Worried about valuations? Go for a balanced advantage fund, say experts

Investors who run an asset-allocated portfolio with periodic rebalancing can manage without them

With the Sensex closing in on the 50,000-mark, the euphoria in the equity markets is palpable. However, as the monthly outflows from equity mutual funds (MFs) demonstrate, investors are also worried about high valuations. Many fund managers and advisors are currently suggesting that investors take exposure to balanced advantage fund (BAF)/dynamic asset allocation fund (DAAF) to cope with this environment.      

Each fund house has a model based on which it decides how much equity allocation its BAF/DAAF will take at different market levels. As markets turn expensive, these funds reduce equity exposure, and vice-versa.

“Currently, investors are becoming anxious about valuation levels and about a possible market correction, and are unsure about the level of equity allocation they should have. Those who wish to hand over the decision to an automated model may invest in these funds,” says Ajit Menon, chief exec­u­tive officer, PGIM India MF, whose new fund offer for BAF will begin shortly.

Automating asset allocation enables investors to buy low and sell high, something that is difficult for them to do on their own due to behavioural biases.

According to Gautam Kalia, head–investment solutions, Sharekhan by BNP Paribas, “The consensus today is that equities are approaching bubble territory. No one knows when the US Federal Reserve will reverse quantitative easing and signal higher rates. When that happens, the correction will be sharp. At the same time, exiting equities entirely is not advisable, since one can’t predict how much longer this bull-run will continue. So, it makes sense to follow an asset-allocation strategy with balanced equity exposure,” says Kalia.

An alternative, DIY approach

Not every investor needs to use these funds, especially for the long-term.

“A long-term portfolio built out of equities, debt and gold, and rebalanced periodically will do the job well,” says Vidya Bala, co-founder, PrimeInvestor.

The advantage of this approach is that the investor has greater control over his portfolio. He can decide on a long-term asset allocation, based on his risk appetite and time horizon and stick to it.

Investors have less control over the level of risk that a BAF/DAAF carry. “The fund manager decides how much exposure he will have to large-cap versus mid- and small-cap stocks. Investors also have little control over how much credit or duration risk these funds will take on the debt side,” adds Bala.

Run these checks

Investors who cannot manage an asset-allocated portfolio or rebalance regularly, or do not have an advisor, may opt for these funds, but only after a detailed study of their strategy. Try to understand the model the fund will follow.

“It is best if the asset allocation decision is based on a transparent, quantitative model, with little left to the fund manager’s discretion, as we plan to do,” says Menon.

Understand the equity range within which the fund will operate. Make sure it is true-to-label, that is, it varies its equity allocation based on market levels and does not keep it static. Also, check its past strategy in derivatives. 

A higher allocation to derivatives will make the portfolio less volatile, but will also reduce returns. Make sure you are comfortable with the level of mid- and small-cap allocation, and the level of credit and duration risk the fund has taken in the past. Finally, invest for at least three years.