The AUM of equity-oriented balanced funds has nearly doubled over the past one year. We examine the reasons for their popularity and the pros and cons of investing in these funds.

                                      

Between June 2014 and June 2015, the asset under management (AUM) of equity oriented balanced funds almost doubled from `18,620 crore to `36,712 crore. Given their popularity at the moment, we examine the factors responsible for the high net inflows into these funds.

First, bullishness in the equity markets saw investors flocking to this asset class.The overall equity AUM of the mutual fund industry grew by around 50% over the above-mentioned period. Equity-oriented balanced funds, which invest more than 65% of their portfolio in equities, too benefited from investors' preference for equities at a time when real estate and gold was faring poorly.

The attractive performance of equityoriented balanced funds also helped. Over the past one year, these funds have given a category average return of 17.39% (as on 21 July).

The influx of new investors has also boosted inflows into these funds. Both fund houses and mutual fund advisers tend to suggest balanced funds to new investors who have not been exposed to the volatility of equities before.

This year's Budget changed the taxation norms for debt funds. Investors are now eligible for long-term capital gain in them after three years instead of one. To some extent, balanced funds benefited from the changed taxation norms for debt mutual funds. The positive outlook for debt is another factor. The outlook for the debt portion of balanced funds also looks good with interest rates expected to fall over the next 12-18 months.

Advantages of balanced funds

One advantage of balanced funds is that over two-third of the portfolio is invested in equities, which act as a wealth building vehicle over the long term.Investors also get the benefit of diversification, that is, exposure to two asset classes within one fund. These funds also offer asset allocation. The investor does not have to worry about rebalancing, which is handled by the fund manager. There is also the benefit of an expert changing the weightage of equities and debt in the portfolio based on his view of their prospects.

The disciplined rebalancing of assets in these funds has a positive fallout on performance. Rebalancing provides an opportunity to buy in the equity market on dips and book profits when the market is up.This helps to generate better risk-adjust ed returns in the long run. The investor also does not have to worry about the tax liability and transaction costs that can arise if he does the rebalancing himself.

Equity-oriented balanced funds also enjoy favourable tax treat ment. As the exposure of these funds to equities is more than 65%, they get treated at par with equity funds despite having some debt exposure.

Disadvantages and risks

Many people harbour the notion that a balanced fund will protect them entirely from market volatility. This is not true. Around two-third of the portfolio is invested in equities, so they too will be susceptible to market downturns, but to a lesser extent than diversified equity funds.

In some balanced funds, the debt portion is managed quite aggressively with the fund manager maintaining a high average duration. If the rate cycle turns abruptly, the debt portion of the portfolio could give negative returns in the short term.

  It is difficult to align these funds to your in vestment objective, which is why I prefer separate equity and debt funds.Suppose you are approaching an investment goal and would like to reduce your allocation to equities. This is more difficult to do with balanced funds than with separate equity and debt funds.

Another issue with some balanced funds is that they don't have a single but two benchmarks, which the investor might find confusing. In such a case, do peer comparison.

Choosing the right fund

Balanced funds are targeted at customers with moderate risk appetite. Make sure that the equity portion of the portfolio does not have too high an exposure to mid-cap stocks and the debt portion does not carry too much duration risk. Check past performance and make sure that the fund has consistently beaten its benchmark (usually the Crisil Balanced Fund Index).