DIY Index Balanced Fund

What are Balanced Funds?

A balanced fund is a mutual fund that contains a stock component, a bond component and sometimes a money market component in a single portfolio according to Investopedia. Generally, these funds stick to a relatively fixed mix of stocks and bonds. Their holdings are balanced between equity and debt with their objective between growth and income. Hence, their name “balanced.” These are ideal for first equity investors, as well those looking to meet their long term goals like retirement, child’s education etc., but also those who do not want to expose themselves entirely to equity risk.

Let us look at an interesting example of how Balanced Funds have created wealth historically. This is only an example and not a recommendation.

Balanced Funds – The HDFC Prudence Way

A study by HDFC Mutual Fund in 2014 showed that Rs. 10,000 invested in the HDFC Prudence Fund in 1994 (now renamed HDFC Balanced Fund) had grown to Rs. 4,50,000 by 2014. From 1994-2014, the world saw many “once in a lifetime” crises and events. Pokhran nuclear tests, SARS outbreak in 2003, Dotcom Bust, 2008 Global financial crisis, UPA era scams, to name a few. However, those who remained steadfast or perhaps had forgotten about their investment prospered in the long run.

Source: www.hdfcfund.com

However, the remarkable fact in that study was was that only ~2,500 investors were able to achieve or harvest these returns. This suggests an enormous amount of “behavior gap” by investors even if by chance or design, they had invested in the correct fund. The table below will give you an idea of how short holding periods are even for mutual fund investors. Only 3% of investors remained invested after 10 years.

Source: www.hdfcfund.com

In the next section let us look at how to think about building and managing your own “balanced fund” but with Index Funds.

The Balanced 60/40 Portfolio

Let us look at the performance of 60/40 stock/bond portfolio which comprises NIFTY Index Fund and a liquid fund. 

The table above shows returns from Nifty Buy and Hold from 1990 to 2020 (July). The second column looks at a 60/40 lump-sum portfolio that starts at the same time. This portfolio is not rebalanced. Since this is a lumpsum portfolio investment with static weights at the beginning, as equity compounds, the weight of the equity portion grows to almost 85% over the investment period and the portfolio starts mimicking an equity B&H portfolio.

The returns of the 60/40 portfolio are slightly lower than the B&H portfolio. It, however, cuts down the risk measured in terms of standard deviation by almost 25%. And the drawdown also reduces considerably. Rebalancing is a contentious issue and we will look at that next week.

Now let us look at 3-year rolling return and standard deviation so that we can take care of the starting point bias, which the above analysis may be subject to. The graph below shows the returns dispersion between Nifty B&H, and an Index 60/40 portfolio. The point that stands out is that in the last ten years, the spread between the returns has narrowed.

So have the standard deviation spreads between B&H and 60/40 portfolio narrowed. But the positioning doesn’t deviate as much as returns deviate. The 60/40 portfolio has consistently lower volatility than Nifty B&H.

You get more return per unit of risk in a 60/40 portfolio is TLDR version if you haven’t read the whole article and just glanced at the tables and graphs.

Next week we add re-balancing to the mix and see what impact that has on returns and on risk.

(Updated excerpt from an article written by Anish Teli which appeared on IndexHeads –  https://indexheads.substack.com/p/a-balanced-life-with-index-portfolio )