How To allocate Investment Portfolio Via The Mutual Fund Route

Allocation in your portfolio is better done by you in consultation with your financial advisor, as you are in control of your investments. That apart, if you want to do the allocation of your portfolio through the mutual fund (MF) route, even for a part of your portfolio, there are certain products that can do the job. We discuss here the products available and the features.

The advantages of doing it through the MF route are:

Tax efficiency: Mutual funds per se are non-taxable entities. If you do the shuffling yourself, you have to pay capital gains tax on your gains;

Discipline: There is regular monitoring of the portfolio by the fund manager. If you are doing it yourself, you may be busy with other things and the discipline may be lacking;

Re-balancing: Portfolio rebalancing in MFs will happen at regular intervals, as per defined norms.

Products available

Vanilla Balanced Funds: Now known as Aggressive Hybrid Funds as per Sebi’s fund classification rules, these funds will have 65% or more of the fund in equity and the balance in debt. This product is easy to understand. The advantage is, the equity allocation in the range of 65% to 80% is done as per the view of the fund manager, on the valuation of the equity market. These funds are taxed as equity; for a holding period of more than one year, long term capital gains tax is 10% plus surcharge and cess.

Asset Allocation Funds: These are fund of funds, i.e., a fund that invests in units of other funds. The other funds are equity and debt; the allocation to the underlying funds in the allocator fund is usually decided by an in-house model of economic and valuation parameters. When equity valuations look stretched as per the valuation model, allocation to equity is on the lower side and when equity valuations look cheap, allocation to debt is lower. Taxation nature of these funds is debt since a fund of funds is taxable as debt. There is no compulsion to maintain 65% (or any minimum deployment) in equity.

Balanced Advantage Funds: There are equity funds by definition, with more than 65% deployed in equity, balance in debt. However, the fund manager goes short to an extent of the equity exposure, so that the net equity exposure, i.e., long equity position net of the short equity position, is lower to that extent. Normally, the net equity exposure in BAF funds ranges from 30% to 80%. The net allocation to equity is decided by the fund manager on a reading of the valuation and prospects of the equity market. Taxation nature is equity, as it is counted on the long position.

Which one to chose?

The parameters for comparison between the products are:

Allocation range: In balanced funds (Aggressive Hybrid Funds), the minimum allocation to equity is 65% to maintain the equity taxation nature. In BAF funds, net allocation to equity may be significantly lower than 65%, say 30%, because the taxation nature of the fund is counted on the long exposure. Same is the case for asset allocation funds; since taxation is that of debt by definition there is no compulsion to maintain a minimum equity exposure.

Performance: Balanced funds are more aggressive, as the equity allocation is higher. BAF and asset allocator funds are more defensive, as allocation to equity, which is relatively more volatile, is lower. Ultimately which fund will give higher return is anybody’s call; it is a matter of the fund manager’s calls on allocation playing out.

Horizon: Ideally, horizon should be long. In case it is not so long, in fund of funds, you require a horizon of three years for tax efficiency. In balanced funds and BAF funds, horizon has to be one year for long-term capital gains taxation.

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