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Go for balanced funds in bear market, equity among bulls

Balanced funds may appeal more than equity funds as when the equity market is in a bear phase, balanced funds are more stable due to restrained equity exposure

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Investors usually manage allocation to equity and debt through focussed allocation to equity and debt funds. This has the advantage of better control over the portfolio and moving in and out of equity or debt, when there is a change in outlook on the asset class. However, in reality, it tends to get ignored because when an asset class is booming, it looks bright and the relative allocation moves up, whereas when the market cycle turns, the investor is left without booking profits.

Another approach to allocation is through hybrid funds. There are various categories of hybrid funds as per the relative allocation to equity, since equity is the higher risk – higher-return asset class against debt. One relevant parameter in this context is the tax treatment of the fund. Equity is more tax efficient as there is no tax for a holding period of more than one year. There is no dividend-distribution tax, and the short-term capital gains tax for a holding period of less than one year is much lower than debt funds. Given this tax efficiency, it will benefit investors if a hybrid fund is classified as equity. However, as per rules, allocation to equity has to be more than 65% to be eligible for the classification. The equity allocation of 65% or higher need not be on a particular day, it is measured on the first and last working day of the month, for the last one year, on an average.

Hybrid funds with allocation of 65% or higher to equity are known as balanced funds. It may be termed as 'aggressive' hybrid fund, since the equity component is relatively higher. The other category of hybrid funds, which is conservative with lower allocation to equity, is called monthly income plans where the equity component ranges from 15% to 25%.

In balanced funds, the fund manager would increase the allocation to equity to more than 65%, to say 70% or 75% when the view on equities is bullish, or it may happen automatically when the market is booming. The fund manager, being an expert, will take the call on when to reduce the equity component. When the view on equity is bearish, equity portion may dip to even less than 65%. To qualify for the equity classification, the fund manager need not have 65% everyday, it is an average of the last one year, and it can be increased subsequently.

Balanced funds may appeal more than equity funds as when the equity market is in a bear phase, balanced funds are more stable due to restrained equity exposure. Though in a typical bull cycle, balanced funds would lag behind equity funds to an extent, but in the long run, they give better risk- adjusted returns i.e. returns adjusted to volatility during investment period.

For investors with the appetite and horizon for investing in equities, the long-term growth story remains intact. Markets have discounted quite a few positives, and Nifty is currently close to 8900 Sensex being close to 28850. In the growth trajectory, there would be volatility. For a graded approach to participate in the India's growth story, investors can look at balanced funds positively.

The writer is senior fund manager – equities, BNP Paribas Mutual Fund.

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