As an investor, you might have come across the time-tested formula of ‘buy low and sell high’. When markets are volatile, you will find many people around you talking about this philosophy. But how do you bring that into practice? You never know what is a low point and what is a high point in the capital markets. To overcome this, asset management companies have come up with mutual fund schemes called balanced advantage funds.
Balancing the risks
Securities and Exchange Board of India has a clearly defined categorisation of mutual fund schemes. Under hybrid mutual funds, balanced advantage or dynamic asset allocation fund is an open-ended dynamic asset allocation fund. This means the fund can change allocation to equity and debt as required. While the market regulator does not impose any asset-wise investment limits for these funds, asset management companies have their own defined limits. Even these limits give immense scope to these funds to maintain a dynamic asset allocation.
Asset allocation is a strategy used to minimise risks. Portions of your money are invested in different asset classes so that if one portion is hit by a negative development, the other portion can hedge the overall returns of the investment, thereby preventing sharp losses. This works because equity and debt markets react to the same events in a completely different manner. To understand this better, look at the returns of equity and debt, the two major asset classes in the year 2008, which saw a major global economic crisis. While returns on equity investments in 2008 were negative (-51 per cent), debt investments during the year gave 28 per cent returns. In the following year, equity returns were 78 per cent, while debt investments gave (-) 9 per cent.
Accordingly, balanced advantage funds attempt to balance the risks by actively managing the allocation to the major investment buckets—equity and debt. Not only are the risks balanced for the investors, the tax treatment of the investment also remains favourable with taxation being like other equity funds, despite having an added layer of diversification.
How does it benefit you?
The concept of asset allocation is often talked about, especially while discussing investments. Similarly, the strategy of buying at lows and selling at highs is also discussed frequently. As mentioned above, what makes it challenging for a retail investor is not knowing what exactly is a ‘low’ or a ‘high’. Going a step further, even trying to foresee a low or a high could be difficult for retail investors. Hence, mutual funds have devised their own strategies based on the expertise of their respective fund managers.
For instance, the ICICI Prudential Balanced Advantage Fund follows an in-house model. This model prompts fund managers to reduce equity exposure if equity valuation goes up. Similarly, the equity exposure is raised when the valuation goes down, thereby making equity assets attractive. This strategy can calm the nerves of conservative investors who might fear the sharp market movements. Accordingly, people with relatively lower risk appetites can use these funds to enhance their gains by stepping into equity with an added layer of strategy.
Author is cofounder of Griffin Capital Advisors LLP.