What you should know about balanced advantage funds

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The balanced advantage funds /dynamic asset allocation funds (BA/DAA) category was created after SEBI’s  new categorisation rules. According to the rules these funds need to “invest in equity/debt that is managed dynamically”. However, there is a lack of any explanation on what funds in this category are meant to do. This article explores how these funds behave and what you need to consider before choosing them.

Allocations vary widely

When the BA/DAA category was created, funds that it housed were earlier either hybrid funds that blended equity-derivative-debt or hybrid funds that were supposed to dynamically alter asset allocation.

This resulted in the following aspects about this category:

  • One, any distinction – if it existed – between ‘balanced advantage’ and ‘dynamic asset allocation’ is disappearing. Funds more or less maintain a 65% equity exposure (equity + derivatives) which makes taxation clear.
  • Two, in the equity and derivative mix, funds differ very widely.
  • Three, this differential means that returns between funds cannot be compared without considering each of their equity exposure.

Since then, these two seemingly different strategies more or less coalesced into a single general tendency. Namely – using a model or set of valuation indicators to identify attractiveness of the equity market. Based on these indicators, the fund fixes the extent of hedging through stock and index futures, the part of equity exposure to leave open, and debt. While the broad idea is the same across funds, in reality, it results in wide differentials.

#1 Funds follow their own model of equity and derivative allocation.

The role of derivatives is to counter equity markets – higher the hedged equity, lower the fund’s vulnerability to stock market movements. This split between hedged and unhedged equity varies very widely between funds.

Some are much more aggressive than others and undertake lower hedging. Others are very dynamic in extent of hedging. The lack of any strict definition leaves enough room for funds to follow any allocation they see fit.

For example, HDFC Balanced Advantage does no hedging at all and behaves like a hybrid aggressive fund. Aditya Birla SL Balanced Advantage can see months where derivative exposure is less than 10% or even nil and others where the exposure is over 30%. DSP Dynamic Asset Allocation is much more conservative with lower unhedged equity exposure.

Look at the table below. It shows the average open equity exposure for different funds in the category, the highest open equity exposure they had, and the lowest since July 2018 (the start of the recategorized period). Note that some funds of the funds were launched in 2019.

As you can see, the range of average equity exposures is very wide. Within each fund, the extent to which they get aggressive is also wide. Kotak Balanced Advantage, for example, can go very low to 30% in open equity and shoot as high as 74% at other times.

This points to the difference in strategies and models that each fund follows. The next table below shows the unhedged equity allocation in the six months between February and July this year for some key funds. This period is a good example of the variations in fund approaches, given the extreme volatility markets have seen.

In February, most funds were shying away from taking equity market bets, and were low on equity exposure. But by April and May, there was a marked difference in fund approaches – the ABSL and L&T funds got aggressive. The ICICI fund remained steady but still at a higher open equity allocation. The Edelweiss and DSP funds were much more conservative. Now move to July allocations, and you will see that there continues to be very different market bets between funds.

The point: Each balanced advantage fund uses different indicators to decide their equity, derivative, and debt allocations. This gives them varying degrees of risk, and will affect their returns especially in the shorter-term market volatility. It additionally makes comparison between funds tricky as it’s not really like-to-like.

#2 Returns and risk for funds are influenced by the allocations

Higher unhedged equity exposure makes those funds more volatile. It results in poorer ability to contain losses during market corrections. On the other hand, it can help deliver better returns over periods longer than 1 year.

Consider March this year. HDFC Balanced Advantage’s worst 1-month return in this period was a loss of 29%. Principal Balanced Advantage lost just 11.75% at its worst. Using the category average as a yardstick for downside capture, 40% of the funds clocked bigger losses during corrections than the category.

However, these funds also gained much more than the category during upswings. Consider all 1-year periods since January 2019 (to consider only the relevant periods post recategorisation). In this period, the highest return ICICI Pru Balanced Advantage posted was 14.5%. A much more sedate Axis Dynamic clocked a 10.6% highest gain.

The table below captures the average returns and volatility in returns from January 2019 to date.

Therefore, when looking at returns for balanced advantage fund, it becomes necessary to additionally look at where the returns are coming from. A high open equity allocation or a higher equity allocation in general will mean that a fund can deliver better returns, but will also be more volatile. On the debt front, though credit risk is not a glaring worry, funds such as ICICI Pru Balanced Advantage and Nippon India Balanced Advantage do hold lower-rated papers, primarily in the AA and AA- sets.

The point: Because each fund holds varying exposures to equity and derivatives, their return capacity and volatility will differ. In consequence, the risk level of each fund is very different.

How balanced advantage funds help

Balanced advantage funds straddle the gap between equity savings and aggressive hybrid.

  • For a 1.5-3 year timeframe: Balanced advantage funds are more aggressive and have the potential to deliver higher returns than equity savings funds over periods longer than 1.5-2 years. For aggressive investors, they present a better alternative to pure debt funds for such timeframes. However, ensure that these funds are not the only component in your portfolio – use them in addition to pure debt funds. Conservative and moderate risk investors can stick to equity savings and pure debt funds.
  • For a 3-5 year timeframe: Given their hedging and ability to adapt portfolios to market scenarios, balanced advantage funds do not fall as much as hybrid aggressive funds do. More, the hybrid aggressive category has been fading over the past couple of years; many have fallen more than large-cap equity funds in years such as 2018. Consistency in their performance is also taking a beating, and their portfolio strategies – such as moving into mid-caps for higher returns – require a longer holding period than 3 years. So in the place of these funds, you can opt for balanced advantage funds, across risk profiles, and blend them with debt funds and large-cap based funds for a diversified portfolio.
  • For very long-term portfolios, if you are an aggressive investor and you wish to keep debt allocations lower than what is necessary, a balanced advantage fund can work well to fill the gap. They can help reduce portfolio volatility and to this extent play part of the role that debt does. So you can partly reduce debt exposure in favour of these funds. Ensure that you do not completely replace debt allocation – use balanced advantage funds along with debt funds.

