Balanced Advantage Funds have the potential to earn superior risk-adjusted returns for the investor and offer a smoother investment journey.
Balanced Advantage Funds (BAF), also known as dynamic asset allocation funds, which hold a total asset under management (AUM) of Rs 200,129.84 crore (as of May 31, 2023), have experienced consistent outflows from October to May for an aggregate amount of Rs 3,893.7 crore.
However, for many types of investors, this could be a suitable category with the potential to offer a smooth investment experience.
One reason for the outflows from this category was misplaced investor expectations.
"Occasionally, the returns from this category mirror that of equity funds, leading many investors to anticipate returns of 12 per cent or higher.
"When returns range between 7-9 per cent, as has been the case for most of the top funds over the past couple of years, there is disappointment, prompting withdrawal of money," says Arun Kumar, head of research, Fundsindia.com.
Rising portfolio yields of debt funds had also led to money moving from balanced advantage funds.
"But with capital gains from debt funds now taxed at slab rates, we expect this trend to reverse," says Alekh Yadav, head of investments, Sanctum Wealth.
Rising interest rates on fixed deposits also played a part.
"Investors who had earlier allocated money to Balanced Advantage Funds, hoping for higher returns without significant risk, started shifting back to FDs," says Pratik Bagaria, fund manager-portfolio management services, dezerv.
Most funds within this category dynamically adjust their equity allocation between 30 and 80 per cent.
When equity market valuations turn expensive, these funds skew their equity allocation towards the lower end of the scale.
Conversely, when valuations become attractive, they increase allocation.
To be eligible for equity-like tax treatment, these funds maintain an overall equity plus arbitrage allocation of 65 per cent or higher. The rest of the balance is invested in debt.
"Besides valuation indicators, some funds also incorporate a small overlay of momentum indicators. One fund, from Edelweiss, determines its equity allocation based purely on momentum," says Kumar.
Investors don't need to be concerned about their asset allocation when investing in these funds.
"Most investors may not have the ability to tweak their allocation to equities and debt based on the part of the market cycle they are in. This task gets outsourced to the fund management team in a BAF," says Nirav Karkera, head of research, Fisdom.
Rebalancing is also handled by the fund manager.
"When investors rebalance their own portfolios by moving out of equities and into debt, or vice versa, they incur a tax liability. This doesn't occur when a fund manager rebalances her portfolio," says Bagaria. Investors also don't have to worry about paying an exit load while exiting a fund.
"When valuations rise, these funds reduce their equity allocation, and vice versa," says Yadav.
Thus, they have the potential to earn superior risk-adjusted returns for the investor and offer a smoother investment journey.
Each fund house determines its allocation to equities and debt based on an in-house model, which may not always perform well.
"The fund might not be sufficiently invested in equities after a market drop, leading to it not participating in the market recovery.
"There's also a chance that the fund might have become underweight in equities during a consistently rising market, thereby missing a large portion of the returns," says Kumar.
He adds that, while valuation as an indicator works in the long term, it could disappoint in the short term.
The expense ratios of these funds could be higher than if one were to invest in separate equity and debt funds.
"In these funds, both the equity and the debt portion have a similar expense ratio," says Bagaria.
Another aspect of these funds that investors should be aware of is that their asset allocation is determined by the prevailing market conditions.
"It's not personalised to suit each investor's needs," adds Bagaria.
Ideal for beginners
According to Karkera, investors with a conservative to moderate risk profile and a time horizon of three to four years may consider investing in this category.
Yadav says that retail investors who are unable or unwilling to manage their asset allocation by themselves could opt for them.
Kumar views these funds as an ideal starting point for those who previously invested in fixed-income products and now wish to venture into the equity markets.
"Such investors may choose this category of funds to acquaint themselves with equity market volatility before venturing into pure equity funds," he says.
Avoid if you have an asset-allocated portfolio
Investors who already have an asset-allocated portfolio can bypass these funds.
"If such an investor invests in a BAF, this fund will manage its own asset allocation. This could make it difficult for the investor to maintain a consistent asset allocation at the portfolio level," says Kumar.
Yadav adds that investors with access to wealth managers and financial advisers, who manage asset allocation on their behalf, can also forgo these funds.
Bagaria suggests that conservative investors who deposit their money in fixed deposits may also avoid these funds, rather than treating them as an alternative.
Enter with a three- to five-year horizon
Investors should approach these funds with a minimum investment horizon of three years.
"However, they should be prepared to extend their investment horizon if the fund performs poorly in the third year due to a downturn in the equity market," says Kumar.
Stick to funds with proven track records
These funds operate based on asset allocation models built by fund houses through back-testing.
"It's better to choose funds that have been active in the market for five years or more, instead of relying on performance based on back-tested data," says Kumar.
Investors also need to assess how the fund has performed in various market phases: bull, bear, and flat markets.
The fund should effectively reduce downside risk while capturing the upside.
Investors should also understand the fund's underlying strategy: whether it is based on a valuation- or momentum-based model.
"Review the fund's volatility (standard deviation) and modified duration to understand its level of risk," says Yadav.
Since these funds invest in equities, debt, and arbitrage, Karkera recommends opting for a fund house with proven abilities across all three categories.
Lastly, investors should enter these funds with moderate return expectations -- in the range of 8-10 per cent -- as any fund that tamps down volatility will also yield moderate returns.
Feature Presentation: Ashish Narsale/Rediff.com