Are you investing in balanced funds for monthly dividends

The trend of older or conservative investors moving their life savings into
balanced funds essentially means that they are convinced these funds can give them
regular dividends that can beat fixed deposits by a good margin over the medium to
long term.

Renu Pothen

As I write this column, it takes me back to the time when our parents were content
that they were able to achieve all their goals by investing into one of the most
simple investment opportunities: fixed deposits. Now, caught up in the buzz around
rocketing markets and a growing economy, I find that many investors of their age
are considering investing into equity focused funds so that they can lead a stress-
free life in retirement. Our discussions with a few retired investors recently gave
us the feeling that they seem to be pretty impressed with the monthly dividends
being generated by balanced mutual funds, and are thinking of moving significant
chunks of their portfolio from banks into these funds. While all of us in the
mutual fund industry have been consciously working towards greater inclusion in the
markets, to me, this trend is a little bit worrying as it goes against well-proven
asset allocation strategies. Some of us might argue that funds with equity exposure
allow these investors a better chance at beating inflation. But have they really
considered the risks involved?

The trend of older or conservative investors moving their life savings into
balanced funds essentially means that they are convinced these funds can give them
regular dividends that can beat fixed deposits by a good margin over the medium to
long term. This might be true in the current scenario, but is this going to be the
reality five years from now as well? How well do these investors understand the
potential volatility and is it fair to subject them to the vagaries of the stock
market?

What is the balanced funds category all about? Can these funds provide a regular
stream of income to investors - not just retirees, but even others who need regular
payouts? My endeavour in this column is to take a quick look at the category, its
management, and its record of providing growth and stability, while keeping
volatility to the minimum when markets get into a jittery mood.

�Balanced funds� fall in the hybrid category and have more than 65 percent of the
corpus invested into equities, while the rest is allocated among fixed income
instruments. A trend that we are seeing now is that funds recently launched in this
category are not entirely investing 65 percent or 70 percent of the portfolio in
direct equities, but a small exposure is being used to find good opportunities in
the arbitrage space.

LIC Mutual Fund Balanced Fund is the oldest fund in the category launched in 1991,
followed by Canara Robeco Balance, UTI Children�s Career Balanced Plan and HDFC
Prudence Fund (erstwhile Zurich India Prudence Fund). As of April end this year,
there are 24 balanced funds in the industry with a total AUM of Rs 98,165 crore. It
is interesting to note here that ~ 55 percent of this AUM is concentrated in four
balanced funds: HDFC Prudence Fund, HDFC Balanced Fund, ICICI Prudential Balanced
Fund and SBI Magnum Balanced Fund. The top 10 balanced funds have 88 percent of the
surplus allocated among them. HDFC Prudence Fund is the largest fund in the
category having a corpus of Rs 22,057 crore which translates into 22 percent of the
market share as far as this category is concerned.

We normally recommend that our first time investors take an exposure into balanced
funds so that they can get a feel of the two asset classes (equity and debt)
without going through a roller coaster ride when the market decides to panic.
However, at this juncture, we should also evaluate to what degree balanced funds
really insulate investors from volatility. We have analysed the portfolios of all
24 balanced funds and have the following observations in this regard:

� Balanced funds have their equity allocation invested across the market
capitalization spectrum. This means that the funds in this category take an
exposure into the large/mid/small cap and even micro cap space. While the fund
mandate given in the Scheme Information Document (SID) allows them to take this
exposure, the mid to micro cap space is a fairly risky one, and it is important
that conservative investors are aware of and understand the resulting risks.

� Coming to the fixed income allocation, active management on the basis of the
interest rate outlook seems to be the norm for a few balanced funds. Taking a more
aggressive stance, a few funds also scout for opportunities in the credit space
(low rated papers, for example), exposing investors to both duration and credit
risk.

These two observations alone should help investors make a more informed decision
about whether funds in this category can give them the regular payouts they desire.
Fund houses can pay out regular dividends only out of the distributable surplus
available with them. Our markets have been partying since we got a reform-oriented
government at the centre. This has given opportunities to fund management teams to
create �alpha� (a return in excess of that indicated by the benchmark index) in
their portfolios by picking up gems in the mid/small/micro caps space. This in turn
has allowed them to garner good distributable surplus in their funds, and thus pay
out good dividends. To top it all, the duration calls in the fixed income space
have also been supporting the returns on these funds. A deeper study of the top 10
balanced funds in our model, however, reveals that these funds have missed out on
regular dividend payouts (even in the monthly option) during 2010-2015. Hence,
investors� dependence on balanced funds having the ability to pay out regular
dividends may prove to be unfounded if Dalal Street decides to change track and
move in a southward direction for some time.

Conclusion
For new and conservative investors, exposure to balanced funds should be guided by
a study of funds appropriate to their risk profile. A deeper study of the funds�
portfolios is warranted to make them aware of the potential risks and
vulnerabilities. For risk-averse investors, parking their hard-earned money into
funds whose surplus is allocated among the most volatile segment of the equity
market, while also taking risky bets in the debt instruments, is something that can
definitely be avoided. It would, in fact, be ideal if portfolios of balanced funds
are created in such a manner that they are suitable to meet risk averse investors�
needs.