Balanced Advantage Funds: Ensure fund's strategy matches your risk appetite

Conservative investors should prefer a valuation-based approach, while those with a higher risk appetite should go for a fund focused on momentum

HDFC Balanced Advantage Fund (BAF) recently crossed Rs 1 trillion in assets under management (AUM), becoming the second actively-managed scheme after Parag Parikh Flexicap to reach this milestone. The balanced advantage category (also called dynamic asset allocation funds) is also approaching Rs 3 trillion in assets. It had assets worth Rs 299,506 crore on May 31, according to the Association of Mutual Funds in India (Amfi).

Why investors are drawn to BAFs

Balanced advantage funds dynamically adjust equity and debt allocation in response to market conditions. “This flexibility lets investors participate in market growth while the fund aims to manage downside risks, making it useful during periods of volatility or uncertainty,” says Gopal Agrawal, senior fund manager (equity) at HDFC Asset Management Company.

 

Performance consistency is another draw. “The category has delivered better risk-adjusted returns over the past three to five years and performed well across market cycles,” says Bhavesh Jain, co-head of factor investing for Edelweiss Mutual Fund.

 

The change in taxation rules for debt funds has also propelled investors towards BAFs.

 

These funds serve as a stepping stone for fixed deposit (FD) investors entering the equity markets. “For first-time investors migrating from FDs, earning returns with lower volatility is a key requirement, which these help achieve,” says Amit Ganatra, head (equities), Invesco Asset Management (India).

Key benefits

BAFs reduce equity exposure when markets are unfavourable and increase it when valuations or momentum indicators are attractive.

 

“Executed well, this approach cuts volatility and delivers returns close to those of pure equity funds,” says Arun Kumar, head of research, FundsIndia.

 

Jain highlights two advantages: better risk-adjusted returns and no cost to the investor for switching dynamically between equity and debt.

 

Additionally, BAFs help tackle behavioural biases, such as investing heavily after a rally or avoiding equities after a downturn. “Logically, one should invest less when valuations are high and more when they are cheap. BAFs enable investors to do this,” says Vaibhav Chugh, director and head of sales, WhiteOak Capital AMC.

 

Volatility is typically lower than in pure equity funds.

 

“A systematic withdrawal plan (SWP) in a BAF provides regular cash flow in a tax-efficient manner,” says Jain.

Limitations to consider

BAFs are not designed to outperform equities. “Lower volatility comes with lower returns,” says Kumar.

Chugh says that if the valuation model is not robust, the fund may underperform. Kumar added that some models cut equity exposure too quickly during recoveries. Some BAFs, according to him, remained under-invested in equities in the past 2-3 years, missing out on a large chunk of the market rally.

 

During prolonged bull runs, BAFs may lag, leading to investor dissatisfaction and exit. “They often forget that BAFs are meant to reduce volatility while also providing decent participation in the equity market returns,” says Chugh.

Who should invest

BAFs suit first-time investors transitioning from FDs. “Once comfortable with the volatility of BAF, they can move to equities,” says Kumar.

 

Investors with low risk appetite will also find them appealing. “Those seeking long-term growth with muted volatility, or regular cash flows via SWP, may opt for these funds,” says Agrawal.

 

Jain suggests that retirees may use them for potentially steady and tax-efficient cash flows.

 

On the other hand, investors managing their own asset allocation may not benefit from BAFs. “A BAF’s equity allocation can range between, say, 30 per cent and 70 per cent. This could skew the investor’s overall asset allocation,” says Kumar.

 

Issues can also arise if the investor raises equity exposure and the fund manager reduces it around the same time.

Different models, varied results

BAFs differ significantly from one another in how they execute their dynamic allocation strategy. Consequently, over the past six months some funds have outperformed while others have struggled.

 

Both the range for equity allocation and the framework for deciding equity allocation vary. “Some models use valuation metrics such as price-to-earnings or price-to-book value, while others blend those. Others follow momentum-based approaches,” says Kumar.

 

Edelweiss Balanced Advantage Fund, for instance, uses market-trend indicators such as momentum, moving averages and volatility.

 

A few additional variations in models exist. “Some BAFs follow a multifactor quant strategy. Some have a hybrid strategy, which is a mix of quant and fund manager discretion. Some have static or narrowly dynamic models,” says Rajul Kothari, partner, Capital League. Some funds also hedge equity exposure to reduce losses.

Choosing the right fund

Select funds with long, stable track records. “Prefer a fund with at least a 10-year history, so you can judge performance across market cycles. Examine rolling three- and five-year rolling returns for consistency. Also, compare drawdowns with peers during major downturns,” says Kumar.

 

Jain recommends going for a fund with a lower drawdown during a bear market and strong upside capture in bull markets.

 

Understand the fund’s investment style: “Is it valuation led or momentum led? Does it follow a rule-based quantitative model, or can the manager override it?” says Kothari. She suggests that conservative investors go for valuation-based models, while those seeking higher equity exposure in bull markets lean towards momentum strategies.

 

Kumar suggests blending two or three BAFs with different models. “Combining a valuation-focused fund with one focused on momentum could offer a more balanced exposure and neutralise the weaknesses of the two approaches,” he says.

 

Investors should monitor net equity levels over time. “Funds with lower equity levels would be more defensive, while the ones with higher equity levels would be better for long-term wealth creation,” says Mohit Gang, co-founder and chief executive officer, Moneyfront. He also recommends checking the fund’s expense ratio, as higher costs erode returns.

 

Finally, do not select a fund based solely on past returns. Gang suggests going for a fund whose approach aligns with your risk appetite and investment goals.

 

Key points to remember when investing in a BAF

• Most balanced advantage funds (BAFs) are recent launches and primarily offer back-tested data; give preference to those with real-life performance records
• Investors should be cautious of funds that frequently change their models
• Conservative investors, especially, should avoid funds with high allocation to mid- and small-cap stocks  
• Evaluate the fixed income portion of the portfolio; some funds may take higher credit or duration risk to enhance returns, which can increase volatility and undermine the conservative nature of BAFs
• Be patient: BAFs are designed to perform across market cycles, not in the short term

 

    (The writer is a Mumbai-based independent financial writer)