Budget 2014 - Rebalance your Equity Portfolio and Debt Investments
There are many investors who put the entire ₹ 1 lakh limit of the Public Provident Fund ( PPF) in April itself because it helps them earn the entire interest income of 8.7 per cent a year. Many financial planners received calls on the Union Budget day from clients wondering if they should immediately put the additional ₹ 50,000 limit that Finance Minister Arun Jaitley had given them for 2014- 15.
Some even lamented the loss of interest income of an entire quarter.
With the Budget passed, many financial planners are busy reworking their clients' portfolios. There has to be some tinkering due to the additional limits. Plus, the debt fund investments have to be changed to make these more tax- efficient.
Portfolio rebalancing is important. Not only because of the Budget but due to the good returns from both the equities and debt part of the portfolio. Suppose you had a portfolio with 40 per cent in debt and 60 per cent in equities last year. Today, this portfolio would be heavily loaded in favour of equities. A ₹ 10 lakh portfolio with a 40: 60 debt equity ratio would have had ₹ 4 lakh in debt and ₹ 6 lakh in equities last year. Now, considering the returns of the equities benchmark, the BSE exchange's Sensitive Index or Sensex, the equities portfolio would have swelled to around ₹ 8 lakh ( 31.9 per cent). Taking the one- year, nine per cent fixed deposit as a benchmark for debt returns, those returns would be ₹ 4.36 lakh. In sum, the portfolio would be worth ₹ 12.36 lakh, up 23 per cent.
If you want to follow the same debt to equity ratio, it has changed to 34 per cent in debt and 66 per cent in equities. So, to bring it back to the same ratio, ₹ 74,160 needs to be invested in debt. This will take the debt portfolio to ₹ 5.01 lakh. Bring down equities to ₹ 7.25 lakh and the 40: 60 ratio will be maintained.
This is an oversimplified case, as the returns would differ according to the instruments. If someone had invested in a top performing mid and small- cap fund, the portfolio returns would have rocketed to 116 per cent annually. And, in the worst case, investing aggressively in gold funds would have led to a decline in the portfolio's value by three per cent.
But rebalancing between asset classes is not enough. It is just the first step. There is to be rebalancing within the asset class as well.
The rebalancing in equities can be crucial. For example, the past one year's exceptional performance would give an opportunity to many investors to exit non- performing stocks and mutual funds. For instance, laggards in the past like the infrastructure and real estate sectors are again finding favour. Infrastructure funds are up 65 per cent — among the top performers — in the past year. Similarly, the BSE mid- cap and small- cap indices are up 88 per cent and 65 per cent, respectively. The current outperformance has helped these sectors' returns even over a three- year and five- year period. That is, returns from infra funds are in the green at five per cent annually over a five year period.
Debt, on the other hand, has to be handled with more care because of the taxation in the Union Budget. Suddenly, the tenure of debt investments has become very important.
Earlier, the majority of investors used to simply put in fixed maturity plans or other instruments and once these matured, they would worry about the next investment, as per the flavour of the season.
Now, things have to be thought out differently. Yes, arbitrage funds look good because they are like debt but due to the underlying investment in equities, they get tax benefits like equities. But with returns of nine to 10 per cent, they are only good for one year or so.
The important thing will be look at debt instruments in line with the requirement or preferably through the prism of financial goals. There is no point in investing in a one- year or two- year fund if you do not need the money then.
If you need it for liquidity, go for short- term funds, of less than one year. Similarly, for longer term needs, go for schemes that are over three years, to benefit from some tax relaxation. Since the inflation indexation benefit is still there after three years, the tax liability will be lower vis- a- vis fixed deposits. This will be useful especially if you are close to retirement, as instruments like asset allocation schemes or monthly income plans will give benefits after three to five- year plans.
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