At least that's what some mutual funds seem to believe currently. That's probably why we have seen a couple of balanced fund IPOs over the last few weeks. But is a balanced fund a really good idea at the moment?

To be sure, a balanced fund is never a bad idea. But what makes a balanced fund seem like a relatively safe investment avenue (in mutual funds) is the mix of equities and fixed income securities, or to put it differently a mix of risk and stable returns.

A balanced fund is particularly suitable for an investor who wants to ride the growth in equities, but does not want to go all the way and is looking a hedge to protect him from a crash in stock prices. Which brings us to the all-important question  what is an ideal balance of equity and fixed income? In an interview to personalfn.com Mr. S.V. Prasad (President  Zurich India Mutual Fund) opined that a 55-60% exposure to equities is ideal with fixed income accounting for the rest.

Well, the ideal has remained just that  ideal. A reality check on most balanced funds reveals that fund managers have taken a higher exposure to equities (at times as high as 70%) disturbing the balance of the portfolio dramatically. And within the equity portfolio, the allocation to technology, media and telecom (TMT) stocks has been very high, which is a matter of some concern to investors who entered balanced funds looking for stable returns and lower volatility. With such a skewed exposure to equities, investors have unwittingly entered into a quasi-growth fund, rather than a 60:40 balanced fund.

But even a 60:40 balance may not help much if interest rates increase. Given the depreciating rupee and the step-up in inflation, there is some pressure on the Reserve Bank of India (RBI) to hike interest rates. In the scenario of higher interest rates, bond yields will move up (i.e. bond prices will fall) and this will have a shrinking effect on the fixed income portion of the balanced fund.

A rise in interest rates will also adversely affect corporate profitability. Moreover investors will up their discount rates for future cash flows, so stocks at current levels will look relatively more expensive and prices will come down. So effectively both the fixed income and equity portion of the balanced fund will be adversely affected.

An ideal investment horizon for most mutual funds (except liquid and money market funds) would be at least 6 months and the case with balanced funds is no different. In other words investors with balanced funds would need to remain invested for at least that long to see some results. But an ideal investment horizon would be at least 12 months.

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