Balancing act

47-Shaik-Jilani Shaik Jilani

BALANCED ADVANTAGE FUND (BAF), also known as Dynamic Asset Allocation Fund, is a category of hybrid mutual fund schemes that invest in asset classes like equity and debt and keep modifying their asset allocation based on the market valuation. As a result, this category of funds has lower risk than pure equity funds but has the potential to give higher returns than debt funds. The highlight of the category is that the fund manager has the flexibility to move anywhere from 0 to 100 per cent allocation in a particular asset class based on market conditions.

BAFs use various tools to gauge an asset class. Some rely on valuation tools such as price to earnings and price to book ratio, or a combination of these to ascertain the proportion of investment in equity and debt.

A traditional hybrid fund would have a predefined ratio of 70:30 in favour of equity or debt, depending on whether you opt for an aggressive or a conservative fund. In effect, the leeway to shift the asset mix was predefined and limited. That is where BAFs have an edge.

Several fund houses use a model-based approach to decide on the allocation mix. Such an approach is generally perceived to remove fund manager bias, if any, towards an asset class. These models indicate which asset class is attractive and the fund manager decides to invest in that particular asset class. Owing to this approach, the portfolio undergoes automatic reallocation so that the fund is invested into equities when the market is cheap and vice versa.

BAFs over the past few years have been increasingly gaining popularity due to their inbuilt asset allocation practice. Almost all the major fund houses today have a BAF in their product offerings. However, the way in which it is managed varies. There are a few options where equity allocation is largely static at over 70 per cent. Such offerings will tend to deliver returns during a bull market. The same goes with equity allocation which is momentum based.

On the other hand, there are some very conservative offerings where the equity allocation is less than 30 per cent. Most of the BAF universe, however, tends to be somewhere in the middle of the spectrum. These funds dynamically change their equity allocation to keep pace with the changing market conditions. HDFC Balanced Advantage Fund, the largest fund in the category, has an equity exposure of up to 75 per cent, while ICICI Balanced Advantage, the second-largest, has an equity exposure of 37.2 per cent. Most other funds in the category have an equity allocation between 30 and 55 per cent.

One of the major challenges for an investor is to ensure that the wealth created by a bull market rally remains protected. In such a scenario, BAF emerges as a good option for lump-sum deployment. Here, one can park all the gains and can rest assured that the investment will not be subjected to undue risks. The caveat here is that one should have deployed money in a conservatively managed BAF.

By being a part of a conservatively managed BAF, one can have an allocation towards equities while being sufficiently hedged. This means your investments will largely remain protected due to limited equity exposure even in case of a correction.

A pioneer in the category, the ICICI Prudential BAF has a track record of more than a decade. The allocation calls in the fund are based on a tried and tested model. Even though the average equity allocation over the last decade was around 54.6 per cent, the returns generated by the fund were at par with Nifty 50. In effect, what an investor of this fund has achieved is that despite the reduced equity allocation, which means lower risk, the return profile has been that of a fully invested equity fund.

The author is managing director, J2 Wealth & Investments.