Balanced advantage funds help in uncertain times

While their equity component aids in generating capital appreciation, their debt portion facilitates steady income

Equity indices are nearing their historic peaks with high valuation despite subdued macroeconomic indicators and stagnant corporate earnings. With large cap and midcap indices such as BSE Sensex, Nifty 50, BSE MidCap and NiftyMidcap trading at PE multiples of over 27, mutual fund investors may be wondering if they should commit fresh lump sum investments, given stretched valuations and fear of correction. Such investors can invest in dynamic asset allocation funds, also popularly known as balanced advantage funds.

What are dynamic asset allocation funds?

As the name suggests, dynamic asset allocation funds are hybrid funds, which manage their investment in debt, equity and equity derivatives dynamically, without any limits specified by the SEBI. This gives these funds the freedom to manage their exposure to equity and debt in response to changing market conditions and various valuation metrics such as price-to-earnings (P/E), price-to-book (P/B) multiples, and the like.

Most of these funds use proprietary quantitative models to re-balance their exposure between equity and debt. These funds increase their equity exposure when valuations are low and decrease it when valuations become high.

Pluses of balanced advantage funds

Moderate risk: Balanced advantage funds help in balancing the risk-reward ratio by investing in equity, equity-related instruments and debt instruments, in varying proportions, depending on changing market conditions and valuations.

While their equity component helps in generating capital appreciation, their debt component helps in generating steady income. They also hold positions in equity derivatives to shield their portfolio from market corrections.

As they reduce their equity exposure during rich valuations, it helps them contain the downside emanating from over-valued markets. The increasing exposure to equities during falling markets also helps exploit the low valuations of quality stocks. Thus, their dynamic debt-equity mix allows them to have lower risk than diversified equity funds while generating higher returns than debt funds.

Outsourced asset allocation: Asset allocation is the process of spreading investments across various asset classes according to one’s investment horizon and risk profile. Usually, mutual fund investors do it on their own by spreading their investments across equity, debt and the like, and re-balance them on the basis of changing market conditions, investment horizon and risk profile. However, analysing the market conditions may not be every retail investor’s cup of tea.

Many investors also find it difficult to execute asset allocation by themselves due to greed and fear. Additionally, frequent re-balancing may also lead to increased investment cost because of exit loads and short-term capital gains tax.

Balanced advantage funds help in uncertain times


Balanced advantage funds solve these problems by allowing you to outsource asset allocation related decision-making to fund managers. Their in-house quantitative models help fund managers to make asset allocation-related decisions based on changing valuations. Quantitative models also help these funds to rule out human bias while making asset allocation.

Tax efficiency: Equity and equity-oriented mutual funds are more tax efficient than debt funds and debt-oriented hybrid funds, especially for those in the higher tax slabs. In order to be treated as equity funds for taxation purposes, most balanced advantage funds usually increase their position in equity derivatives, whenever their exposure to stocks goes below 65%. As equity-related derivatives are treated as equities for taxation, balanced advantage funds continue to be treated as equity instruments even if their actual exposure to stocks goes below 65%.

Minuses of balanced advantage funds

The cautious approach taken by balanced advantage funds during stretched market valuations can adversely impact their performance. Reduced equity exposure in a sustained bull rally may lead them to lose out on market opportunities and underperform equity funds with a significant margin.

Downside risk may still remain: Despite the freedom to change their equity and debt exposures from 0 to 100%, balanced advantage funds generally continue with a sizeable equity component even during overvalued market conditions.

Hence, their continued equity exposure during over-valued markets will not allow them to totally do away with downside risk in the event of a steep market correction.

Lack of liquidity: Balanced advantage funds charge exit loads of up to 1% on redemption within one year of investment. Liquid funds, ultra-short duration and most of the low duration and short duration funds do not charge exit loads. Hence, short term debt funds offer higher liquidity than balanced advantage funds.

Expense ratio: The expense ratio of balanced advantage funds can go up to 2.6%, similar to what equity funds charge. While the expense ratio in case of short-term debt funds usually remains within 1%, their direct plans charge less than 0.50%. The higher expense ratio of balanced advantage funds can further affect returns if a steep market correction coincides with the maturity of their investment horizon.

Uncertainty on tax: Despite the freedom to take position in equity derivatives for availing equity taxation, some balanced advantage funds choose to keep their equity component (including the equity derivatives) below 65% due to market outlook of their fund management. In such cases, it attracts debt taxation. Their investors come to know about the tax treatment only after the end of the financial year. Thus, there would always be an element of uncertainty for investors regarding tax treatment.

In summary, balanced advantage funds are equipped to make the most from both over-valued and under-valued market conditions.

However, their conservative approach can lead them to underperform pure equity funds in the long run. Balanced advantage funds should also not be considered an alternative to short term debt funds. They are best suited for moderate-risk investors with long term financial goals.

(The writer is CEO & Co-founder,

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