Opt for balanced advantage fund if you are worried about equity valuations

Make sure fund does not take too much mid- and small-cap exposure, or has poor quality debt papers

Topics  fund | Amfi | Investors

Balanced Advantage Funds (BAF), also known as Dynamic Asset Allocation (DAA) Funds, are once again in the limelight. Inflows into these schemes have averaged Rs 11,007.9 crore per month between August and October, according to data from the Association of Mutual Funds in India (Amfi). Fund houses are selling these schemes as a solution to investors who want equity exposure but are worried about steep equity market valuations.

Balanced Advantage Funds (BAF), also known as Dynamic Asset Allocation (DAA) Funds, are once again in the limelight. Inflows into these schemes have averaged Rs 11,007.9 crore per month between August and October, according to data from the Association of Mutual Funds in India (Amfi). Fund houses are selling these schemes as a solution to investors who want equity exposure but are worried about steep equity market valuations.

How do they work?

BAFs invest in a mix of equity and debt. Allocation to these sub-asset classes is decided by a model based on valuation, momentum, macro-economic variables, or a mix of these parameters. These funds usually allocate more to stocks when they are attractively valued, and vice versa. The idea is to make money by participating in the upside of equities while curtailing the downside by taking shelter in debt when equities become overvalued.

Get downside protection

BAFs’ ability to offer downside protection compared to diversified-equity schemes appeals to investors with moderate risk-taking ability. “Markets are at high valuations. After making big returns from equities, people are keen to diversify and ensure that their future journey is less bumpy. That’s why they are entering a product that can give them better returns than fixed income while reducing the risk of steep drawdowns,” says Ashutosh Bhargava, fund manager and head, equity research, Nippon India Mutual Fund.

These schemes can help investors tide over volatile times. “Many investors expect volatility in the market due to the emergence of the new Covid-19 variant. BAF models are ideally suited for volatile periods,” says Amol Joshi, founder, PlanRupee Investment Services.

Tax efficient

The portfolios of these schemes are constructed in such a manner that exposure to equity and equity-related instruments is always above 65 per cent. Hence, the capital gains from these schemes get the tax treatment of equities.  

Another tax-related advantage of these schemes arises during rebalancing. When investors rebalance by selling the units of equity funds to buy debt funds, or vice versa, they have to pay tax on their capital gains. No such liability arises when a hybrid mutual fund rebalances its portfolio.

Underperform in bull markets

Investors entering BAFs must be prepared for the fact that they will underperform in a bull market. “BAFs tend to underperform diversified equity funds when the markets see a one-way upward movement,” says Joshi.

These funds are not entirely volatility-proof. “Since they have equities in their portfolios, they will have some degree of volatility, though it will be lower than in pure equity funds,” says Joshi.

Study the portfolio

The equity allocation of BAFs ranged from 29.4 per cent to 66.8 per cent at the end of October. “Fund such as BAFs work on a pre-defined asset allocation model and it’s important to understand that,” says Deepak Jain, head-sales, Edelweiss Asset Management.

Some funds maintain a high allocation to equities irrespective of market valuations. They will be more volatile than BAFs should be and can be avoided. Some follow a pro-cyclical strategy while others are countercyclical. While both will provide downside protection, investors should select an approach they are comfortable with.   

Be wary of funds that have taken high exposure to mid- and small-cap stocks in the past during market rallies on the equity side. And check for poor-quality papers on the debt side.   

Should you invest?

These funds can be a good starting point for investors who have a five-year horizon and lack access to good advice. “BAFs are well suited for new investors who have not seen an entire market cycle. They are also suited for conservative investors who cannot risk money at their stage of life to the possibility of a big drawdown. Even mature investors can hold them, though their allocation should be lower than that of a new or conservative investor,” says Bhargava. Evolved investors, or those who have an advisor, can opt for separate equity and debt funds, which allow investors greater control over the portfolio mix.


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