Balanced Advantage Funds: Make A Right Choice

Unlike static allocation strategies, balanced advantage funds (BAFs), also known as dynamic asset allocation funds, actively rebalance portfolios to suit changing market conditions. If the equities are overvalued, the managers might reduce equity exposure and allocate more to bonds or alternative investments. Also, if certain assets appear undervalued, the managers might increase exposure to these assets expecting mean reversion. The article explain the financial benefits that can be derived from such funds 

The equity market has been on a rollercoaster ride over the past three months. Benchmark indices have tumbled nearly 10 per cent before clawing back to a 5 per cent loss. Most sectors have struggled, with IT and banking indices being the rare exceptions that managed to stay out of the red. This volatility can be attributed to several factors: lacklustre September quarter earnings from India Inc., sustained selling by foreign institutional investors (FIIs), the strengthening US dollar, and rising US benchmark bond yields. [EasyDNNnews:PaidContentStart]

As the equity markets grow increasingly volatile, there’s mounting pressure on the Reserve Bank of India (RBI) to reduce policy rates in view of the slowing economic growth. In such a scenario, debt investments with long duration become a more attractive option. However, tracking economic cycles and understanding their impact on equity and debt markets can be challenging for retail investors. This is where balanced advantage funds come into play. These funds are managed by experienced professionals who make investment decisions on your behalf, leveraging their expertise to navigate complex economic dynamics effectively 

How do Balanced Advantage Funds Work?
Unlike static allocation strategies, balanced advantage funds (BAFs), also known as dynamic asset allocation funds, actively rebalance portfolios to suit changing market conditions. If the equities are overvalued, the managers might reduce equity exposure and allocate more to bonds or alternative investments. Also, if certain assets appear undervalued, the managers might increase exposure to these assets expecting mean reversion. 

The pro-cyclical model, on the other hand, follows market trends, increasing equity exposure in rising markets and reducing it during downturns, relying on trend indicators like daily moving averages and trend strength indicators. In a volatile market like the present one, a static equity-heavy portfolio may suffer significant losses. In contrast, a BAF can reduce equity exposure, increasing allocations to bonds or cash to cushion the impact. 

Once the markets stabilise, the fund can pivot back to equities, ensuring it capitalises on the recovery. This adaptive approach was particularly effective during the corona virus-triggered pandemic market drawdown from January to March, 2020. While Nifty 50 plummeted by 46 per cent, the worstperforming dynamic asset allocation fund declined below 35 per cent, and the best-performing fund limited losses to just 13 per cent. By losing less during downturns, BAFs set the stage for better wealth creation over the long term. 

Losing less during market volatility becomes equally important for long-term wealth creation. During phases of market volatility or at points where valuations have run up, investors can increase exposure to balanced advantage funds. Tactical allocation calls under a dynamic asset allocation structure of hybrid mutual funds makes cash available from within the portfolio at the right time when not many investors on their own shell out cash towards correcting the asset classes. 

The recent market turbulence has highlighted the limitations of static portfolios. Large-Cap funds, in particular, have been hit hard as FIIs have pulled out of large-cap stocks. While most funds have posted negative returns over the past three months, BAFs have demonstrated resilience. Despite generating negative returns on an average, they have managed to cushion the downside more effectively than pure equity funds. 

Rise in AUM and Inflows
Balanced advantage funds are gaining popularity among investors, as evident from the rising asset under management (AUM) and consistent net inflows over the past year. The graph illustrating monthly net inflows and net AUM from November 2023 to October 2024 shows a steady upward trend in AUM. It increased from ₹222,082.85 crore in November 2023 to ₹283,952.73 crore by October 2024. This consistent growth highlights sustained investor interest and the robust performance of this fund category. 

Inflows fluctuated significantly, with notable peaks in August 2024 (₹3,215.06 crore) and October 2024 (₹2,456.18 crore), indicating heightened investor confidence during these volatile months. In August 2024, global equity markets, including India, faced a sharp decline due to Japan’s raising interest rates and weak macroeconomic data from the US. Despite this, BAFs saw substantial inflows, reflecting investor trust in their stability. 

