Updated: Aug 31, 2022
Starts on: 21st July 2022 and Closes on: 3rd August 2022
What are Balanced Advantage Funds?
Balanced Advantage funds are hybrid mutual funds which is also known as Dynamic Asset Allocation Funds. In a Balanced Advantage fund, the asset allocation between the two asset classes - equity and debt - is managed dynamically depending on the prevailing stock market conditions.
For example – If the stock prices are high, the fund manager may tilt the asset allocation more towards debt and when stock prices are low, the tilt can shift more towards equities. Generally, the fund manager, utilizes a process driven approach (also known as asset allocation model) to shift the portfolio between the two assets, equity and debt, depending on the market conditions. This is the reason, when stock prices are very high, the investors do not see a big fall in their investment value as maximum investment would be in debt securities. Likewise, investors can gain maximum when the markets recover as the fund manager would have allocated higher into equities when the markets were low.
In summary, fund managers of balanced advantage fund shifts the asset allocation based on market valuation – shift to equity when valuation is low and shift back to debt when valuation is high. The aim of dynamic asset allocation is to reduce downside risk and generate superior risk adjusted returns for investors.
What asset allocation models are used by Balanced Advantage funds?
Asset Management Companies have their in-house mathematical models which decides equity and debt allocations depending on market conditions. Generally, these models are created based on the fund manager’s hypothesis of asset allocation at different valuation levels which can generate superior returns for investors over a long investment horizon. Fund managers duly back-test these models using historical data to see if the funds’ investment objectives can be met.
Counter-cyclical model: This model increases equity allocation by reducing debt allocation in falling markets and reduce equity allocations in rising markets. These models endeavors to buy low and sell high. However, different fund managers may use different valuation metrics for dynamic asset allocation e.g. P/E, P/B etc.
Pro-cyclical model: Pro-cyclical models essentially try to follow the market trend and thus increase equity allocation in rising markets while reduce it in falling markets. Pro-cyclical models are based on market trend indicator like daily moving averages and indicators of the trend strength / health (Standard Deviation, Downside Deviation etc.). Some pro-cyclical models may use other factors like valuations, macro-economic factors etc.
How derivatives is used in Balanced Advantage Funds?
Derivatives are used to manage active equity exposure through hedging which helps the fund managers to keep gross equity exposure above 65% so that investors can avail equity taxation. This is done while keeping in mind the asset allocation determined by the model.
The other reason for using derivatives is to generate returns for investors through arbitrage opportunities. As you may know, Arbitrage are risk free profits made by the scheme by exploiting price differences between the spot (cash) and the derivatives (Futures and Options) segments of the market.
What are the risks?
In the short term, the fund can give negative returns due to the equity holdings in the portfolio.
Therefore, investors should have minimum 3+ years of investment horizon for investing in these funds.
Things an investor should consider for Balanced Advantage Funds?
Risk: Even though these funds have considerable percentage allocation in debt securities, they are not entirely risk free. The reason is equity components, which makes balanced advantage funds vulnerable to equity market risks. This makes the NAVs fluctuate as per the market movements. However, balanced advantage funds are less risky compared to pure equity funds.
Return: The returns of balanced advantage funds would not be like pure equity funds, but perhaps higher than that of fixed income funds. If you are a moderately aggressive investor, you can expect relatively good returns provided you have minimum 3-5 years of investment horizon.
Financial Goals: If you do not like high risk, balanced advantage funds can be ideal for meeting your medium to long term goals as these funds can generate relatively good returns in the long term and are also tax efficient compared to assured income products / or fixed income funds.
Investment horizon: You should have minimum 3-5 years of investment horizon for investing in balanced advantage funds. Investors with lower than 3 years of investment horizon, should not invest in these funds.
What is the taxation for Balanced Advantage Funds?
As mentioned earlier, most of the balanced advantage funds in India are taxed as equity funds. In equity oriented funds, short term capital gains (investment held for <12 months) are taxed at 15% while long term capital gains (investment held >12 months) are tax exempt up to Rs 1 Lakh in a financial year. Capital gains in excess of Rs 1 Lakh are taxed at 10% only + Cess. The tax advantage of balanced advantage funds may be beneficial for investors who predominantly invest in fixed income investments.
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.