Balanced Funds. Mix of stability and performance. Mutual Funds. Robust long term performance track record

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1 Mutual Funds Mix of stability and performance funds are hybrid funds that invest in a mix of equity and debt instruments. Most balanced funds predominantly maintain 65-70% exposure to equities while the rest is maintained in fixed income instruments. funds are less volatile than pure equity funds due to the cushion of debt proportion in the fund. Hence, these funds do well when the stock markets are going through a difficult phase. They are better equipped to withstand shocks in falling markets. However, when stock markets are rising, they may not do as well as funds with 100% equity component but perform better than debt funds. Capital gains tax on balanced funds is similar to equity funds viz. exempt after one year and 15% if sold before one year, plus applicable surcharge if any. Debt portfolio mainly comprises government securities or good credit quality corporate bonds. Therefore, credit risk is very low in the debt portfolio. After a sharp rally in equity markets, the funds can be a preferred investment avenue as the debt proportion serves to protect on intermediate relief rallies on the downturn while providing minimum 65% participation on further upsides. Robust long term performance track record Funds funds invest 65% of the portfolio in equities and the rest in debt instruments funds have displayed a consistency in performance. The category has on an average delivered 17% return over the past year. The annualised CAGR returns over the past three year, five years and 10 year time periods have been 11.4%, 15.7% and 10.6%, respectively. Across all these time frames, the category average performance has beaten the Crisil Fund Index and the benchmark Nifty 50 Index by wide margins. Category performance is strong on a calendar year basis as well. Exhibit 1: Annualised performance (as on August 31, 2017) Crisil FundsCategory Nifty 50 Fund Index 1 Year Years Years Years Source: ACEMF, ICICIdirect.com Research Exhibit 2: Calendar year performance Year FundsCategory Nifty 50 Crisil Fund Index (13.9) (24.7) (14.4) (4.1) YTD Research Analyst Sachin Jain sachin.ja@icicisecurities.com Source: ACEMF, ICICIdirect.com Research; YTD returns till August 31 Jaimin Desai jaimin.desai@icicisecurites.com

2 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Jul-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Net Inflow ( Cr ) Crore Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 ( crore) (%) Strong performance and increased inclination towards equity market by traditional investors fuel strong inflows The balanced funds category continued to receive significant flows, with the average monthly inflow (net) for 12 months to June 2017 amounting to ~ 5076 crore. Total 48% YoY growth in number of retail folios and 181% YoY growth in number of HNI folios (both as of June 2017) indicate the massive appeal of this category in the non-institutional space. Continued robust performance by the category, as a whole and increased retail investor participation in equity markets in recent years benefited flows into balanced funds. Exhibit 3: Funds AUM as percentage of industry AUM doubles over last 14 months Fund AUM (LHS) % of Industry AUM (RHS) Source: AMFI, ICICIdirect.com Research The AUM of balanced funds has witnessed a stellar increase during this period, more than doubling to crore in July 2017 from crore in the year ago period Exhibit 4: Robust flows over the past year Exhibit 5:.. lead to 143% rise in AUM Source: AMFI, ICICIdirect.com Research Source: AMFI, ICICIdirect.com Research Over the last two or three years, the balanced space has emerged as one of the fastest growing equity categories and offers an ideal gateway for first time retail equity investors. In FY17, balanced funds AUM growth outpaced all other categories bar non-gold ETFs Page 2

3 Fund structure, stock selection combine to lend consistency Historically, balanced funds have provided effective diversification in a portfolio. By combining two asset classes that have a low correlation, balanced funds serve to mitigate risk to some extent. Maintaining equity allocation at 65-75% limits exposure to sustained bull or bear phases in the equity market. Managers have the option to tailor asset allocation by increasing or decreasing the debt portion of the portfolio depending upon the outlook on equity. Exhibit 6: Downside protection a salient feature Year Crisil Fund Index Nifty 50 FundsCategory Capture Ratio (%) (34.3) (51.7) (37.6) (14.4) (24.7) (13.9) (4.1) 3.2 (0.79) YTD Source: ACEMF, ICICIdirect.com Research; 2017 YTD returns till August 31 Exhibit 7: Performance in various market phases (CAGR returns) Crisil Nifty 50 FundsCategory Phase Description Fund Index Capture Ratio (%) Apr 03-Jan 08 Strong bull Jan 08-Mar 09 Strong bear (35.8) (53.2) (44.4) 0.83 Mar 09-Nov 10 Strong bull Nov 10-Dec 11 Bear (15.0) (25.4) (18.4) 0.73 Dec 11-Aug 13 Flattish Aug 13-Feb 15 Strong bull Feb 15-Feb 16 Bear (12.1) (21.1) (12.5) 0.59 Feb 16-Mar 17 Bull Source: ACEMF, ICICIdirect.com Research The capture ratio shown here represents the extent of participation or return delivered by balanced funds (as a category average) for every 1% return given by Nifty 50. As the tables show, the capture ratio has increased in recent periods. Performance of balanced funds during bull runs when contrasted with bear phases showcases the value of balanced funds in portfolio management. Historically balanced funds have managed to curtail losses during equity market downturns. This is obvious to an extent as a lower proportion of the portfolio being invested in equities ensures that balanced fund performance does not suffer as much as pure equity funds. Similarly during phases of strong equity performance, balanced funds are unable to participate entirely in the rally as presence of debt in the portfolio caps the extent to which equity performance is captured. The clear advantage of balanced funds in terms of downside protection is evident. Hence on a risk-adjusted basis balanced funds have a stabilising effect on the portfolio. An interesting trend can be seen recently and during periods of flattish or sideways equity markets. Over the years balanced funds have steadily improved performances across cycles. The capture ratio vis-à-vis Nifty 50 has gone up during positive runs i.e. greater participation in up moves while reducing during negative runs i.e. lesser participation in down moves. A possible explanatory factor for this trend is superior stock selection on the part of fund managements. By dynamically latching onto possible performers early while identifying and avoiding possible laggards, balanced funds have navigated recent years smartly.