On the other hand, June 2024 recorded one of the lowest net inflows (₹644.16 crore) due to market uncertainty following unexpected results in the general election. Investors recognised this as an opportunity to invest in direct equities or equitydedicated funds. Overall, the data underscores the resilience and growing popularity of BAFs, which continue to attract investments even amidst fluctuating market conditions. 

Selecting the Right BAF
Not all BAFs are the same, unlike other fund categories where most funds within a specific category invest in a similar universe of equities. In BAFs, the fund manager has the flexibility to allocate assets between equity and debt. Within these asset classes, they can further diversify into subcategories, such as large-cap, Mid-Cap or Small-Cap stocks in equities, and long-duration or short-duration bonds in debt. Each asset allocation strategy carries its own distinct risk-return profile. 

For instance, funds with a higher allocation to equities typically generate higher returns compared to those with lower equity exposure. Additionally, within equities, funds with a larger allocation to small-cap stocks may offer higher returns, albeit with greater volatility. Since risk and return go hand in hand, funds with significant equity exposure are generally more volatile. 

This concept can be illustrated by comparing two of the largest funds in the BAF category—HDFC Balanced Advantage Fund (HDFC BAF) and ICICI Prudential Balanced Advantage Fund (ICICI Prudential BAF). With AUM of ₹94,866 crore and ₹60,545 crore, respectively, these two funds account for over 40 per cent of the total category AUM as of October. Both funds adopt different investment strategies. Until 2020, HDFC BAF maintained over 90 per cent of its corpus in equities. 

After a change in the fund manager, its equity exposure reduced but still remains above 70 per cent, including equity derivatives. On the other hand, ICICI Prudential BAF has taken a more conservative approach, maintaining an average equity allocation of around 70 per cent, including derivatives, while its direct equity exposure typically stays below 50 per cent. The fund’s derivative exposure allows it to qualify for equity taxation. 

These differing portfolio management strategies result in distinct risk-return profiles. While HDFC BAF has historically delivered higher returns than ICICI Prudential BAF, it is also more volatile. Interestingly, the risk taken by HDFC BAF does not seem to be fully reflected in its returns. The Sharpe ratio, which measures risk-adjusted returns, is higher for ICICI Prudential BAF, indicating better performance relative to the risk involved. 

The accompanying table provides a detailed comparative analysis of both the funds, highlighting their unique investment approaches and performance metrics. 

Besides looking at the asset allocation of the funds explained above, investors should carefully assess a fund’s performance track record across different market cycles to understand its resilience and adaptability. The expertise and experience of the fund managers play a significant role in the fund’s success. An important aspect before selecting a balanced advantage fund is to look at the rebalancing strategy and exposure of the funds towards various categories of assets. 
 
Who Should Invest in Balanced Advantage Funds? 

Not every investment suits everyone, so if you are considering investing in BAFs, it’s essential to keep the following points in mind to make an informed decision: 
1. Capital Appreciation and Income Over Long Horizons: BAFs aim to strike a balance between growth and stability by investing in both equity and debt instruments. They seek long-term capital appreciation while generating income through dividends and interest. This balanced approach provides a smoother journey towards your financial goals, though the returns may not match those of pure equity funds.
2. Moderate Volatility: If you are looking for growth but prefer to avoid high volatility, BAFs can be a suitable option. These funds dynamically adjust their asset allocation between equity and debt based on market conditions or their predefined investment strategy. This flexibility helps reduce the impact of market fluctuations, offering a more stable investment experience compared to the pure equity funds. 
3. Moderately High-Risk Appetite: BAFs are ideal for investors with a moderate risk tolerance. The mix of equity and debt helps balance risk exposure. While the equity component provides growth potential, the debt portion adds stability. This makes BAFs a good fit for those comfortable with taking on moderate risk for potentially higher returns. 
4. Minimum Three-Year Investment Horizon: Given their dual asset approach and long-term focus, BAFs tend to perform better over extended periods. A minimum investment horizon of three years allows fund managers to navigate different market cycles and optimise returns, aligning with the fund’s strategy. 

In summary, BAFs are well-suited for conservative to moderate risk-taking investors. They offer a balanced approach to risk and returns, making them a prudent choice for achieving long-term financial goals while managing volatility effectively 
 

[EasyDNNnews:PaidContentEnd] [EasyDNNnews:UnPaidContentStart]

[EasyDNNnews:UnPaidContentEnd]