While investing one has host of options, instruments wise and they can be broadly classified into equity, debt and gold. Many generally invest in all these asset classes in haphazard way and forget the financial planning mantra of “asset allocation”. Systematically deploying your savings in a disciplined manner, in various asset classes after understanding your risk appetite is referred to as “asset allocation” and one’s ideal asset allocation depends upon the factors such as:

 

• Age
• Income
• Expenses
• Nearness to goal
• Risk appetite

 

And if one has to broadly follow asset allocation, you can go by the thumb rule for asset allocation - which is 100 minus your age. So, for example if your age is 30, 70% (100 – 30) of your money can be invested in equity and the rest 30% can be invested in debt instruments; and doing so you would be classified as a aggressive investor, who assumes more risk.

 

Following the asset allocation (Use PersonalFN's asset allocator) exercise, either by giving due consideration to the aforementioned facets or simply going by the thumb rule provides you the prime advantage of diversification between asset classes, thus providing your portfolio a hedge against downside risks experienced by either of such asset classes.

 

The "balanced funds" category in mutual funds, entails in them this benefit by providing you an effective asset allocation, while you are invested in a single avenue of investment, and offers you the following advantages:

 

• Shift across two asset classes depending upon the investment opportunities in the market
• Hedges your portfolio when one respective asset class experiences turbulence
• Enforces discipline by maintaining a pre-determined asset allocation (generally 65% in equity and the rest 35% in debt, thus maintaining an equity orientation for tax status which other equity funds enjoy)

 

And all this more importantly is managed by professional fund managers who have rich experience in research & analysis along with fund management. So, you are left with less stress of ascertaining where the equity and / or debt markets are heading, economic scenario, investor sentiments etc.

 

Now having assessed the advantages of investing in balanced funds, let us see how they have fared against the diversified equity funds.

 

Performance

(NAV data is as on December 22, 2010. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 6.37%)
*Note: Category average has been calculated taking the "simple average", of all the funds in the respective categories and not only the set of funds above in each category. (Source: ACE MF, PersonalFN Research)

 

The table above reveals that most balanced funds on the return front have performed quite well across time frames, thereby competing with the diversified equity funds. But a noteworthy point is, while performing competitively they have exposed their investors to lower risk (refer Standard Deviation column in the table above), and has thereby given enticing risk-adjusted returns almost similar to the diversified equity funds (refer Sharpe Ratio column in the table above).

 

While you may certainly argue on the return front saying - "diversified equity funds have performed better", but in our opinion one should not rule out the risk which they have exposed its investors too. And, in that context balanced funds on the other hand have a dual ability of clocking impressive returns by keeping their volatility (i.e. risk) under check which makes them an attractive investment proposition for investors with low risk appetite.

 

Performance Across Market Cycles

(Source: ACE MF, PersonalFN Research)

 

Moreover, from the table above it is evident that during the down turn of the equity markets your wealth erosion is restrained in balanced funds due to set asset allocation model (generally 65% in equity and 35% in debt) followed by them. And this is unlike diversified equity funds where downside risk is greater since 80% - 100% or 90% -100% (of the fund’s total assets) are generally maintained in equity.

 

Now one may say - "but on the upswing of the equity markets they perform better". Yes sure, but that’s due to their very nature of asset allocation, which protects you against the downside and confines the performance on the return front when equity markets are in a bull phase.

 

HDFC Prudence vs. HDFC Top 200

Note: For the purpose of comparison only one fund from each category is taken.
Base: 10,000 (Source: ACE MF, PersonalFN Research)

 

The chart above too reveals that, when the equity markets were on their upswing prior to the emergence of sub-prime mortgage crisis, HDFC Top 200 (diversified equity fund) performed better (appreciated by 89% on an absolute basis) right from December 22, 2005 till January 21, 2008 (i.e. the date on which news of sub-prime mortgage crisis emerged in the U.S.). But as the atrocities of the sub-prime mortgage unfolded, the equity markets went on a downswing, which led to diversified equity fund like HDFC Top 200 fund take a greater hit (fell by 45% on an absolute basis) than a balanced funds like HDFC Prudence Fund (which fell by 43%).

 

Moreover, if one had invested a sum of 10,000 each, in the respective funds on December 22, 2005, and had stayed invested then you would yielded almost competing returns (HDFC Top 200 Fund 27,987 and HDFC Prudence Fund 25,560) as on December 22, 2010.

 

In a nutshell...

Hence, balanced funds are ideal investment avenue within mutual funds if you aren’t ready to assume very high risk, but want to participate in the equity markets to add a zing to your return on investments.

 

Therefore, if you want your portfolio to deliver a stable performance over the long term, then you should consider allocating some portion of your investible amount to balanced funds in addition to diversified equity fund.

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Comments
naman_g_shah@rediffmail.com Jan 01, 2011 HDFC Prudence vs HDFC Top 200 chart shows end value of HDFC Top 200 as more whereas the article write up shows otherwise. Kindly correct the figures in the article. Going by the same comparison, it seems that, Balance funds also get badly affected, if not equally, during the bear phase but has potential limitation to grow during the bull phase. In such a scenario, isn't it a good idea that, investor themselves distribute their money in pure equity fund and pure debt funds rather than going for balanced fund?
research@personalfn.com Jan 04, 2011 Dear Mr. Naman, We appreciate your comment on our article - “A balanced approach to mutual fund investing!!”, and thank you for bringing to our observation the error in the article, which now stands corrected. Yes, you are absolutely right on citing the fact that balanced funds too get affected during the downturn of the equity markets and have limitation during the upside of the equity markets when compared to diversified equity funds. However, a noteworthy point is that, during the downturn they fall lesser vis-à-vis diversified equity funds which provides a hedge to your portfolio during the bear phase of the equity markets. You may certainly go in for a diversified equity fund, but by doing so you’ll be ignoring the idea of automatic “asset allocation” (which balanced funds provide), which may make your portfolio look very aggressive and risky. Coming to your idea of picking up debt funds, it isn’t very simple as one needs to have a thorough understanding about interest rate cycles and the interest scenarios to select the right debt mutual fund product for your portfolio. And by chance through your own judgment, if you select a debt mutual fund, which is inappropriate to the prevailing interest rate scenario you may cause damage to your portfolio. Hence, please don’t rule out the inherent advantage of automatic “asset allocation” which balanced funds provide along other ones such as: 1. Shifting across two asset classes depending upon the investment opportunities in the market. 2.Providing an hedge to your portfolio when one respective asset class experiences turbulence. 3. Discipline enforced in you by maintaining a pre-determined asset allocation
syed_askari2007@yahoo.co.in Jan 06, 2011 I feel it is good advice.
kbr9121965@yahoo.com Jan 06, 2011 Instead of Balanced Fund can we buy Fund of Fund in the market whereFund Managers select the best performing funds
research@personalfn.com Jan 07, 2011 Dear K B Raut,  If your preference is towards building a hybrid portfolio of equity stocks and debt instruments and where you have resources to do your own research and identify the right fund,and if you prefer tracking and monitoring of your portfolio on your own, then you can go for Balanced Funds. If you don't want the hassle of selecting, tracking and maintaining your mutual fund portfolio, then you can invest in a single process oriented Fund of Fund. The fund manager will do all the required research, monitoring and changes if required. In Fund of Funds you will get benefit of holding number of funds through a single fund and accordingly benfit with exposure to multiple funds through a single fund. Thanks, Team PersonalFN Research

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