The Hindu Business Line : Balanced funds may lock into higher equity pie

Come June, balanced funds may have to alter their structure to step up their equity exposures and maintain it at 65 per cent, if they are to avail themselves of the tax benefits extended to equity oriented funds.

The recent Budget proposes to tweak the official definition of "equity oriented funds" to include only those funds which have 65 per cent or more of their investments in stocks.

Currently, all funds that have a 50 per cent equity exposure are "equity oriented funds". These enjoy exemption from dividend distribution tax and lower rates of tax on short-term capital gains.

Balanced funds currently allocate between 60-65 per cent of their assets to stocks. But they have considerable leeway in their objectives to swing between a 40 per cent and a 60 per cent equity exposure. Now, fund houses may have to tweak this structure to "fix" the equity exposure at 65 per cent, if they want their balanced funds to enjoy tax benefits.

"The tax benefits are substantial. We will be changing the structure of the scheme and increasing the equity exposure, but after we take a formal decision," said Mr N. Sethuram, Chief Investment Officer of SBI Mutual Fund. SBI's Magnum Balanced Fund had a 65 per cent exposure to equities by end-January.

Mr Sethuram also feels that the changes will blur the boundary between pure equity funds and balanced funds. "Equity funds can hold up to 30 per cent of their portfolio in cash; balanced funds will now have to hold 65 per cent in stocks. There is not much of a difference between the two," he pointed out.

Franklin Templeton, which manages Franklin Templeton India Balanced Fund and FT Dynamic P/E ratio Fund, said it is discussing the proposals with tax consultants before finalising a decision. But the fund already has an equity allocation of 65 per cent on FT India Balanced Fund. "Our exposure to equity has been on the higher side, on account of our conviction about the long-term potential of equities. Having said that, these proposals may impact the asset allocation of balanced funds that wish to offer tax-free dividends to investors," said Mr Sukumar Rajah, CIO of the fund house.

With the stocks markets on a dream run, most fund houses have tended to take a bullish view of equities. While most balanced funds had 60-65 per cent in stocks, HDFC Prudence was the only outlier with a 59 per cent equity allocation by end-January. A higher equity allocation may become a permanent feature if fund houses decide to take advantage of the new proposals.

But as one fund manager pointed out, "You can have a lower allocation to equities over a month or two, because the 65 per cent limit is reckoned on the average of monthly balances through the year." Funds also have a comfortable three-month window until June 1, to make these changes. That is when these proposals, if passed into law, will take effect.