also risks involved:

Market Volatility: The equity market component can lead to fluctuations in the fund's value, particularly during market downturns.

Interest Rate Risk: Changes in interest rates can affect the prices of debt securities within the fund, impacting its performance.

Limited Upside: Compared to pure equity funds, balanced funds may offer lower returns during strong bull markets due to their conservative asset mix.

Who Should Invest in a Balanced Fund?

A balanced fund is ideal for investors with a low risk tolerance who seek a balance between growth and income. Retirees generally scale back on equity exposure and prefer the stability offered by balanced funds. These funds also serve investors who are looking to diversify their portfolios without taking on the high risks associated with pure equity funds.

Factors to Consider Before Investing in Balanced Funds

When considering a balanced fund, it's important to evaluate several factors to ensure it aligns with your investment goals and risk tolerance.

Investment Risk: While a balanced mutual fund is less risky than pure equity mutual funds, they are not completely risk-free. The equity market exposure can still lead to fluctuations in the fund's value.

Investment Returns: Balanced funds aim for steady returns over the long term. Look for funds with a history of consistent performance across various market conditions.

Cost of Investment: Consider the fund's expense ratio, which can impact your net returns. Lower expense ratios are generally preferable.

Past Performance: Review the past performance of the balanced fund, ideally over a period of at least 5-10 years, to gauge its resilience and fund manager's expertise.

Taxation: Understand the tax implications of your investments, including STCG and LTCG tax, and any tax exemptions available.

Investment Objective: A balanced mutual fund is suitable for long-term goals like retirement planning, children's education, or purchasing a home, where a mix of growth and income is desired.

Taxation Rules of Balanced Mutual Funds

Capital Gains Tax

The tax rate depends on the holding period of the investment and the proportion of equity and equity-related instruments. Here are the details:

Short-term Capital Gains Tax (STCG)

If the investment is held for less than 12 months -

• For equity and mutual funds with more than 65% equity, the short-term capital gains tax rate is 20%.
• For debt funds with more than 65% debt, the short-term capital gains tax is based on the investor's income tax slab rate.
• The increase in the tax rate for STCG on mutual funds may discourage short-term trading.

Long-term Capital Gains Tax (LTCG)

If the investment is held for more than 12 months:

• For equity and mutual funds with more than 65% equity, the long-term capital gains tax rate is 12.5%.
• For debt funds with more than 65% debt, the LTCG tax is based on the investor's income tax slab rate.
• The tax exemption limit for equity-oriented funds for LTCGs has now increased to ₹1.25 lakh.

Tax on Dividend Income

Dividend income from balanced funds is subject to taxation as per the investor's income tax slab. Additionally, mutual funds must deduct a 10% TDS on dividend income exceeding ₹5,000 annually.

How to Invest in a Balanced Mutual Fund?

You can invest in a balanced fund through the issuing fund house or online platforms like INDmoney. Follow these steps to invest:

• Open the INDmoney app and log in with your credentials.
• Navigate to the "Mutual Funds" section within the app.
• Use the filter options to select "Balanced Funds" to view the available options.
• Decide whether to make a lump sum investment or set up a Systematic Investment Plan (SIP) for regular contributions.
• Enter your desired investment amount and confirm the transaction.