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Asset Allocation Fund vs. Balanced Fund

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Asset Allocation Fund vs. Balanced Fund

Mutual fund plans and schemes have mushroomed to such an extent that the average investor is confused about the class of fund in which he should invest his hard earned money. Equity funds, debt funds, balanced funds, asset allocation funds, money market funds, index funds, sector funds, et al – how does the investor choose?

Today, we shall have a look at the wisdom of investing in Balanced funds vis-s-vis Asset allocation funds.

Balanced Fund

A balanced fund is also known as a diversified fund. A balanced fund invests in a mix of equity and debt instruments.  65% to 75% of the portfolio is in equity and the residual amount in fixed income securities. The target investor is the one who is focused on fundamental safety of investment with reasonable income and moderate capital appreciation. A balanced fund does not significantly change its overall equity-debt composition though it may, of course, make changes in the equity/debt portfolio.

Asset Allocation Fund

The portfolio of an asset allocation fund moves seamlessly between equity and debt. In a dynamically managed fund, the equity or debt portfolio could (subject to mandate of the fund house) vary from anywhere between zero to 100%. The returns from such funds depend heavily on the investment knowledge and skill of the fund manager. There are also passive asset allocation funds in which the composition of debt and equity is determined by the fund house on the basis of an objective parameter such as the Price/Earnings Ratio (PE Ratio) or the yield gap (arrived at by the formula 10-years G-Sec yield/Nifty earnings yield). Such funds are rebalanced on a monthly basis.

Tax Implications

Before we enter the arena of comparison of balanced fund and asset allocation fund, let’s be clear about the tax implications of investing in these funds.

Balanced Fund : A balanced fund is treated on par with an equity fund. At least 65% of the portfolio of such funds is invested in equity and, therefore, the returns on an investment in such a fund is Tax Free after a holding period of more than 1 year.

Asset Allocation Fund : These funds are treated as debt funds. The return on investment held for less than 3 years is treated as short term capital gain and tax is payable at the income tax rate applicable to the investor. When the investment is held for more than 3 years, long term capital gains tax is applicable and the investor can also claim indexation benefit.

Purely, on this count the investment in a balanced fund is a clear winner. But, no decision should be made on the strength of a single parameter.

Let the Figures Speak

What we are going to do is select two funds – an Asset Allocation Fund and a Balanced Fund and study the results of a hypothetical investment in these funds through the SIP route. We will visit two scenarios based on historical evidence of performance.

Asset allocation fund vs Balanced Fund
RD vs Asset allocation fund vs Balanced Fund

First let us look at the parameters.

  • The total amount invested is Rs.5.00 lakh in 100 monthly instalments each of Rs.5,000/-;
  • The start date of the SIP has been taken as January 1, 2007 and the end date as April 1, 2015;
  • Had the monthly instalments of Rs.5,000/- been invested in a Recurring Deposit Account at 9% per annum, the pre-tax corpus would have been Rs.7,43,950/-
Valuation date Amount (Rs.) invested Asset Allocation Fund Balanced Fund
Market Value (Rs.) Return (%) Market Value (Rs.) Return (%)
April 1, 2015 5,00,000 8,95,414.18 13.84 9,41,012.12 14.79

The returns from both the funds are much better than the return from Recurring Deposit.  There is not much to choose between the Asset Allocation Fund and the Balanced Fund.

Asset allocation fund vs Balanced Fund
RD vs Asset allocation fund vs Balanced Fund
  • The total amount invested is Rs.12.00 lakh in 24 monthly instalments each of Rs.50,000/-;
  • The start date of the SIP has been taken as February 6, 2014 and the end date as January 6, 2016;
  • Had the monthly instalments of Rs.50,000/- been invested in a Recurring Deposit Account at 9% per annum, the pre-tax corpus would have been Rs.13,06,123/-
Valuation date Amount (Rs.) invested Asset Allocation Fund Balanced Fund
Market Value (Rs.) Return (%) Market Value (Rs.) Return (%)
January 31, 2016 12,00,000 12,46,452 3.77 13,13,113 9.10

The return from the Recurring Deposit is substantially better than that from the Asset Allocation Fund and only marginally inferior to that from the Balanced Fund.  The reason is attributable to the steady decline in the Sensex and the bond yields that drove the NAV of the funds down.

Mutual funds may not outperform conventional savings and investment instruments 100% of the time. We have just seen an example of a period during which the Recurring Deposit return was better than the Asset Allocation Fund return and almost equal to that from the balanced fund.  It is when the stock prices and NAV are down that it makes sense to continue with a SIP because your money purchases a larger number of units. When markets recover as they eventually do increases, your units will be worth much more.

And So The Story Ends

The narrow corridor for portfolio management in Balanced Funds leaves limited room for out-performing the market but reasonable returns can be expected unless the market is in the doldrums.

The greater flexibility afforded the Asset Allocation Funds demands considerable investment expertise from the fund manager and even then returns can be unpredictable  The conservative investor whose focus in on reasonable return and protection of the original investment would be better off with a Balanced Fund.

The Asset Allocation Fund investment is for investors with a higher risk appetite and the financial strength to wait for the good times. The investors in Asset Allocation Fund should also ensure that they have efficient tax planning in place.

This article is, obviously, not intended to be the last word on the subject and we welcome your opinion.

Notes

Case Study 1 features the Kotak Asset Allocator Fund as the Asset Allocation Fund and the ICICI Prudential Balanced Advantage Fund as the Balanced Fund.

Case Study 2 features the DSP BlackRock Dynamic Asset Allocation Fund as the Asset Allocation fund and DSP BlackRock Balanced Fund as the Balanced Fund

The choice of funds was made at random.

(This article provides general advice and recommendations and does not constitute personal advice. While the calculations are accurate for the period to which they refer, the opinions and examples in this article are for informational and educational purposes only. I have never invested in any of the funds named in this article. The statements in this article should not be construed as advice to invest in the funds named. Mutual fund investments are subject to market risks. Investors are advised to perform personal due diligence before investment. Readers are responsible for the decisions they take.) 

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Randolph Rowe is a professional banker and former General Manager of Small Industries Development Bank of India (SIDBI). He brings with him the wealth of 34 years of all-round experience in the banking sector - comprising 12 years with IDBI and 22 years with SIDBI - which he combines with his flair for writing.

1 COMMENT

  1. This is one of the best tutorials, well defined and explained with graphs and case studies. I don’t think an allocation vs. balanced fund can be explains more clearly and neatly. This can’t be explained in simpler way. Well done author. I am so glad that I got a chance to read this one.

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