Balanced Equity Funds: the low risk, high reward option

Balanced equity funds or equity-oriented balanced funds are those with min 65% equity exposure so that they can be classified as equity funds by the taxman. The rest of the portfolio (35-25%) has debt securities (gilts, corporate bonds, money-market instruments etc.).  Here is why I think these funds can match the returns of diversified equity

Here is why I think these funds can match the returns of diversified equity funds by taking significantly lower risks (approx. 33% lower in terms of the categories standard deviation).

Balanced equity funds are typically recommended by 'experts' to new mutual fund investors as a 'less volatile option'. For a new investor, the volatility associated with 65-70% equity exposure is pretty much the same as that associated with 100%  equity exposure.

However, for someone who understands the benefits of a balanced fund, they can the perfect choice: no-frills, low on expenses and most importantly low stress with a reward comparable to diversified equity funds.

Here are some benefits:

1) A single balanced fund is equivalent to an investment portfolio for long-term goals (1oY+). The equity and debt portfolio is independently diversified: across market caps, across bond types etc

2) Gains from the debt portion is available free of tax (as per current law)

3) The fund manager rebalances the portfolio periodically (each month if I am not wrong) and maintains the asset allocation without any tax implications or exit load.  This is crucial to reducing volatility and preserving gains.

Balanced funds vs. Equity funds

1) Consider all 12-year-old balanced funds (hybrid equity oriented at VR). There are 18 such funds.

2) Consider all 12-year old large cap, large and mid-cap, mid and small cap and multi-cap funds listed at VR. There are 58 such funds.

3) Calculate the standard deviation of last 12-year annual returns. This is a measure of risk: that is ,by how much do returns each year can vary from the arithmetic average.

4) Calculate CAGR. This is for a lump sum investment 12 years old. XIRR for SIPs will be different. It is tough to calculate this for all 76 funds considered, but I would wager that the results will not be too different.

5) Plot CAGR vs the standard deviation. This is a plot of reward vs. risk.

balanced funds vs equity funds

 

Lower standard deviation implies lower volatility and lower stress. Notice that most balanced funds have a lower standard deviation that equity funds.  However, their returns are comparable!

A good 33 out of 56 equity funds are within the red box (between 15% -25% cagr) where all but 2 of the balanced funds reside.

To me, this looks like a terrific deal. I get comparable returns at much lower risk.

Most people will be happy with a 12-year cagr of 15% or even 13.7% - the lowest cagr which is by a balanced fund.

About 39% of the equity funds have produced a return higher than 25%, but only with considerably higher risk. Is it necessary for us to take on such high risk? Not for me thank you.

Two reasons: 1) I value my health and 2) I have better things to do than to constantly watch over my folio, market movements etc.

It is easier to invest in a dull and boring SIP when the volatility is lower.

Many say that it is a good idea to separate the equity and debt components of a portfolio. I agree. However, for a long-term goal, there is no need to do this right from the start.

The investor can start an SIP in a single balanced fund and let it run for a few years (with an annual review).  For a 20 year goal, after about 5-7 years of investing, the investor can consider transferring some gains to a debt fund from time to time.

Alternatively, the investor can treat the balanced fund as a pure equity fund and have some debt allocation from the start. That is, ignore the debt allocation in the balanced fund and have a small (say 10-15%) separate debt allocation from the start.

One could even consider the balanced fund as 100% equity, invest 60% in it and 40% in a debt instrument.

There are are so many ways to play this.

Conclusion: Equity oriented balanced funds are not just for the newbie. They are for everyone.

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50 thoughts on “Balanced Equity Funds: the low risk, high reward option

  1. Himanshu Pant

    Interesting post , so Pattu sir does it mean that Balanced equity fund are better than pure equity funds in general ? I don't see any significant loss in returns over here to my surprise

    Reply
  2. Himanshu Pant

    Interesting post , so Pattu sir does it mean that Balanced equity fund are better than pure equity funds in general ? I don't see any significant loss in returns over here to my surprise

    Reply
  3. Anand

    Fantastic! Lot of folks (including me) should react like "something that was a back of the mind impression" but now have the analytics behind it!!
    And at the very basic, this is the near practical (non emotional) mechanism for getting something out of - buy low, sell high 🙂 and debt returns being thrown in free!

    As an avid believer of this approach and having a full allocation to one such fund for the whole of my retirement kitty, currently I am grappling with few thoughts..
    1. "XIRR for SIPs will be different" - I guess having a view of this is bit important, as this is the scenario that most of individual investors would end up having. Btw, having an increasing SIP XIRR scenario comparison is the closet one to real life..
    2. Once the corpus grows (or is a substantial portion of goal in a relative sense), two aspects come out - diversify across the fund manager/house and analyzing the performance of debt part of it - would really love to see your thoughts/analysis that clear the air around this.

    Btw, the conclusion "Equity oriented balanced funds are not just for the newbie. They are for everyone." - is a clincher and something for folks like @scripbox to take notice off..

    Thanks for the post Pattu!

    Reply
    1. pattu

      Thank you. SIPs will trend a bit differently. Dont have the tools for large scale calculations but I bet it will not be very different. Once the corpus gets big, if you get uncomfortable you can add another balanced fund

      Reply
  4. Anand

    Fantastic! Lot of folks (including me) should react like "something that was a back of the mind impression" but now have the analytics behind it!!
    And at the very basic, this is the near practical (non emotional) mechanism for getting something out of - buy low, sell high 🙂 and debt returns being thrown in free!

