According to experts, the largest fund in this category — HDFC Balanced Advantage — maintains its equity allocation on the higher side and changes it within a narrow band.
The other funds in the category follow one of three strategies. The first is valuation-oriented. When equity valuations move up, such funds reduce equity exposure and vice versa. These funds try to offer investors a smoother journey across market cycles. They are likely to provide sound risk-adjusted returns across market cycles, but could underperform in a bull market.
The second type is momentum-oriented. When the market is moving up, these funds increase equity exposure, and vice versa.
“Momentum is a proven investment concept. There is no problem with a fund following this approach, but investors should not misread the fund’s strategy,” says Arun Kumar, head of research, FundsIndia.
The third type follows a mixed valuation-cum-momentum strategy.
“The downside of a pure valuation-led approach is that such funds reduce equity allocation too early in a rally. But the anticipated correction could come much later. So, these funds could miss out on a lot of the upside. That is why some fund houses combine valuation and momentum indicators in their models,” says Kumar.
Investors must first decide which of the three models suits them.
Next, check a fund’s track record over a few years to see how its asset allocation has changed in the past.
“This will provide a sense of the range within which the fund’s equity allocation will move — whether the band will be narrow or wide,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. This will also tell you whether the fund remains true to its model.
Finally, check the fund’s returns. If you are buying a fund from this category mainly to contain downside risk, you should check how much it fell in a market crash, such as that of March 2020.
“Go with a fund that contained downside risk well during such an event,” says Anup Bansal, chief investment officer, Scripbox.
Remember this is a middle-of-the-road category that should primarily reduce volatility to levels lower than an equity fund and enable you to earn returns higher than a debt fund.
Watch out for these risks
If a BAF/DAA fund consistently maintains high equity allocation, it is likely to have a lower level of hedging in its portfolio. “Such funds could be more volatile,” says Vidya Bala, co-founder, PrimeInvestor.
Take a close look at the quality of debt papers in the portfolio. “Some of these funds have taken exposure to lower credit quality papers in the past,” says Bala.
The downside risk in some of the funds within this category, especially the ones that maintain higher equity allocation, can be high. During the market crash of March 2020, the one-year return of one fund was minus 24.6 per cent.
Finally, if maintaining accurate asset allocation (suited for your risk appetite and time horizon) appears difficult with these funds, buy separate equity and debt funds, maintain a constant asset allocation, and rebalance periodically.
“You could invest in these funds for a two-three-year horizon for a specific goal — when you want better returns and greater tax efficiency than you would get in a debt fund and are prepared for slightly higher risk,” says Bala.
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