What is BAF and how is an investment in BAF good in volatile markets?

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Balanced Advantage Fund - BAF

In the midst of the current stock market volatility, several fund companies are recommending investments in balanced advantage funds, also known as dynamic equity asset allocation funds, after the recent recategorization exercise.

These funds aim to give better risk-adjusted returns as fund managers can actively increase or decrease equity allocation using predefined formulae. What we need to focus on is if there is any merit in the ‘advantage’ tag and if these are better options than normal balanced funds.

The uniqueness of this category lies in the dynamic allocation between equity and fixed income (bonds), depending on prevailing market conditions. These funds shift more money into bonds when market valuations appear expensive, and do the reverse when valuations are cheap. The equity component can typically vary between 30% and 80%, though some funds do go beyond these limits.

Most of the funds also take arbitrage positions through equity derivatives. This allows the funds to keep the actual equity exposure low in a heated market, yet maintain effective equity allocation above 65% to reap tax benefits.

These make use of valuation metrics to determine the level of exposure to equities at any given point. Its equity allocation is based on the price-to-book value (PBV) ratio of the index and is rebalanced daily.

The aim is to buy low and sell high, helping the investor ride out the volatility over the long term. Even Warren Buffet also always suggests the concept of buy-low and sell-high.

Given the greater flexibility, balanced advantage, or dynamic asset allocation funds can make the most of market volatility.

The category would suit a wide spectrum of investors today given the downside protection and risk-adjusted return it delivers in the backdrop of high valuations and earnings uncertainty.”

Yet, they are not suitable for everyone. While inexperienced, risk-averse investors may take comfort in the low volatility, others with even moderate risk appetite may find the return profile underwhelming. Balanced advantage funds protect the downside well Investors with moderate to high-risk appetites may find the return profile inadequate.

Here, the fund manager maintains the equity allocation corresponding to the category—65-80% for aggressive hybrid funds, 40-60% for balanced hybrid funds, and 10-25% for conservative hybrid schemes. The remaining is invested in fixed-income instruments.

Critically, the identity crisis that plagued the earlier balanced funds category has been resolved with the new fund categorization. Most funds identified as ‘balanced’ in the earlier system tended to tilt towards equities, with more than 70% allocation to this segment. This exposed investors seeking a ‘balanced’ approach to unnecessary risk. These funds are now more appropriately slotted under the ‘aggressive hybrid’ category, while the ones actually adopting a balanced approach are now distinctly identified as such and cannot stray beyond the prescribed limits.

This article was written by S.N.Sanjeeva, an AMFI-Registered Mutual Funds Distributor.

Mutual Funds investments are subject to market risk, before investments please read all scheme-related documents carefully.