    As an avid believer of this approach and having a full allocation to one such fund for the whole of my retirement kitty, currently I am grappling with few thoughts..
    1. "XIRR for SIPs will be different" - I guess having a view of this is bit important, as this is the scenario that most of individual investors would end up having. Btw, having an increasing SIP XIRR scenario comparison is the closet one to real life..
    2. Once the corpus grows (or is a substantial portion of goal in a relative sense), two aspects come out - diversify across the fund manager/house and analyzing the performance of debt part of it - would really love to see your thoughts/analysis that clear the air around this.

    Btw, the conclusion "Equity oriented balanced funds are not just for the newbie. They are for everyone." - is a clincher and something for folks like @scripbox to take notice off..

    Thanks for the post Pattu!

    Reply
    1. pattu

      Thank you. SIPs will trend a bit differently. Dont have the tools for large scale calculations but I bet it will not be very different. Once the corpus gets big, if you get uncomfortable you can add another balanced fund

      Reply
      1. Anand

        Thanks Pattu and sorry im seeing your response late.
        On your comment, "Once the corpus gets big, if you get uncomfortable you can add another balanced fund" - i guess there is a need for analysis of having a risk adjusted return analysis when two or more funds are combined
        e.g. (when funds are in same category and having same portfolio weightage)
        1. HDFC Balanced + Tata Balanced
        vs
        2. HDFC Balanced + HDFC Prudence
        vs
        3. HDFC Prudence + Tata Balanced
        vs
        4. HDFC Prudence + HDFC Balanced + Tata Balanced

        btw, it will be really nice to have the combined analysis with the basket of funds that one would have in portfolio (and this is basically going towards having a view of ones overall return/risk quantum of the portfolio) ..

        Thanks

        Reply
        1. freefincal

          Hi Anand, I don't think you need to worry too much at that point. Spreading risk is your main goal and as lons as the funds have decent track record, I think it should be fine.

          Reply
          1. Anand

            Thanks Pattu and yes understand. Only nagging point remains about taking a more informed call, whether just based on the funds individual track record - vs combing them and seeing the backdated portfolio's return/risk metrics; but then again, maybe im complicating it too much 🙂

  5. JD

    Great Analysis yet very simple to understand.
    Query: I am using your goal planner and automatic portfolio updater excel.

    If i know my retirement corpus and retirement is almost 20 yrs away. How much i should save in next 5 yr and keep it as it is so i can get my corpus after 20 yrs.

    I hope you undstd what i want to do. I wana save enough in next 5 yrs only for my retirement.

    Thanks Guru.
    JD

    Reply
    1. pattu

      Hi JD, you need to find out
      1) your expenses after 5Y for a given inflation
      2) Use the retirement calculator with years to retirement as 20.
      3) adjust the present corpus until investment amt becomes zero.
      4) that present corpus is your target after 5Y.
      5) use a goal planner with that target and find out how much to invest

      Reply
  6. JD

    Great Analysis yet very simple to understand.
    Query: I am using your goal planner and automatic portfolio updater excel.

    If i know my retirement corpus and retirement is almost 20 yrs away. How much i should save in next 5 yr and keep it as it is so i can get my corpus after 20 yrs.

    I hope you undstd what i want to do. I wana save enough in next 5 yrs only for my retirement.

    Thanks Guru.
    JD

    Reply
    1. pattu

      Hi JD, you need to find out
      1) your expenses after 5Y for a given inflation
      2) Use the retirement calculator with years to retirement as 20.
      3) adjust the present corpus until investment amt becomes zero.
      4) that present corpus is your target after 5Y.
      5) use a goal planner with that target and find out how much to invest

      Reply
  7. Nithin

    Wow, I had never looked at balanced funds this closely before. Thanks for shedding the light on this. To sum it up three things have impressed me :
    1. Balanced funds inherently perform tactical asset allocation. i.e. When equity spurs, portion of it's profit is shifted to increasing debt component and vice versa to maintain 65:35 allocation.
    2.Debt component of balanced funds still gets equity-like treatment for tax purposes, so this is a great way of getting best of both worlds.
    3. You will have have lesser/smaller ulcers in owning units in this fund.

    Reply
  8. Nithin

    Wow, I had never looked at balanced funds this closely before. Thanks for shedding the light on this. To sum it up three things have impressed me :
    1. Balanced funds inherently perform tactical asset allocation. i.e. When equity spurs, portion of it's profit is shifted to increasing debt component and vice versa to maintain 65:35 allocation.
    2.Debt component of balanced funds still gets equity-like treatment for tax purposes, so this is a great way of getting best of both worlds.
    3. You will have have lesser/smaller ulcers in owning units in this fund.

    Reply
    1. $udhakar

      @gaurangray3, As an investor in balanced funds, any short term gains are treated just at par with equity mutual fund. You do not need to worry about which portion (equity,debt).

      If your question is with respect to AMC/mutual fund management, how they calculate short term capital gains on equity /debt, you do not need worry there also. Mutual funds are not charged with taxes for short term gains.

      Reply
  9. JD(Bharuch)

    Dear,
    If so , Why not kind of retirement funds , also can be considered at same level of Equity oriented balanced funds? or Can we take them also as one fund for Retirement? Example: Tata Retirement funds.
    Any Analysis for such kind of funds?

    Thanks

    Reply
  10. SHAJI UNNI

    Hello Pattu Sir,
    1) What is your view on Mirae asset prudence fund view. Its a new balanced fund in the market. one year old.
    2) Also kindly write your your view UTI oppr fund. I have been investing in this fund since last 5 years. As you know 6 months back the fund manager had changed and seems the new fund manager"s record is not so impressive. I know you also hold this fund hence asked your view.

    Regards
    Shaji Unni

    Reply
  11. Sanjeev gargish

    Dear sir,
    For a 10 year horizon is it fine with me to invest only in tata balanced fund. I am 47 years old self employed. Shall I not invest in multi cap fund?

    Reply

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