Choosing a balanced advantage fund? Look beyond returns to strategy, risk

Balanced advantage funds are raising equity exposure, but investors must assess allocation models, portfolio risks and downside protection-not just past returns

Balanced advantage funds (BAFs), also called dynamic asset allocation funds (DAAs), have raised their equity exposure to multi-year highs, according to a recent report in Business Standard. This could potentially boost their future performance. Investors looking to enter these funds should go beyond past returns and understand both the asset-allocation framework and the risks embedded in the portfolio they select.

 

Understand the allocation model 

BAFs can follow very different asset-allocation frameworks. “Valuation-based models typically increase equity exposure when markets appear attractively valued and reduce it when valuations become expensive,” says Abhishek Tiwari, chief executive officer (CEO), PGIM India Asset Management. Some funds use trend or momentum indicators, while others combine valuation, trend, earnings and macroeconomic variables. 

 

Counter-cyclical models buy when sentiment is weak and trim exposure during euphoric phases. “A counter-cyclical approach is intended to reduce the fund’s overall volatility,” says Ankit Agarwal, fund manager, Motilal Oswal Mutual Fund. 

Investors should examine how the model behaves in different conditions. “Assess how effectively the model increased equity exposure when markets were attractive, and reduced risk when valuations were elevated or market conditions became uncertain,” says Pooja Paralikar, product head, Abakkus Mutual Fund.

 

They should also understand how much discretion the fund manager has. The framework should be logical and transparent, be applied consistently and remain disciplined across market cycles.

 

Check the equity range 

A fund’s historical equity-exposure range offers another window into its risk-management approach. “The historical equity range shows how actively a fund manages risk,” says Tiwari.

 

Funds with wider allocation flexibility may offer greater downside protection if their asset-allocation calls are timely and effective. “However, wider allocation flexibility places a greater burden on the fund’s decision-making process because allocation mistakes can affect returns,” says Tiwari.

 

Funds operating within a narrower equity range provide more predictable participation in equity markets. But they may not reduce risk as aggressively during periods of market stress.  

Investors should choose a fund whose historical allocation behaviour matches their risk tolerance and return expectations.

 

Study the portfolio  

Portfolio construction can cause meaningful differences in returns even among funds with similar equity exposure. “The market-cap mix and the credit quality and duration of the debt portfolio can materially influence a fund’s risk and return,” says Paralikar.

Examine the allocation across largecap, midcap and smallcap companies. “A higher allocation to midcap and smallcap stocks can increase return potential in favourable markets but can also increase volatility and downside risk,” says Paralikar. 

Examine concentration in particular sectors or stocks. “Concentrated sector bets can materially increase a fund’s volatility,” says Abhishek Kumar, Securities and Exchange Board of India (Sebi)-registered investment adviser and founder, SahajMoney.com.

 

The fixed-income portfolio needs equal scrutiny. Lower-rated fixed-income instruments may offer higher yields but carry greater credit risk. A high-quality debt portfolio, on the other hand, can provide stability during periods of market uncertainty. “Credit risk in the fixed-income portion can undermine the objective of downside protection,” says Kumar. 

Also assess maturity and duration. Longer-duration fixed-income portfolios are more sensitive to changes in interest rates. 

Investors should choose a fund whose underlying portfolio risks match their risk appetite, investment objectives and time horizon.

 

Check consistency of return  

BAFs aim to provide a smoother investment experience across market cycles rather than capture the entire upside of a bull market. Investors should assess performance across multiple market environments rather than a single period. “Rolling returns can be used to assess the consistency of returns,” says Tiwari. 

Examine downside protection during major corrections as well as participation in market recoveries.  

“Investors should compare rolling risk-adjusted returns with the category benchmark across full market cycles to judge whether asset allocation adds genuine value rather than merely tracking momentum,” says Kumar.

 

View performance in the context of the fund’s strategy. “Pro-cyclical strategies may perform well in an upward-trending market but may provide inadequate downside protection in a sharp bear market,” says Agarwal. 

Judge a balanced advantage fund by how its asset allocation has worked across different market cycles and how consistently it has delivered,” says Subhendu Harichandan, executive director, Anand Rathi Wealth.

 

Compare risk measures

Risk metrics matter because risk management is a core objective of balanced advantage funds. Use a combination of measures because no single metric provides a complete picture. 

The downside capture ratio shows how much of market decline the fund participated in. A lower ratio is generally preferable in this category.  

Assess risk-adjusted returns rather than returns alone. “Use the Sharpe ratio as it measures risk-adjusted performance after accounting for volatility,” says Agarwal.  

Investors should also compare the fund’s standard deviation with its category benchmark across full market cycles. 

 

Match fund to risk profile 

BAFs are not a one-size-fits-all category because their risk profiles can differ considerably. “A fund’s risk profile depends on its allocation model, average net equity exposure and underlying portfolio,” says Paralikar. 

Investors should align the fund’s historical net equity allocation with their own tolerance for volatility. “Have a minimum investment horizon of three to five years for a BAF,” says Kumar. 

Aggressive funds participate more meaningfully in rising markets. They also experience greater volatility during corrections. 

Conservative funds generally cut equity exposure more sharply when valuations are elevated or market risks increase and maintain a relatively higher fixed-income allocation. 

The appropriate fund is one whose risk-return profile aligns with the investor’s financial goals, investment horizon and ability to remain invested through different market conditions. 

Investors with a horizon of preferably five years or more and the ability to tolerate short-term market fluctuations may consider relatively aggressive funds with higher net equity exposure.  

An investor moving from pure equity and seeking a smoother experience may be comfortable with an aggressive BAF. More conservative funds may suit first-time equity investors, retirees and investors who prefer a smoother investment experience. An investor accustomed to traditional fixed-income returns and taking a gradual step towards equity may also prefer a more conservative fund.

 

Watch for warning signs 

Investors should periodically review a BAF to check if it has begun to move away from its stated investment approach. “Strategy drift is an important warning sign. A fund originally positioned as conservative may no longer suit the investor if it gradually takes much higher equity risk,” says Paralikar. 

“Persistent underperformance across a full market cycle is also a cause for concern,” says Harichandan. 

A change in fund manager is not a reason to act. Investors should check whether a fund-manager change has caused a noticeable shift in investment style, portfolio construction or risk. 

Other warning signs include excessive portfolio turnover without corresponding returns, rising costs and a shift towards illiquid lower-rated bonds. A sharp increase in the total expense ratio combined with multi-year rolling underperformance against peers should trigger a full portfolio review. 

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The writer is a Mumbai-based independent journalist