How Balanced Advantage Funds can give you the Best of Both Worlds

If the recent record breaking highs in the stock market are giving you FOMO (fear of missing out) about investing, take it as a good sign.

For young and new investors, the messages are ever present - start investing now, compounding is your friend, and of course, don't forget to diversify! SIP is considered the smartest and easiest way for young investors. However, within the world of SIPs and Mutual Funds, the choices are mind boggling. It's important to note that a large proportion of mutual funds are wedded to equity, which means you're still going to be exposed to the same risks.

Equity has its advantages - high liquidity, a potential for long term returns, and can serve as a hedge against inflation. Debt on the other hand, comes with lower volatility. It can deliver moderate returns, compared to the flashy performance of equity, and doesn't have equity's high liquidity. It comes with significantly lower risk, steady interest income, and can help you diversify your portfolio. It can, however, be daunting for new investors to balance both, especially when they're just starting out.

This is where Balanced Advantage Funds (BAFs) come in.

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The Best of Both Worlds

BAFs are a type of hybrid mutual fund that invest in a mix of equity and debt instruments. They are also known as Dynamic Asset Allocation Funds, because they adjust their portfolio allocation between equity and debt based on the market valuations. The aim of BAFs is to provide optimal returns with minimal risk by taking advantage of market fluctuations.

Let's understand what Dynamic Asset Allocation means. In a nutshell, Dynamic Asset Allocation is a strategy that involves changing the proportion of equity and debt in a portfolio based on the market valuations. When the market is undervalued, the strategy leans towards increasing exposure to equity and when the markets are overvalued, exposure shifts towards debt. This helps to capture the upside potential of equity while protecting the downside risk with debt.

Dynamic asset allocation can be done using various methods, such as price-to-earnings ratio, price-to-book value ratio, dividend yield, etc. These methods help to measure the relative attractiveness of equity and debt at any point of time. Based on these methods, the fund manager can decide how much to invest in each asset class and rebalance the portfolio accordingly.

BAFs tend to follow either a pro-cyclical or a counter-cyclical strategy for asset allocation. A pro-cyclical strategy means that the fund increases its equity exposure when the market is rising and reduces it when the market is falling. This strategy is based on the assumption that the market trend will continue, and the fund can capture the upside potential and avoid the downside risk. Essentially, they buy equity when they assess the market is rising and sell when the market is expected to slide.

A counter-cyclical strategy means that the fund decreases its equity exposure when the market is rising and increases it when the market is falling. This strategy is based on the assumption that the market is mean-reverting, and the fund can buy cheap and sell expensive in equity. In this strategy, the fund sells equity when the price is still rising, booking profits, while giving themselves a comfortable margin against the eventual correction - they don't play close to the edge. The same logic applies when the market is falling - they buy low, but while it is still falling; once again, avoiding the edge.

Some BAFs also use hedging techniques to reduce the risk of their equity exposure. Hedging means taking an opposite position in a derivative instrument such as futures or options to offset the potential loss from the original position. For example, if a fund has 50% exposure to equity, it can hedge 20% of it by selling futures contracts on an equity index. This way, if the equity market falls, the loss from the equity position will be partly compensated by the gain from the futures position.

Who do Balanced Advantage Funds work for?

BAFs are suitable for investors who want to enjoy the benefits of both equity and debt investments, without worrying about the timing of the market. This makes them perfectly suited to the novice investor, and for investors who don't have the time and headspace to manage their own portfolios actively. Essentially, these are best suited to the mutual fund investor who uses SIPs to build out their portfolio.

BAFs build on the advantages of a SIP investment model. In an equity based mutual fund, your SIP helps you balance out the temporary ups and downs of the market. In a BAF, the dynamic asset allocation adds on another layer, by constantly adjusting to the market, to your benefit. This lowers overall volatility of your investment, while also ensuring more stable returns when the markets are down, and improved performance when the markets are flush.

Some of the key benefits of investing in Balanced Advantage Funds are:

• Dynamically generates returns: BAFs aim to provide returns by taking advantage of both equity and debt markets. Based on the market's performance, BAFs can swing between equity and debt to generate capital appreciation from equity when the markets are favourable and income from debt when the markets are unfavourable.
• Lowered risk: BAFs aim to minimise risk by adjusting their portfolio allocation between equity and debt based on the market conditions. They build on the diversification you get from regular equity based mutual funds, and hence, can reduce volatility by booking profits when the markets are high and investing more when the markets are low.
• Tax efficiency: BAFs are treated as equity funds for tax purposes if they invest at least 65% of their assets in equity or equity-related instruments. This means that the long-term capital gains (after 1 year and over Rs.1 lakh) under BAF are taxed at 10%.
• Convenience: BAFs provide convenience to the investors by eliminating the need to monitor the market movements and rebalance the portfolio. Even if your portfolio consists largely of mutual funds, you still need to rebalance between debt and equity instruments based on market performance and your risk appetite. With BAFs, this too becomes automatic.

Right now, India's current investment climate presents a novel opportunity to the retail investor - our economy is racing ahead, and that translates into more money in our hands. The investments we make today are set to amplify themselves significantly in the years to come, helping us build wealth, and set ourselves up for long term financial success.

Add a Smart AdvantEdge to your investment strategy by exploring Balanced Advantage Funds here.

Disclaimer:

One-time KYC (Know Your Customer) is mandatory to invest in mutual funds. You can complete your eKYC here: https://invest.sundarammutual.com/. Investors must deal with/invest in only SEBI Registered Mutual Funds. Details are available at www.sebi.gov.in. Complaint Redressal: Investors can reach us on or write to us at . For escalation, write to grievanceredressal@sundarammutual.com or lodge your grievance with SEBI through their SCORES (SEBI Complaint Redressal System) Portal at https://scores.gov.in.

An Investor Education initiative by Sundaram Mutual.Mutual fund investments are subject to market risks, please read all scheme related documents carefully before investing.

Moneycontrol Journalists were not involved in the creation of the Article.