Balanced funds do not under-perform such a strategy now. Moreover, such an approach increases transaction costs. In fact, after netting out such costs under a simple strategy of investors making their own allocation between debt and equity instruments, they may observe that the returns are inferior to that generated by `balanced' funds. The buy-and-hold approach is also a roller-coaster ride with a big risk component.

Earlier, small savings promised yields of 8-9 per cent. The debt portion of balanced funds promised a yield of less than 6 per cent. Investors had to opt for the riskier choice of investing a major proportion in small savings and the rest in equity funds.

The debt portion of balanced funds has, however, turned competitive now. The after-tax return of small savings is now down to about 7.5 per cent, which the debt portion of balanced funds can either match or lag by a small margin. If balanced funds actively manage the debt portion, the returns may be higher than those from small savings.

Why balanced funds?

The fundamental philosophy emphasised in investment literature supports the case for balanced funds. This is that a mix of equity and debt will outperform an investment strategy focusing exclusively on one. Balanced funds try to do just this. They mix equity and debt in a stated proportion and maintain it fairly consistently.

It works too. In the past four years, the average balanced fund delivered returns that are 30 per cent better than that of the Nifty Index while being 33 per cent less volatile than the same index; that is, they deliver higher returns at lower risk.

Balanced funds also fare well in comparison to equity funds. Their returns and volatility work out to about two-thirds that of equity funds. That is a commendable achievement.

Considering the opportunity costs saved by balanced funds, their suitability to the average investor does increase even more. In the absence of balanced funds, investors will have to sell and buy equity funds at appropriate intervals. This is necessary to keep the proportion invested in equity carefully monitored. Such buying and selling will attract taxes. Investors will also need to incur other costs, such as security transaction tax, entry loads and exit loads. These costs and taxes will reduce returns. Balanced funds do not suffer from such disadvantages.

The numbers

In the past four years, balanced funds generated average monthly returns of 1.86 per cent.

An alternative portfolio that is 60 per cent invested in equity funds and 40 per cent in debt funds — let's call it the hybrid fund — generated average monthly returns of 1.91 per cent.

Nifty's average monthly returns were about 1.43 per cent

Top equity funds generated average returns of 2.73 per cent.

Movements in Nifty or equity funds explained 85 per cent of the returns generated by balanced funds.

Statistically, balanced fund managers also seem to be adding value because of their strategies.

Clearly, their performance is better than that of Nifty. Adjusted for volatility the performance is also better than that of equity funds. It would, however, be more appropriate to the compare with the hybrid funds. Here, too, the balanced funds come out well. Their monthly returns are not substantially lower than that of hybrid funds.

The volatility in the monthly returns is also not substantially higher than that of the hybrid fund. In this backdrop, if you consider the costs related to an alternative involving hybrid funds, the balanced funds come out looking good.

There are some glitches though. On an average, balanced funds out-performed the hybrid alternative in just 23 of the past 48 months. This shows that investors need to be careful in their choice of balanced funds.

The out-performers

Over the years, one balanced fund has really performed impressively: HDFC Prudence. It is still a strong candidate for a first-time investor in mutual funds.

Another fund with a long credible record is Templeton Pension Plan. Unlike other balanced funds, Templeton Pension invests 40 per cent in equities and 60 per cent in debt. Even adjusting for the lower amount invested in equities, the performance is impressive. The disadvantage is that this is a long-term plan suitable for retirement. So, there is a penalty for withdrawal before the age of 57. On the other hand, it bestows handsome tax benefits, which would enhance the returns.

Fortunately for investors, a number of other balanced funds have also put up reasonably good shows over the past four years. These include Franklin India Balanced Fund, Kotak Balanced and Tata Balanced. These funds have out-performed the Hybrid Index in more than 24 of the past 48 months.

In terms of average returns, PruICICI Balanced and UTI Balanced have not fared as well as their peers. There is, however, an interesting facet to their performance. They have delivered positive returns in more number of months than their peers. Among all these funds, Franklin India Balanced has been the most impressive. It is less volatile than its peers and has delivered better returns.

Alliance '95, DSP-ML Balanced Fund, Escorts Balanced, FT India Balanced Fund and SBI Magnum Balanced have delivered attractive average returns. These are, however, riskier and more volatile alternatives. Investors looking for aggressive fund management may consider these funds. Escorts Balanced Fund, in particular, has notched up returns that are commensurate with the higher risk.

In contrast, funds such as GIC Balanced and JM Balanced have also emerged as less risky alternatives. The glitch about all these funds is their inconsistency. The number of months in which these funds have delivered attractive returns is lower than some of their peers. Over longer periods, this inconsistency may be smoothened out.

It would, however, be better if investors stick to HDFC Prudence, Templeton India Pension Plan and Franklin India Balanced for now. A plan to systematically invest funds across many months is advisable. The intention should be to pull out funds many years from now when the equity market is again at its peak.

The probability of such a long-term strategy paying off handsomely and delivering attractive annual returns of 10-15 per cent per annum is high.

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