Making sense of balanced fundsBalanced or hybrid funds have sprouted in many variants over the years. These range from conservative Monthly Income Plans (MIPs) to aggressive equity oriented funds. How do you distinguish them all? Read on.

What is a balanced fund?

On a broad level, it is a fund which invests in both equity and debt. This asset composition can be created in two ways.

  1. By actually holding stocks and bonds in a certain ratio. For instance a fund holds stocks worth Rs 500 crore and bonds worth Rs 500 crore and achieves an asset mix of 50:50.
  2. By using derivatives. A fund holds stocks worth Rs 800 crore, bonds worth Rs 200 crore and short futures worth Rs 300 crore. This can also achieve an asset mix of 50:50.

The relative proportions of the two assets determines the name of the fund in question. There are roughly five types of hybrid funds as per the new SEBI classification system:

SEBI Name Industry/Historical Name Equity Share Tax Classification
Aggressive Hybrid Fund Balanced Fund 65-80% Equity
Equity Savings Fund Equity Savings Fund 65% – 96% Equity
Balanced Hybrid Fund Balanced Fund 40-60% Debt
Conservative Hybrid Fund MIP (Monthly Income Plan) 10-25% Debt
Dynamic Asset Allocation Fund/Balanced Advantage Fund Dynamic Asset Allocation Fund/Balanced Advantage Fund No formal limits Debt

Hybrid Funds (Conservative, Balanced, Aggressive)

These are the most standard type of balanced funds. They invest in debt and equity within the boundaries laid down by their mandates and SEBI rules. They do not use fancy formulae, strategies or derivatives to achieve their asset allocation.

Equity Savings Funds

These funds use derivatives to achieve the character of a debt fund while still being classified as equity funds for tax purposes. They hold a 65% of their assets in equity to get the favourable tax treatment given to equity funds but use derivatives to push their equity exposure below this level as per the fund manager’s view. For example holding Rs 100 crore worth of a stock and shorting Rs 100 crore worth of its futures can nullify the equity holding. Short and long term capital gains in equity funds are taxed at 15% and 10% respectively compared to 20% (with indexation) and the slab rate for debt funds.

Dynamic Asset Allocation Funds

These funds use asset allocation strategies such as relative PE ratios to move between equity and debt. They do not lay down narrow upper and lower limits for equity versus debt proportions and can move heavily into either flavour depending on what the strategy or fund manager says.

One additional category that is hybrid in character but not strictly so is ‘multi-asset funds.’ These funds hold not just equity and debt but also other assets such as gold. SEBI classification rules require such funds to hold at least three types of assets in their portfolio with at least 10% of the corpus in each asset at any point of time.

Author
Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at neil@rupeeiq.com.