The Retail Investor’s Dilemma

T Prem, I am assuming that you are comfortable with the equity ratio of about 65 per cent to 70 per cent which balanced funds generally opt for. While ‘balanced’ could mean 50 per cent in debt and 50 per cent in equity, this is not what really happens. The Income Tax law states that a fund that maintains a level of 65 per cent in equity will be treated as an equity fund and hence dividend distribution tax will not apply. (For debt funds, there is a dividend distribution tax of 28.33 per cent which is not particularly tax-friendly.) To avoid incurring DDT, many funds stick to a minimum of 65 per cent in equity at any point of time.

To arrive at a conclusion, I have analysed a few balanced funds versus a combination of a few top performing equity funds along with a 30 per cent in Franklin India Short Term Income Plan representing the debt funds.

The performance of the HDFC and IPru balanced funds do stand out in their own peer group and also when compared with a set of self combined funds, as in Table 2. 

But a deeper study would require us to examine the risk taken to obtain the higher returns in the balanced funds. An apt measure is the downside risk and the Sortino ratio. This calculation reveals that the balanced funds of Table 1 exposed the investor to a higher degree of volatility than the constructed set of Table 2.

But the return delivered for incurring this higher volatility was not commensurate with the risk taken. Hence it does seem that for a less volatile performance, a constructed set of carefully chosen equity funds is better. Another feature of balanced funds in the period under examination is that they were relatively tilted towards mid-cap stocks, and hence the need to have mid-cap funds in Table 2! 

For a passive investor who is not too mindful of a degree of higher volatility, the HDFC or ICICI Prudential balanced funds seem alright. But if one wants greater control of the portfolio, a chosen set of equity funds and debt funds that are best of breed in their categories may be better.