BAF: A refuge from volatility for new and risk-averse investors

BAFs provide an asset allocation tool for investors that are relatively hassle-free and help investors deal with market gyrations better through relatively emotionless investing

Heightened stock market volatility and declining net asset values of equity funds (NAV) are denting investors’ portfolios. In such times, balanced advantage funds (BAF), also known as dynamic asset allocation funds, are a good vehicle to invest in the markets. “BAFs provide an asset allocation tool for investors that are relatively hassle-free and help them deal with market gyrations better through relatively emotionless investing,” says Mahesh Patil, chief investment officer (CIO), Aditya Birla Sun Life Asset Management Company (AMC). 

How BAFs work 

BAFs invest in a dynamic mix of stocks and bonds. Allocation to these asset classes is determined by proprietary models that assess the relative attractiveness of bonds and stocks, utilising inputs like valuation, momentum, and macroeconomic trends.

“These schemes typically employ proprietary, in-house market valuation models to determine net equity levels, which brings discipline. They allocate more to equity when market valuations are low and less when valuations are high, thereby benefiting from market volatility. Therefore, the current heightened market volatility is favourable for these funds,” says Ramesh Mantri, CIO, WhiteOak Capital AMC. 

Thrive on volatility  

  BAFs can increase equity allocation when stock prices become attractive and reduce it during sharp upswings. “BAFs can be a good option to take advantage of the expected volatility. Instead of maintaining a static equity allocation, these funds automatically adjust (reduce or increase) their equity exposure based on market conditions,” says Jiral Mehta, senior research analyst, Fundsindia. 

To maintain liquidity, these funds invest substantially in large-cap equities and high-quality bonds. This also contributes to stability of these funds. 

 

Don’t expect equity-like returns 

The key risk in these funds is of underperformance during a strong market rally. Since BAFs hold bonds alongside equities, their returns are likely to lag behind those of pure equity schemes during bull markets. 

“Market factors that impact both equity and fixed income will have an impact on BAFs. During this period of consolidation, correct allocation to equities and fixed income will be the key to better performance,” says Patil. 

Ideal for new investors 

BAFs offer a gradual exposure to equities and help beginners become familiar with market volatility.  

“If you are a new investor or someone who has been investing in fixed deposits (FDs) and is looking to explore equities, then these funds can be a good option to begin with. With time, you can decide what asset allocation is best for your portfolio and allocate accordingly,” says Mehta. Even conservative and moderate-risk investors can benefit from BAFs due to their hybrid structure, which provides equity exposure with reduced volatility. “Investors seeking reasonable returns with lower volatility compared to pure equity schemes may consider investing in these funds,” says Mantri. 

Take a long-term view 

Investors should approach BAFs with a minimum five-year horizon. This will enable them to earn sound risk-adjusted returns across a full market cycle. Selecting a scheme with a proven track record and a stable fund manager is critical. These funds can be a part of investors’ core portfolios. “While these schemes may not generate the highest possible returns, their inherent structure inspires confidence to allocate a larger portion of your investable corpus. Therefore, these schemes can form a part of investors’ core portfolios,” says Mantri. 

Some funds run on a momentum rather than a valuation-based model. If you want less volatility, think twice before investing in them.