WHEN THE MARKETS soar to new heights, the fear of an imminent crash keeps many investors on edge. What if you could invest confidently without constantly worrying about when to enter or exit the market? Balanced Advantage Funds (BAFs) offer that peace of mind. This category of funds with over 12.8 lakh crore of assets spread over 48 lakh folios (as of August 2024) has been the go-to solution that thrives in both uncertain times, bullish times and flat markets ie full market cycles.
BAFs are hybrid mutual funds designed to adapt to changing market conditions by dynamically adjusting the allocation between equity and debt. These funds have gained significant popularity in India due to their flexibility and potential for consistent returns across market cycles. For years, BAFs have helped investors stay put in moments of uncertainty and convert them into opportunities to secure consistent returns.
Understanding BAFs
BAFs, also known as Dynamic Asset Allocation Funds, adjust their equity and debt exposure based on market conditions. Unlike traditional hybrid funds that maintain a static ratio between equity and debt, BAFs use a flexible asset allocation strategy. This allows the fund to increase equity exposure during market dips and reduce it during market highs, thus aiming to “buy low and sell high.” The key feature of BAFs is their use of quantitative models to guide these allocation shifts. This approach helps investors navigate market volatility without needing to time the market themselves. This makes BAFs an attractive option for both seasoned and novice investors.
BAFs work by following a dynamic investment process that is largely driven by quantitative models. Fund managers assess market conditions using metrics like the P/BV ratio etc, to determine the fund’s equity and debt allocation. For instance, if the equity market is overvalued, equity exposure is cut and debt allocation is hiked to mitigate risk. Conversely, when the market is undervalued, the equity exposure is increased to capitalise on potential gains.
BAFs mostly endeavour to adopt a flexi-cap approach for equity allocation. In case of debt allocation, they aim to invest in high quality instruments with over 80% of the portfolio in AAA-rated papers.
The BAF strategy helps to balance risk and reward by avoiding extreme exposure to any single asset class, allowing for a smooth investment experience.
Risk-return profile
Balanced Advantage Funds offer a balanced risk-return profile, sitting between pure equity funds and debt funds. Since BAFs adjust their asset allocation according to market conditions, they tend to carry lower risk than equity funds, especially in volatile markets. However, their return potential is higher than that of traditional debt funds due to their equity exposure.
The ability of BAFs to participate in market rallies while protecting downside during bear phases makes them appealing for investors seeking moderate capital appreciation and income generation.
In the last one year period ended September 30, BAFs as a category have delivered 25.7% return. In the last three- and five-year period, category returns are 14.8% CAGR and 13.9% CAGR respectively.
The tax treatment of Balanced Advantage Funds is similar to equity mutual funds. If the equity exposure is maintained above 65%, BAFs are classified as equity funds for tax purposes. Gross equity exposure in funds is usually maintained between 65% and 100%. If the equity allocation falls below 65%, the gross equity exposure is maintained at 65% using equity derivatives.
BAFs are suitable for a wide range of investors, especially those with moderate risk tolerance and a medium-to long-term investment horizon. Conservative investors can benefit from the downside protection provided by the dynamic asset allocation strategy, while aggressive investors can still enjoy equity-like returns during market upswings.
Investors looking for diversification without constantly monitoring the market may find BAFs ideal, as these funds take care of asset rebalancing, offering peace of mind amid market fluctuations. Additionally, the use of a quantitative model minimises emotional bias, allowing for more discipline.
One such BAF which investors may consider investing in is the ICICI Prudential Balanced Advantage Fund. With an AUM of over Rs60,000 crore, the fund is one of the largest and oldest in this category. As of September 30, 2024 the fund delivered a strong return of 23.59% on a one year basis and CAGR returns of 13.75% and 14.37% on three-year and five-year basis, respectively.
The writer is a mutual fund distributor