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Balanced Funds Carry Certain Risks
Such funds may be giving fabulous returns but their increasing equity exposure makes them risky
SMART investors rely on equity oriented balanced funds because they offer best of both worlds: tax efficiency enjoyed by equity funds and the ability to give inflation-adjusted returns. The budget may have made debt funds less tax efficient but equity-oriented balanced funds continue to enjoy the same tax treatment as equity funds. Since debt portion also becomes tax-free after one year, balanced funds have now become a more efficient way to hold debt.
Relevance of balanced funds has increased because of the tax disadvantage for debt funds. Budget has withdrawn the 10 percent tax without indexation benefit on long-term capital gains for debt mutual funds and extended the holding period from 12 to 36 months.
Investors also prefer balanced funds because of the perceived lower risk. Most balanced funds keep their equity exposure between 65 percent and 75 percent (the minimum threshold is 65 percent according to tax laws) and the debt portion to around 30 percent. This, however, does not make them less risky . "Diversified equity funds keep a small cash component and sometimes increase cash levels to 15-20 percent. So, there is not much difference between the two from risk perspective. Balanced funds are also increasing their risk levels to beat the Nifty -a large-cap index with 100 percent equity exposure -across time periods. For example, HDFC Prudence Fund and HDFC Balanced Fund, having AUMs of `6,528 crore and `1,773 crore, respectively , posted one-year returns of 64 percent and 56 percent, respectively . Nifty, on the other hand, posted 33 percent during the period.
Balanced funds need to frequently rebalance their portfolio to maintain the equity-debt ratio. The ability to take active segmental calls and move between largeand mid-caps also adds to their risk profile. Most balanced funds don't have large-cap restrictions and this helps them to load mid-caps whenever they want.
This can generate higher returns, but increases the risk levels. HDFC Prudence is the best example. Large balanced funds, such as HDFC Prudence, are historically overweight on mid-caps. This is playing to their benefit now. With a high and stable asset size, fund managers also have the ability to take long term calls and venture into high beta space.
HDFC Mutual Fund had a larger exposure to stocks and are benefiting from the expected economic revival. Hence, their funds saw a good run up.
However, in the bear markets of 2000-1 and 2007-9, several balanced funds suffered severe losses. JM Balanced Fund, for example, crashed by 64 percent between 8 January 2008 and 9 March 2009, compared to the Nifty losing 59 percent. With the stock market peaking every now and then, a sudden change in market sentiments could, therefore, be devastating, especially for balanced funds having exposure to midcap and high beta space. ICICI Pru Balanced Advantage Fund is a one of the more efficient balanced funds, as it uses futures to bring the equity exposure down, while retaining the cash-equity levels above 65 percent. The client could, therefore, benefit from the fund manager's calls without compromising with the tax structure of the fund.
REITS
Lower entry barrier for investing in real estate. Minimum investment `2 lakh.
Diversified portfolio of properties reduces risk for investor.
Due diligence conducted by REIT manager and trustee before investing.
Get professional help and avoid the headache of directly managing real estate Greater liquidity. Investor can fully or partially exit REIT by redeeming units.
Possible to earn regular returns because 80% of corpus in finished projects.
By pooling investments, investors can increase the bargaining power.
Can invest in any city without being physically present at the location.
Direct Investment in Property
Required outlay for investment in property is at least `25-30 lakh.Investment in single property is risky and returns are volatile.
Investor has to check the background of builder and property details on his own.
Buyer has to maintain the property and recover rent from tenant.
Searching for a buyer can take weeks, even months before investor can exit.
Investment won't give immediate returns if the project has not been completed.
Investor has to fight his battles alone against well-connected builders.
Physical presence during deals mean only accessible markets can be tapped.
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