Balanced funds are those funds that invest the majority of their portfolio in stocks and the rest in fixed-income instruments. A balanced fund thus straddles two asset classes – equity and debt.
What is the benefit in doing so?
Who do these funds suit?
Here are the answers.
What they are
Balanced funds invest about 65% to 75% of their portfolio in equities and the remaining in debt. Depending on the equity market conditions, funds either reduce equity holding or increase it. Such tweaking is within the 65-75% range. Funds almost never take equity above the 75% limit; the portfolio always holds a sizeable debt component. Balanced funds do not bring their debt component down to zero nor lift it beyond 35%.
The more aggressive among balanced funds work with a 70-75% equity holding while the conservative ones move between 65-70% in equity. The aggressive funds are thus able to deliver higher returns than the conservative ones when markets rise but will also fall more when markets correct. Their volatility will consequently be higher.
The balanced benefit
Whether aggressive or otherwise, all balanced funds have one thing in common – they have far lower risk than pure equity funds while allowing reasonable participation in the stock markets. The equity and debt portions play different roles in a balanced fund’s portfolio and together make a well-crafted investment option.
The equity portion’s role is to deliver returns. The equity holding is significant enough to ensure a reasonable participation in the stock market and the inherent higher returns in this asset class. More, funds move across market capitalisations in their equity holdings, holding a good amount of mid-cap stocks when opportunities are ripe.
In doing so, they try to extract as much as possible from their equity holdings. But the lower equity exposure of 65-75% compared to the 95% average for pure equity funds (the remaining 5% is held in cash to meet redemption requirements) brings down the risk level too. When markets correct, this reduced equity exposure results in losses being much lower than pure equity funds.
The debt portion serves to protect. Debt and equity, to begin with, rarely move in tandem so there is already a hedge to the equity through the debt. Further, the debt portion delivers its own returns that supplement equity returns or compensate for equity losses.
Funds also do not manage the debt portion actively. They mostly invest in top-rated quality corporate debt, hold these instruments, and earn the interest accrued on them. But some of them go long on duration to make the best of an interest rate move.
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