Selecting balanced advantage funds

While this category is versatile, picking the best fund can get tricky because of the differences in each fund. So keep the following points in mind when looking at funds:

  • Don’t compare returns without looking at underlying portfolio allocations.
  • Have a clear objective before you choose a fund in the balanced advantage category. For example, if your aim is to hold a fund for dynamic asset allocation and it is for the long term, you would be okay with funds that vary their asset allocation by a wide margin as long as they deliver well across metrics. However, if you are using this category as a substitute for debt or for short-term horizons as explained above, you will do well to see if the fund hedges well or hedges at all. Some like HDFC Balanced Advantage don’t. You will also need to know whether the fund is more aggressive or conservative based on how much it hedges (and how much debt it moves into) on an average.
  • Expense ratios can be a big differentiator between the direct and regular plans.
  • At PrimeInvestor, we avoid funds that are very aggressive or extremely dynamic in this category. We think the intent of this category is to contain volatility and protect downsides on market corrections and we look for funds that can fulfill this role. This is unlikely to be the right segment to look for higher upside.  You can use our Prime Funds or check our MF review tool for our view on funds you hold in this category.
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16 thoughts on “What you should know about balanced advantage funds”

  1. Dear Bhavana
    Thank you for the insightful article.
    BAFs are being pushed to conservative risk averse investors who would want better annual returns than FD in the range of 8-10% after TDS. BAF achieves this by selling equity when the market is high and capitalising on short term debt and buying equity when the market is low. This way they can reap the returns from both debt and equity.
    However as per your article BAF is for aggressive investors. It is sad that consumers are being misled by the advisors.
    I also see that BAF performed very poorly in 2018 and there was capital errosion as well. What was the reason for this poor performance, if you could please explain. Moreover even in a good market,it has given returns lower than blue chip equity. Would you please also explain why for my understanding.
    How is the Tata Balanced Advantage fund as compared to other ?
    Look forward to your advice.
    Thanks and Regards

    1. Bhavana Acharya

      Balanced advantage funds are not only for high-risk investors. They can be used by any investor, but what the investor is using it for is very important. For example, conservative investors can use it to get higher returns than debt funds, but without taking the high risk of pure equity funds (assuming the timeframe is longer). The key is blending these funds with others, as explained in the section on How balanced advantage funds help. Second, each fund is different in terms of the way it hedges and takes equity calls, so the second important factor is to know what the fund does.

      Because these funds have equity exposure, they will see losses. Just that the extent of loss and the extent of volatility will be much lower than pure equity funds/aggressive hybrid funds. These funds cannot deliver more than equity funds, especially when markets are rallying higher. Their portfolio necessarily has debt and most funds do some amount of hedging. This debt and hedging help contain losses when markets fall but will also limit gains when markets rise. – Thanks, Bhavana

  2. Hi Bhavana
    I had heard about variations in DAA/BA Funds but didn’t come across a single article which explains it clearly. Thanks for doing it.
    What represents hedging / futures in the fund portfolio? I was trying to look for but couldn’t find, perhaps I am unaware of the terms used for futures in the fund portfolio. Please help.

    1. Hello sir,

      Typically, the hedging is in the form of futures and options, which will be collectively noted as derivatives in fund portfolios. Funds hedge by using futures on the stocks which they own in their portfolio in the spot market; they buy in spot and sell in future. You may find more explanation here.


      1. romil_vakharia

        Very insightful article!

        In terms of risk-return profile, what is the difference between conservative DAAF (DSP) and Equity Saving Funds (Kotak) as it seems both have similar strategies?

        DSP DAAF has much lower expense ratio as well.

        1. Equity savings typically have lower net equitye xposure and therefore lower volatility. thanks, Vidya

  3. Hi, Good article.
    I understand most these funds try to ‘buy low’ and ‘sell high.’ But there are some, like Edelweiss BAF, which are ‘pro cyclical.’ Could you comment on that.

    1. Instead of getting carried away by terms like pro-cyclical (which is essentially saying being one up on street), suffice to say that they follow rule-based inevsting based on triggers/alerts that their rules throw them. The fund has had its bad days in earlier years and turned around in recent times. Nothing is lasting in tactical/momentum calls. thanks, Vidya

  4. what is hedging of equity ?
    Is 65% exposure in equity is mandatory in this category ? if yes- see data where exposure is less than that- please throw some light on that?
    standard deviation higher /lower wrt BA/DAA category ?how to see ?

    1. Hello sir,

      Hedging in an equity fund happens when the fund covers the equity risk by using stock futures. When a fund buys a stock, it could go up or down. To offset this risk, the fund goes for stock futures and locks into a price. For a fund, the open equity (unhedged equity) is the extent of equity exposure that is not covered by this derivative holding. The tables in the article show the open equity exposure only.

      For tax purposes, the derivative holding is counted as equity. It is not mandatory for BA/DAA funds to have 65% in equity (derivative+open equity). These funds will be less volatile than hybrid aggressive and pure equity funds, but are more volatile than equity savings funds.


  5. Nanda Kumar Rajaram

    Thanks for sharing the analysis. You have ICICI Pro BAF – in Prime Funds, presume there is no change to that recommendation ?

    1. Hello sir,

      We review Prime Funds on a quarterly basis and undertake changes if necessary. We explain the changes and give updates on the list in our quarterly product updates.

      ETA: Request you to please also mail us separately using this form for queries on any of our recommendations.


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