Seeking safety with reasonable returns

When stock markets go up sharply, risk-averse investors start feeling the jitters. There is always an apprehension that a correction is just round the corner. For investors who get ulcers with every sharp rise and fall, balanced funds are a good option.

These schemes invest 65 per cent of their corpus in equities and the rest in debt. As a result, they are more stable in a falling market. Two, by investing just two-thirds, or 65 per cent, in equities, they qualify for tax benefits meant specifically for equity schemes and stocks. That is, a capital gains tax of 10 per cent applies if the units are sold within one year and there is no capital gains tax if the scheme is held for over a year.

Govind Pathak, director, Acorn Wealth, said: “Equity-oriented balanced funds, with a higher proportion in equity, are treated as pure equity funds as far as taxation is concerned. In that sense, balanced funds help provide better tax management.”

The returns are reasonable as well. According to data from Value Research, a mutual fund rating agency, the average returns from equity-oriented balanced funds have been 15 per cent in the past six months (as on November 30). In comparison, the category average of diversified equity funds is 22 per cent. The Bombay Stock Exchange Sensitive Index or Sensex has returned 16 per cent in the period.

But debt-oriented balanced funds (schemes that invest a lower proportion than 65 per cent in equities) are taxed as debt funds. The short-term (less than one year) capital gains is added to the income and taxed according to the applicable slab. But long-term capital gains get inflation indexation benefits. The tax rate is 10 per cent with indexation and 20 per cent without indexation. If you choose the dividend option, the tax is deducted by the fund and the income is tax-free in your hands.

Such funds are especially useful when markets are falling because they allow investors to reduce losses. For example, if equity markets correct 50 per cent, a scheme with 100 per cent allocation could fall in tandem or more, depending upon the fund manager’s calls. On the other hand, equity-oriented balanced ones have the 35 per cent debt cushion that leads to lower losses.

For instance, the Sensex has fallen 5.76 per cent in the past two years, whereas equity-oriented balanced funds have fallen by only 1.94 per cent. Debt-oriented balanced funds have even given positive returns of 5.31 per cent. “At a time when equity portfolios lose half the money invested, balanced funds lose only one-third,” said Kartik Jhaveri, founder, Transcend Consulting.

However, it does not make sense to keep your entire portfolio in balanced funds. Separate investments in equities and debt funds allow you to take advantage of rising markets and interest rates. At best, keep 15-20 per cent of your portfolio in such funds because they help you keep the portfolio balanced. “Ideally, one may want to buy different equity and debt schemes at different points in time to earn maximum returns on investment, which is not possible with balanced funds,” said Anil Rego, chief executive officer, Right Horizons.