BAF fund managers divided on equity markets over risk-reward landscape

Equity allocation varies by a big margin across schemes as fund managers use different models

Fund managers are divided on equity markets if the equity allocation of their balanced advantage funds (BAFs) is any indicator. In BAFs, the money manager decides on the debt/equity allocation based on market conditions.

While on the one hand, ICICI Prudential BAF has slashed its equity allocation to an all-time-low of 30.5 per cent, Aditya Birla Sun Life BAF and Nippon India BAF have raised their equity allocation to 54 per cent (the highest since November 2020) and 63 per cent, respectively (the highest since May 2018).

Among smaller asset management companies (AMCs), Union Mutual Fund (MF) has decreased equity allocation to 33 per cent; Edelweiss MF has raised it to 70 per cent.

The differences stem from the methodology deployed by each fund house. 

For example, ICICI MF uses the price-to-book (P/B) valuation model. Others employ the price-to-earnings (P/E) ratio or a mix of both. Nonetheless, some fund managers also take factors, such as interest rates, bond yields, dollar, etc into consideration.

“ICICI Prudential BAF is managed counter-cyclically, reducing the equity in a bull market and raising it in a bear market based on a P/B ratio and other key variables. At present, the net equity allocation is almost at the lowest level, consistent with the model’s suggestion that equity valuations are high,” says S Naren, executive director and chief investment officer, ICICI Prudential AMC.

Ashutosh Bhargava, fund manager and head-equity research, Nippon India MF, agrees that the valuations are on the expensive side. He says the above-average equity allocation is due to positive cues from other factors. 

“Valuations are expensive. However, in Nippon India BAF, we have three key supporting variables like the dollar, commodities, and price momentum. These supporting variables indicate a positive bias and therefore, our net equity allocation is above average,” adds Bhargava.

The varying models are also shaped by how much risk a fund manager wishes to take. For example, IDFC MF’s BAF model allows the fund manager to apportion 40-50 per cent to equities when the P/E ratio goes above 22.

“Going by our predefined P/E model, the fund will maintain a net equity exposure in the 40-55 per cent band as the P/E value remains above 22,” says Sachin Relekar, senior fund manager, IDFC AMC.

The varying investment approach means a huge deviation in returns for schemes in these categories.

The returns delivered by different BAFs differ by as much as 22 per cent in one year and 11 per cent in three years, with HDFC MF BAF delivering 19 per cent and Motilal Oswal Dynamic Fund giving 7 per cent, according to Value Research data as on December 6.

The Indian market has remained range-bound for over a year, leading to a time correction. Yet valuations continue to be on the higher side, with the Nifty commanding more than 20x its estimated 12-month forward earnings — nearly double that of the Morgan Stanley Capital International Emerging Market (EM) Index.

DSP MF in its December report said the valuation of Indian large-cap companies was close to record levels, compared to EM peers. However, the fund house said the higher comparative valuation was largely a function of ‘ultra-cheap’ valuations elsewhere.

“India’s relative valuation to its EM peers is near record levels. This is largely a function of ultra-cheap valuations elsewhere due to a cloudy outlook in EMs and dismal earnings growth. So the valuation premium is more a function of EM peers’ performance rather than just India’s outperformance,” stated the report.

Motilal Oswal AMC sees the sentiment towards equity improving but expects the market to consolidate in some time.

“We do expect the market to consolidate in some time, given that bond markets seem to be relatively better poised at the moment. A few months of consolidation or a fall in bond yields will make equity relatively attractive again,” AMC said in a report.