Many retail investors, especially recent entrants, are a jittery lot with the Sensex rallying beyond the 80,600 level. Fearing that equities have become overvalued, they are in a dilemma whether to continue with their investments, pause them, or exit equities. One mutual fund category that can help them deal with these questions is balanced advantage funds (BAFs), also called dynamic asset allocation funds.
Why invest now?
Most BAFs follow a counter-cyclical strategy wherein the fund manager reduces equity allocation as market valuations move up, and vice versa, thereby providing sound risk-adjusted returns.
Currently, retail investors perceive equity market valuations to be expensive. “The current price-to-earnings (P/E) ratio of the Nifty 500 is close to its 10-year average. There is no need to panic and exit the markets. Many BAFs currently have an equity allocation of around 50 per cent, suitable for investors who do not want to invest all their money in equities,” says Nehal Mota, co-founder, Finnovate. She adds that interest rates have peaked and are poised to fall, which means the debt portion of these funds is also in a sweet spot.
Many investors believe a correction is imminent. “If the market falls, a BAF manager can increase equity allocation to benefit from the correction,” says Alekh Yadav, head of investment products, Sanctum Wealth.
BAFs enjoy favourable tax treatment. “Whenever the fund manager reduces the equity allocation below 65 per cent, the shortfall is made up using arbitrage, allowing these funds to enjoy equity taxation,” says Vivek Banka, co-founder, GoalTeller.
Between 2015 and 2024, the calendar year category average return of BAFs has never been negative, which makes them suitable for conservative investors looking to control risk.
No control over asset allocation
Many investors have portfolios with asset allocation suited to their risk appetite. “If they were to go for a BAF, where the asset allocation keeps changing, their portfolio level asset allocation would get distorted,” says Yadav.
The investor outsources the asset allocation decision to a fund manager. “If her calls go wrong, the investor suffers,” says Mota.
These funds will likely underperform the Nifty, a pure equity index, during a bull run. “Most BAFs stick to largecap stocks and have less exposure to mid and smallcaps, which can affect returns when the latter segments are doing well,” says Banka.
Assess fund’s risk level
Risk levels vary among funds within this category. “Some are aggressive and maintain an equity allocation range between 60 and 75 per cent. Others are more conservative. Their equity allocation at times goes as low as 40 per cent,” says Banka. While the former may outperform during a bull market, the latter will likely provide better downside risk protection.
Similarly, some funds stick to largecaps, while others take considerable exposure to mid and smallcaps. Investors should select a fund whose risk level matches their appetite.
Managing a BAF requires asset allocation decisions. “Check the fund manager’s experience in managing this strategy,” says Mota. She also suggests evaluating a fund’s risk-adjusted returns, and the quality of papers it holds on the debt side.
Yadav suggests assessing how effectively the fund manager switches between equity and debt in various market conditions, and whether the equity-debt allocation changes dynamically or remains static. Consistency of performance is another key criterion.
First Published: Jul 15 2024 | 7:47 PM IST
