Balanced funds aren't risk-free

Exposure to equities, especially to mid- and small-cap stocks, and also from holding higher-duration bonds can sometimes turn the tables on the investor

Balanced funds (or equity-oriented hybrid funds) have emerged as a popular category in the past few years. From Rs 12,047 crore in September 2013, the assets under management (AUM) of these funds have risen more than five-fold to Rs 68,784 crore currently. In fact, the sale of these schemes has been on the rise in the past couple of months, as a number of fund houses are pushing these products aggressively.

Financial advisors are advising first-time investors in equities to invest in these funds for their lower volatility compared to pure equity funds. Investors should, however, bear in mind that these funds do carry certain risks.

 

First, given the 65-75 per cent exposure to equities, these funds are not immune to volatility. They maintain an average equity exposure of above 65 per cent to avail of the equity-like tax treatment. In one fund within the category, the equity exposure goes as high as 74.56 per cent.

For conservative investors, this level of equity investment could be too high. “Balanced funds will definitely fall when the markets fall, though they may fall less than pure equity funds,” says Vidya Bala, head of research, Fundsindia.com.

Many balanced funds today have a mid- and small-cap exposure of above 30 per cent, with the highest being 44.8 per cent (of the equity portfolio). A 71 per cent exposure to equities, and within that a 44.8 per cent exposure to mid- and small-cap stocks, translates into a 31.76 per cent exposure to mid- and small-caps in the overall fund portfolio. “The mid- and small-cap space can have periods of exuberance leading to huge volatility in fund performance. This may not appeal to conservative investors with a moderate risk appetite who want consistency in these funds,” says Sanjay Parekh, fund manager, Reliance Regular Savings Fund-Balanced Option.

The current high valuations of mid- and small-cap stocks is also a cause for concern. “The Nifty Midcap Index has historically traded at a discount of 10-35 per cent to the Nifty 50 Index. In recent times it has been trading at a premium. We feel this is not sustainable,” says Parekh, whose fund has a 17.08 per cent allocation to mid- and small-cap stocks.

Risk could also lie within the fixed-income portion of the portfolio. “Many fund managers take duration risk on the fixed-income side,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Advisor India. Investors need to understand their own risk profile before betting on these funds. Conservative investors who want a lower equity exposure (than 65 per cent) may buy a debt fund or two. “Doing so will bring down the overall equity exposure in their portfolio,” says Belapurkar. Investors should also look at past calendar-year returns. “If in a falling market the balanced fund managed to contain downside risk better than its peers, you may opt for it,” says Bala. Parekh suggests having sub-categorisation of balanced funds based on market cap. “Investors with a lower risk appetite should consider funds with a higher large-cap exposure,” he says. By investing for five years or more, too, you can effectively counter the risk in these funds.

Conservative investors may also look at equity-savings or equity-income schemes, which invest in equity, debt and arbitrage opportunities and have a risk-return profile between that of monthly income plans (MIPs) and balanced funds. “Invest in them if you want lower volatility and have a time horizon of three years,” says Bala. She, however, warns that their returns will not match those of balanced funds. Those wanting to build wealth and having a time horizon of five years or more should stick to balanced funds, she says.