4 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-17 Aug-12 Aug-13 Aug-14 Aug-15 Aug-17 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Feb-17 Aug-17 Exhibit 8: Structural design caps participation during strong up or down moves Despite ensuring low volatility, balanced funds performance has improved significantly in the last few years due to active stock selection and the same has ensured higher participation in rising market (20.0) (40.0) (60.0) Presence of debt limits exposure to runaway bull or bear phases Crisil Fund Nifty 50 Data: 1 year rolling returns. Source: ACEMF, ICICIdirect.com Research. Exhibit 9: Healthy participation during sideways or mild market phases Since most of the balanced funds maintain equity allocation in a narrow range, it automatically ensured regular rebalancing of the portfolio. Fund manager book profit when equity market goes up and increase allocation to equities when market goes down to maintain equitydebt allocation. This lend balanced funds the advantage in a volatile market and helps it to outperform (15.0) Stock selection provides participation during flattish phases (30.0) Crisil Fund Nifty 50 Data: 1 year rolling returns. Source: ACEMF, ICICIdirect.com Research Exhibit 10: Downside cushioned when equity markets struggle Downside protection in a falling equity market is the key USP of balanced funds (20.0) (40.0) (60.0) Crisil Fund Nifty 50 Data: 1 year rolling returns. Source: ACEMF, ICICIdirect.com Research Page 4

5 Taxation benefit Capital gains in equity schemes are tax free after a year of holding. funds, by virtue of being invested in not less than 65% equities at all times, also qualify for equity taxation. funds are taxed as equity funds and therefore are tax efficient as compared to other hybrid or debt funds Debt funds qualify for long term taxation after three years of holding. Long term capital gains in debt funds are taxed at 20% (post indexation) while short-term gains are taxed at the investor s marginal tax rate. On the other hand, short-term gains in equity funds are taxed at 15%. Dividend income tax treatment is also far more favourable for equity fund investors (tax free irrespective of period of holding) whereas dividend from debt funds is charged to dividend distribution tax (DDT). As a result, balanced funds enjoy a significant tax advantage. The debt portion of the portfolio also qualifies for equity taxation in terms of both rate of tax and period of holding. In respect of taxation, an investor would thus be much better off investing in a balanced fund instead of maintaining separate equity and debt portfolios in a 65:35 ratio. Suitability The structure and utility of balanced funds could benefit investors in a variety of ways. funds are ideally suited for conservative equity investors. First time or new equity investors can use balanced funds as a gateway to equity mutual funds. By shielding such investors from wild swings of the equity markets balanced funds could help build up appetite for equity investing, till the time the investor becomes more seasoned. Additionally, investors who have a fair risk appetite but are unable to define an exact asset allocation can let balanced funds address the decision. Investors who are over-invested in fixed income products can allocate some part of their portfolio to balanced funds in order to get some equity exposure while not straying entirely from the comfort of debt. Recommended Funds Birla Sunlife 95 Fund DSPBR Fund HDFC Fund ICICI Prudential Fund L&T India Prudence Fund Page 5

6 Pankaj Pandey Head Research ICICIdirect.com Research Desk, ICICI Securities Limited, 1 st Floor, Akruti Trade Centre, Road No. 7, MIDC, Andheri (East) Mumbai research@icicidirect.com Disclaimer ANALYST CERTIFICATION We Sachin Jain, CA and Jaimin Desai, CA Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or Funds. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: ICICI Securities Limited (ICICI Securities) AMFI Regn. No.: ARN Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai , India. 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