If mutual funds were cricketers, then hybrid funds would be the all-rounders. With a combination of debt and equity in varying proportion, hybrid (or balanced) funds can both bat and bowl. Like most average all-rounders, you can expect them to deliver consistently, if not brilliantly. Equities are the best instruments for long-term growth of capital and a portfolio of diversified stocks reduces the risk of individual equities. In spite of diversification reducing some risks, equity as an asset class is still volatile, especially in the short-term. Debt instruments, on the other hand, are stable. This stability, however, comes at a cost — their returns are low. Over the long-term, debt instruments cannot beat inflation, while equities are capable of doing that in a significant manner. Beating inflation is essential to increase the value of your investments. Based on these characteristics, it would seem that a blend of both equity and debt could provide a more stable and rewarding mix. And this is where balanced funds play an important part. While the equity portion of a portfolio should boost returns, the debt component should lower volatility. However hybrid funds deliver lower returns than equity funds in bullish markets, they do a better job of protecting investors’ money during a bear phase. But, not all hybrid funds are alike. While equity-oriented hybrid funds give more weightage to stocks, debt-oriented balanced funds are tilted more towards fixed income instruments. Debt hybrid fund category largely comprises of funds with diverse product positioning such as children-oriented funds, asset allocation plans and pension funds. Can you do it yourself? A combination of equity and debt in the ratio of 60:40 would normally be called a balanced fund. So, why not do it yourself? The biggest hurdle here is that booking profits in any of these components would subject the portfolio to capital gains tax and this would severely reduce returns, especially over the short run. Portfolio re-alignment would also be extremely difficult. As mutual funds are pass-through instruments and not subject to tax, balanced funds can do the same job in a more tax-friendly manner. For past two-three years, the debt markets have been on fire. But lately the stock markets have also picked up. To a large extent, in order to remain tax-efficient, hybrid funds category has held over 50 per cent in stocks. This way, balanced funds were able to escape the 22 per cent dividend distribution tax applicable to funds with less than 50 per cent allocation to equities. With the dividend distribution tax being re-instated since this fiscal, it makes sense for hybrid funds to invest more than 50 per cent in equities. Though the equity markets didn’t go anywhere in the first quarter, and the debt markets were also volatile. But the recent rally in the stock markets and stability in the debt markets have given a big boost to the returns of balanced funds. Therefore in the first quarter, these funds lost 4 per cent while average diversified equity and income fund was down 6 and 0.02 per cent respectively. Since the start of second quarter, diversified and income funds have gained 48 and 4.55 per cent, while balanced funds are up an average 30 per cent. Now its evident that balanced funds have a lot to offer to investors. The picks among the balanced funds are—HDFC Prudence, FT India Balanced, and Unit Scheme’95.
