Why do some balanced mutual fund schemes outperform a majority of pure equity diversified schemes?
Well, the answer lies in their asset allocation. Some balanced schemes take their equity exposure to as high as 70%-75%, hence outperform many pure equity schemes.
Balanced schemes are expected to invest around 65% in equity, while equity-diversified funds maintain an equity allocation in excess of 80%. Yet, many balanced funds intentionally raise their equity exposure to take advantage of a market rally.
If you noticed, these schemes are able to do well by being quite unbalanced. With this allocation strategy, several balanced schemes are able to outperform their benchmark- the CRISIL Balanced Fund Index-by a wide margin.
While most investors are only concerned about returns, what they fail to realise is that they are taking a higher risk. This is what caught the attention of the mutual fund regulator, the Securities and Exchange Board of India (SEBI), which has been taking several pro-investor initiatives that have, at times, been unnecessary in the past. <.
Balanced funds are often touted as a lower-risk alternative to equity schemes. But, balanced schemes that maintain an equity allocation of around 75% are no different from equity schemes with an equity exposure in excess of 80%, in terms of risk.
For the past few years, the market regulator has been taking a tough stand against new balanced fund launches that allow an allocation in excess of 65%. SEBI has been pushing a 50:50 equity-debt mix to balance the funds in the literal sense.
In the past, all balanced funds maintained a 50:50 allocation, but changed to 65:35 (equity:debt) after the tax laws changed in 2006. While this benefits investors in the form of tax-free gains, a few schemes have taken advantage of the added equity exposure to deliver higher returns, albeit with greater risk.
The SEBI ex-Chairman, Mr UK Sinha, a few years back voiced his concern saying, “Balanced funds should be balanced and they should, therefore, have a more equitable distribution between equity and debt.” However, SEBI has not translated this into a written rule or regulation, fearing a backlash from the industry.
In May 2013, erstwhile JP Morgan Mutual Fund had filed for a new balanced fund offer, which aimed to invest 65%-75% in equity. However, SEBI approved the offer two years later when the fund house reduced the equity allocation to 30%-60% in equity. To meet the minimum equity allocation requirement to qualify as an equity scheme for taxation purposes, the fund introduced a 10% allocation to equity arbitrage opportunities.
Now as SEBI proposes to simplify the classification of mutual fund schemes, this may lead to a change in the definition of balanced funds. The regulator may also push fund houses to merge similar balanced schemes in to one.
While SEBI’s efforts are well intended, in the past several initiatives caused a disruption in the industry. While some of these truly benefitted investors, such as the abolition of entry load, introduction of direct plans, more stringent disclosures, etc.; other initiatives such as salary disclosure of key executives, minimum net worth to setup mutual funds, had no relationship to how a fund house or its schemes were being managed.
This time again, SEBI’s efforts to have balanced schemes conform to an equitable allocation may be unwarranted. As advisers and distributors may promote aggressively allocated balanced schemes that have done well in the past. SEBI should therefore focus more on curbing mis-selling.
In July 2015, SEBI introduced a ‘Riskometer’ to help investors understand the risk involved before buying a scheme. However, with a lack of clear definitions, the use of the Riskometer across fund houses has been inconsistent.
All balanced schemes are marked as ‘moderately high’ risk, even those with an aggressive equity allocation. There are even some small-and mid-cap schemes marked as ‘moderately-high’ risk. SEBI should ask fund houses to define the risk level as per the underlying asset type and percentage allocation. Unless this is implemented, fund houses can easily mislead investors with their own definitions.
As an investor, due diligence is a must before investing in financial products. Always seek unbiased advice where there is no conflict of interest. No advice is free; there aren’t any free lunches. It’s the lucrative underlying commissions that’s driving most in the industry. Therefore, it is pertinent to pay a small fee to a financial guardian in order to receive impartial recommendations.
When selecting balanced funds, it is best to focus on the risk-adjusted returns. More importantly, maintain a long-term investment horizon of 5 years or more. One of the best ways to invest in balanced and/or other equity-oriented schemes is through a Systematic Investment Plan (SIP). This will help you tide over the market volatility, as well as develop a regular saving habit.
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