Tuesday, March 24, 2015

How did I select the Balanced Fund

First thing first: 

What is balanced fund: In general, when we say balanced fund, it means a fund which comprises of equity and debt in its portfolio. The percentages of equity and debt vary from AMC to AMC and from FM to FM. Example: A fund from AMC X may choose to be called as Balanced Aggressive and hence must have more allocation to equity. Similarly, a fund from AMC Y may choose to be called as Balanced Moderate may have 50-50 equity to debt allocation or more allocation to debt holdings.

Now the next question:

What is the need of balanced fund: For ULIP, we say that insurance and investment must be separate and hence you must avoid ULIP. Then why one must invest in Balanced fund which is a mixture of equity and debt fund? Why not have 2 separate funds for equity and debt? Personally, I avoid having 2 different funds to achieve what 1 Balanced fund can achieve. Agreed? Why complicate and keep track of 2 different funds rather than just select 1 and track it yearly or twice a year. The other reason is rebalancing. Suppose, you are investing in 2 different set of funds (1 is equity and other is debt fund). Now, the market seems to be a bull market. Hence, you will have to take the pain of limiting the inflow into equity fund and increasing the inflow into debt fund (to limit the volatility). Balanced fund is suppose to do this automatically i.e. the Fund Manager will do all this depending upon his conviction on the market. So now, you just have to select the right balanced fund for you. Note: this rebalancing stuff has to be done only if the goal is 7-8 years away. If your goal is 10-15 years away, you are very well off on a pure equity fund. The longer duration gives us the flexibility to rebalance the portfolio from equity to debt in the boom cycle. However, short term goal need not give the flexibility to a common man like us who are not very informed about the market and its macro/micro factors. Hence, I would rather invest in a Balanced fund for goal which is 7-8 years away. (Note 2: Pattu has mathematically shown that in 8-10 years, all the debt, liquid and balanced fund gives similar returns. Liquid fund achieves that with lesser volatility. Choice is yours. Remember: “Personal finance is personal”). Let us see this with an example: say the goal is 15 years away. Boom happens in 3rd and 9th year. When we are in the 9th year, we must redeem from the equity and put that in debt fund (however, when the quantum of amount in fund is very large as compared to the goal amount, you are not really needed to do this rebalancing. Just withdraw the amount needed during the goal year and keep the rest in as it is to grow). Now, choosing the same fund for goal which is 7-8 years away is difficult. We will not redeem in 3rd year as the goal is far away. Unfortunately, the next boom does not come in the goal period. Hence, the solution here is to have the Balanced fund for mid-term goals. The fund mandate does the re-balancing for us.

How I started my search: The base is always Pattu’s “How to select equity MF”.

Navigated to Valueresearchonline -> Funds -> Balanced -> Equity. Then click on the Returns tab. Sort the returns in the descending manner.

What we get is the big list of funds available for selection. Our objective is to select just 1. Difficult. So we have to look at multiple factors to narrow our list to just 1 fund.

Check if the fund belonging to the AMC whose fund is already in your portfolio or you planning to buy any fund from that AMC. Example: If I have funds from Franklin, HDFC and ICICI then I may want to narrow down on the funds which belong to these AMCs. In this way, we can narrow down to 3-5 funds.

If the above point is not applicable to you, just pick any 3-5 funds from the list which have given decent returns (> 10%) over 10 years (I know goal is 7-8 years away. However, 10 years selection is to check the consistency of a fund over longer period of time).

Once you have shortlisted 3-4 funds, open all the funds in different tabs of the same browser. Let us say we zeroed on Tata Balanced, HDFC Balanced and Franklin India Balanced.

Compare all the funds on below parameters:
Expense ratio
10 year return
Sortino ratio (the more the better.)
Standard deviation

Now just check which parameter is most important to you.

Example: alpha of Tata is more than HDFC. However, HDFC compensates that in expense ratio. Again, sortino is higher for Tata. Finally, it is just trade-off between these parameters. One of the fund would be good in some parameter while bad in other. So it is just which is important to you.

Personally, as Ashal says, instead of asking others about their opinion on best policy, check what suits you. I am planning to go with HDFC balanced fund due to its low expense ratio, decent sortino ratio, decent alpha and due to the fact that I already have HDFC in my portfolio. Add to this the fact that HDFC balanced has better Ulcer ratio than HDFC prudence (i.e. this fund would be less volatile). The courtesy for this Ulcer ratio goes to Pattu.

Readers, do let me know if I have missed any parameter for selection of balanced fund.