Balanced funds are mutual funds that invest in both stocks and bonds. These funds invest 50–75% in equity and rest in debt. Equity is mostly large cap companies whereas debt is mostly long-term debt. Typically, retirees or investors with low-risk tolerance invest in these funds for income and growth at the same time.
Growth: Asset Under Management (AUM) for has grown by ~5x in less than 3 years. It’s incredible growth for this category.
AUM growth of Balanced Fund (AMFI)
Balanced funds are marketed as income plans where fund manager handle asset allocation to safety to the investors. Another major benefit marketed is that its tax saving on returns on debt component. But why not buy one large cap equity fund with 65% weight and rest invest in debt fund.
Balanced Advantage Funds: Recently, a new kind of balanced funds is launched and they are getting huge popularity. They are called balanced advantage funds. The only difference is that they use derivatives to manage allocation asset allocation across debt and equity. They also take more flexibility on asset allocation percentages. Again, it’s can be easily achieved by using arbitrage funds along with large cap equity and long-term debt fund.
Let’s dig deep.
Safety from Market: It can only provide safety from the market if the debt has a negative correlation with equity but that’s rarely true. We did a comparison of a portfolio of large cap equity fund and short-term debt fund.
Returns: Over 5 years, this portfolio generated 25% alpha over Crisil Balanced Fund benchmark and that too with half the risk. That shows buying a portfolio of debt fund and equity fund is better than balanced from both risks and returns perspective.
Let’s talk about taxation also.
Taxation: One thing is sure that even if you are investing in the Balanced fund or Proxy Balanced Fund you should be looking at a tenure of more than three years and after 3 years anyways taxation on debt fund is negligible. Even if we look at less than 3 years exit lets consider following cases:
Calculation for Case 2/4: Assuming 10% returns on debt fund, 33% weight of debt fund and 30% as tax will make tax liability to be 10% x 33% x 30% = 1%
So, in the end, the point is that even though balanced fund are so popular and mutual funds are marketing it very aggressively led to such a huge growth in AUM. But it’s much better to invest in a portfolio of debt fund (35%) and Large Cap Fund (65%) from Returns, Risk and expenses perspective. Also, the tax benefit of a balanced fund is minimal.