The Right Balance

Had you invested Rs 1 lakh in a balanced fund in 2011, it would have grown to Rs 1.76 lakh today. Balanced funds have, on average, returned 12 per cent a year over the past five years (July 2011 to July 2016), much more than the 8 per cent returns given by the BSE Sensex and the 10 per cent given by large-cap funds. The top performing balanced funds, in fact, returned more than 15 per cent a year during the period (see Top Balanced Funds).

Tata Balanced Fund has been the top performer. It has returned 16 per cent over the past five years and 17 per cent over the past 10 years. While maintaining 70-75 per cent allocation to equities, which provide the alpha, the fund focuses on optimising debt returns while lowering volatility by focusing on quality papers such as gilts and highly-rated corporate paper. The focus is on lower credit risk and duration management. Its top holdings are capped at around 4 per cent of assets and that too in stocks like HDFC Bank, Infosys and Yes Bank, to name a few. The top five sectors in the portfolio are banks, pharmaceuticals, software, consumer non-durables and cement. The fund also holds some mid-cap companies like Shree Cement, whose stock price has risen from Rs 11,000 to Rs 16,000 in the past one year.

Maintaining Alpha

Although the returns given by balanced funds may not seem very high at first glance, they stand out when compared to what other fund categories have given. This when they invest only 65-70 per cent money in equities. The rest goes into debt and reduces risk. This doesn't mean they take undue risks with the stocks that they choose. "We avoid high-risk equities in the balanced fund as it will negate the promise of lower volatility," says Anand Radhakrishnan, CIO, Franklin Equity, Franklin Templeton Investments - India. Franklin India Balanced Fund has returned 15 per cent a year over the past five years and 23 per cent over the past three years. "The fund's equity allocation has gone into a diversified portfolio of large-, mid- and small-cap stocks. The fund manager also uses a macro overlay to align sectoral exposure in line with economic growth outlook," says Radhakrishnan. The portfolio is tilted towards financials with 20 per cent exposure followed by automobiles at 7 per cent and energy at 6 per cent. The top holdings are HDFC Bank, Axis Bank, Infosys, Indusind Bank and Yes Bank. The average equity allocation has been about 68 per cent over the last few years.

Cushion of Debt

Pure equity funds like large-cap, mid-cap or multi-cap funds are mandated to be fully invested into equities at most times. Hence, the risk a person takes by investing in pure equity funds is relatively higher in the absence of the cushion provided by the debt part of the portfolio.

The outperformance of balanced funds can be attributed to the fact that both the underlying asset classes have done well of late. The equity component saw a major upswing with stock markets doing well after a lag, while the debt component benefited from a fall in interest rates. For instance, Birla Sun Life Balanced Fund 95 has been able to maintain consistency in returns due to strong stock selection process, disciplined profit-booking approach and flexible equity exposure. The fixed income allocation is also managed actively, in line with the outlook on interest rates. The fund manager generally invests the debt portion in a portfolio comprising government securities and corporate bonds with high credit ratings and high secondary market liquidity. The fund has been among the longest standing balanced funds with a track record of more than 20 years and has been consistently beating its benchmark index.

Diversification

According to Sankaran Naren, CIO Equity, ICICI Prudential AMC, balanced funds are a good way to reduce volatility and earn reasonable risk-adjusted returns. This is because of pre-determined allocation towards debt and equity, offering the benefits of both growth though equity as well as stability through debt. Further, with these funds, you needn't worry about selling when stock markets go up or buying when they go down, as the fund manager keeps changing the allocations on his own depending on the market conditions. These funds have to maintain their allocation under all circumstances. Hence, the automatic re-balancing limits your risk in the fund. ICICI Prudential Balanced Fund, for instance, maintains at least 65 per cent and maximum 80 per cent exposure to equities. The exact number is determined using an in-house Price to Book Value (P/BV) model in which current market levels are compared to the fair value range to determine if the market is undervalued or overvalued. A P/BV lower than the fair value range triggers an increase in equity levels and vice versa. "The conservative nature of investors is kept in mind while constructing the portfolio," says Naren. The fund does not take aggressive calls on any leveraged sector or companies and avoid companies with high valuations. Majority of the portfolio comprises large-cap companies that dominate the Sensex such as Coal India, Cipla, Reliance Industries and Bharti Airtel. The three sectors with the most weights are energy, financial and healthcare. The rebalancing of the equity portion takes place on a weekly basis, which shows the fund is managed actively like a pure equity fund. The fund has been among the top five performing funds over the last five years by returning 15.5 per cent. Over the past three years, it has given returns of 22 per cent.

There is also a different breed of balanced funds like ICICI Prudential Balanced Advantage Fund in which the equity allocation could range between 30 per cent and 80 per cent. The number is decided on the basis of an in-house dynamic asset allocation model. The fund has returned 14 per cent a year in the past five years and 18 per cent in the last three years. "The fund follows the philosophy of buying low and selling high to generate returns with lower volatility. It also ensures tax efficiency with equity taxation," says Naren.

How to choose a winner

There are numerous funds in the category, making it difficult to choose the best one. So, how can one go about it? First, it may be wise to look at the returns of the fund in question. Look for consistency in performance over longer tenures like three, five and 10 years.

Choose a fund house with a strong parentage. See who the promoter is and who is managing the fund. Choose funds that offer a better risk-return trade-off. A good mutual fund is one that gives better returns than others for the same risk taken. Narrowing your search based on some of these parameters will give you a few winners (See Top Balanced Funds).

Are they for you?

Markets go through cycles and only a well-crafted financial plan can help you weather this volatility over the long term.

"Research has shown that the probability of attaining financial goals is much higher by following this approach rather than by trying to juggle around investments and timing market cycles," says Radhakrishnan.

A balanced fund is ideal for you if you are looking for an asset allocation product or are new to the world of equities.