Investors in equity markets are, perhaps, experiencing some unnerving moments. If the Sensex rises steeply one day, a global event or bad news the next day sends it scurrying down. These swings have become common due to factors such as slowing earnings and worries on growth not picking up.

investors can counter this volatility by adding balanced funds to their portfolios. One key advantage these funds have is that they offer different asset classes, equity and debt within a single investment structure.

In other words, they offer the dynamism of equities and the relative stability of debt.

Cushion against falls Investors might lose patience with the stock market if their portfolios turn loss-making. But with the equity market expected to do well in the long run, investors cannot ignore equity in their investment portfolios.

India’s structural growth story is conducive to equities delivering good returns in the next three to five years. Along with such good opportunities, however, comes volatility — and one way to counter this volatility is through balanced funds.

Such funds reduce risk due to the diversification into debt and have the essence of growth because of equities.

Assume you have invested entirely in equity, which is now down 10 per cent. The value of your portfolio would be reduced by that percentage. However, if you add 50 per cent of debt assets to your equally-balanced portfolio, even if equity drops 10 per cent and debt holds steady, the value of your portfolio will fall less as compared to equity markets. The debt portion in a balanced fund provides the necessary cushion to your overall portfolio. Balanced funds rebalance the debt-equity exposure depending on the shifts in stock market valuations and expectations of interest rates in case of debt investments.

These funds are able to shift the portfolio towards the more favourable asset class depending on the situation. Such funds use valuation yardstick such as price-to-book value and compare it with the mean in order to arrive at the asset allocation break-up. For investors, such funds offer an asset allocation tool without having to compute the asset allocation and then invest in multiple securities based on the allocation arrived at. Besides, balanced funds also offer tax efficiency. As most balanced funds have 65 per cent exposure to equity, they are taxed like equity funds. Therefore, if the holding period is greater than a year, the applicable long-term capital-gains tax would be nil.

If the holding period is less, the gains are subject to short-term capital gains. In the dividend option, dividends paid and received are tax-free (attracting no dividend distribution tax) irrespective of holding period.

(The author is MD and CEO, ICICI Prudential AMC)

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