Balanced funds vs Diversified equity funds

While I have always felt that this is really not even a debate, there are many readers who really think that it is possible to get better returns from a Balanced funds as compared to a diversified equity fund. Well, that will be a great thing if it were true. After all, the holy grail of all investors is to have a product which reduces risks and gives you similar or better returns than the riskier counterparts !!

Instead of getting into the past histories and data, let me try tackling this issue with a simple example. Assume the following scenario:-

  • You are investing in a balanced fund X and a pure equity fund Y simultaneously.
  • Fund house and manager are the same and you do it for a period of 10 years.
  • For Balanced fund 65 % is in equity, the rest is in debt.
  • As the FM is the same, the portfolio invested in is also the same. So if your investment is 10000 Rs a month, 6500 Rs will go to equity.
  • Let us assume a return of 12 % in equity and 9 % in debt over the 10 year period. These are logically conservative but will serve to illustrate the point.
  • Corpus reached for pure equity fund Y in 10 years will be 23.23 lacs.
  • Blended rate of return for fund X is 65 % of 12 % + 35 % of 9 % or 10.95 %.
  • Corpus reached for Balanced fund X in 10 years will be 21.83 lacs.

Note that I have assumed a high rate for debt and a relatively low rate for equity returns. If you increase this difference the performance gap will be more obvious. So, if this is the case why is it that some Balanced funds have better returns? The answers can be again arrived at if you think a little objectively:-

  1. The FM of a Balanced fund may take lower risks with the portfolio. This has more to do with the nature and mandate of these funds.
  2. The above will help in a market not doing well but equally it will under perform quite a bit in a bull market.
  3. In a bear market the riskier stocks can get battered quite badly. As such the recovery for these will also take much longer. Again the risk is on 100 % of the portfolio as opposed to the Balanced fund where the risk is on 65 % only.

However, this does not say anything favourable for the Balanced funds. You might as well invest whatever you want to in Debt instruments and the rest in Equity. That is a more logical way of doing it without getting into the hybrid instruments. You should only look at Balanced funds in the situations I have stated in the last post.

Imagine this too – with declining rates and improving equity markets it is quite possible to have equity returns at 15 % and debt returns at 8 %. In this scenario you will get a blended rate of 12.55 % which is about 2.5 % less than the pure equity fund rate.

Of course, at the end of the day it is your money and your plan.

Advertisements

5 thoughts on “Balanced funds vs Diversified equity funds

  1. Some things:

    1. You seem to have completely ignored rebalancing. This means that when stocks fall, money can be (and is usually) moved from the debt part to the equity part, and vice versa when stocks rise. This enhances the return. Thus, you blended return calculation is incorrect.

    2. Not everyone is after returns. Some want risk adjusted returns. In other words, if I can get inflation beating returns with lower volatility, why not go for it?

    3. The 10+ year returns of several balanced funds are much higher than that of many diversified equity funds.

    Like

    • Irrespective of rebalancing equity oriented funds need to keep 65℅ minimum in equity.
      What you choose is your prerogative, but we are really discussing principles here, not individual preferences for investment.
      Not true with the same portfolio. Comparison of Apples and oranges is really a futile exercise.

      Like

  2. Going forward expect lower returns due to inflation targeting 4 +/- 2%. So each basis point above 6% is real income. Plus GST introduction, so for the next five years we are in unknown territory. When the whole world is showing degrowth with dwindling exports, how can we alone be growing. Increasing Direct and indirect taxes would also restrict available surplus for your personal investment.

    Like

    • I had both of these though stopped them about a couple of years back. Prudence was an aggressive balanced fund and did rather well but the reality is the portfolios of that and Top 200 were very different.

      With the same portfolio a Balanced fund cannot beat a diversified equity fund, it is both a logical as well as mathematical impossibility 🙂

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s