What are retirement portfolios made of? At a minimum, a retirement portfolio should contain a debt component for stability and to draw periodic income from, an equity component to allow the portfolio to grow and keep up with inflation, and importantly a rebalancing plan to optimise growth and stability. (we are not talking about physical assets here).
If this is the need, what if we use a balanced advantage fund, which invests in both debt and equity, and the fund manager takes care of asset allocation as well? Does that reduce your job to just coming up with a withdrawal plan? And are there any hidden risks in going with this seemingly ready-made solution?
In this article,let’s look into how a full-fledged retirement income generation plan from a balanced advantage fund stands against one from a managed equity and debt portfolio.
Portfolio 1: Balanced advantage fund
Balanced advantage funds, as an official mutual fund category, came into existence after SEBI’s classification of mutual funds in 2018. A typical balanced advantage fund has an effective equity exposure anywhere between 30% to 80% based on the fund manager’s perception of whether equity is overvalued or undervalued. It is important to note that each fund house will have different metrics to assess this.
Now, this category is officially in place only for the past 6 years. But we need longer data to assess the feasibility of balanced advantage funds as a retirement product. Therefore, we picked a fund that chose to be a balanced advantage fund even before SEBI’s category came into being, making it a pioneer in this category. We are talking of ICICI Pru Balanced Advantage (which was first launched as ICICI Pru Equity and Derivatives Fund) For the period we have chosen, from January 5, 2007, to July 5, 2024, the fund has given a CAGR of 11.49%.
Portfolio 2: Separate equity and debt funds
For this portfolio, we have selected funds with similarly long track records from the same fund house. The equity fund chosen is the ICICI Prudential Value Discovery Fund, and the debt fund is the ICICI Prudential Short Term Fund. We have used different asset allocations, which will be explained in the Analysis section below.
For the period from January 5, 2007, to July 5, 2024, the ICICI Prudential Value Discovery Fund delivered a CAGR of 17.04%. The ICICI Prudential Short Term Fund has achieved a CAGR of 8.19% for the same period.
Rebalancing plan
In an asset-allocated portfolio, rebalancing is done to take profit from inflated assets or to add to an asset that is available cheaply. This can be done on a rule-based approach, such as once a year, if the asset allocation has moved in either direction by a certain threshold, bringing it back to the original allocation. For example, in a 60-40 Equity-Debt portfolio, if equity goes up to 65% or above, you would sell part of the equity and buy debt to bring the total allocation back to 60-40. Similarly, if equity drops to 55% or below, you would sell part of the debt and buy equity.
However, since our two-fund retirement portfolio is quite minimalistic, we cannot allow selling debt to buy equity, as the debt fund is what we are counting on to meet future monthly withdrawals. (In an advanced retirement portfolio, there can be separate components to take care of periodic withdrawals and debt as part of the long-term portfolio to carry out rebalancing.) Hence, in our two-fund portfolio, rebalancing is done only if equity gets inflated. Redemption of equity is done when the equity asset allocation goes up by more than 5% from the original allocation, and this will be invested into debt.
Analysis
For our analysis, we started with an initial capital of Rs. 1 crore and tested initial annual withdrawal rates of 4%, 5%, and 6%. In each case, we applied an annual increment of 6% to the withdrawal amount to adjust for inflation, as typically done in retirement portfolios.
For example, with an initial annual withdrawal of 4% per year, the monthly withdrawal would be Rs. 33,333 (4% of Rs. 1 crore / 12).
In the second year, the monthly withdrawal would be Rs. 35,333 (106% of Rs. 33,333).
In the third year, it would be Rs. 37,453 (106% of Rs. 35,333). And so on.
The monthly withdrawal at the end of the period would be Rs. 89,759.
Please note that taxes have not been accounted for in this analysis.
Portfolio transactions
For Portfolio 1, the initial capital of Rs. 1 crore was invested in the ICICI Prudential Balanced Advantage Fund on January 5, 2007. Withdrawals began from the same fund starting from January 5, 2007, lasting till July 5, 2024.
For Portfolio 2, we considered two different asset allocations: a 50:50 equity:debt and a 30:70 equity:debt ratio. The initial capital of Rs. 1 crore was allocated to the ICICI Prudential Value Discovery Fund and ICICI Prudential Short Term Fund according to the chosen asset allocation. Monthly withdrawals were initiated from the ICICI Prudential Short Term Fund starting from January 5, 2007, to July 5, 2024.
Every January 5th, the portfolio’s asset allocation was reviewed. If the equity portion had increased by 5 percentage points or more from the initial allocation, it was rebalanced by redeeming from equity and reinvesting into debt to maintain the original allocation.
Here is how the results stands:
Metrics for evaluation
- Balance Capital: The remaining amount in the portfolio after all withdrawals have been made.
- Balance Capital Growth Rate: The annual growth rate of balance capital, after all the withdrawals in this period.If this rate keeps up with inflation (assumed at 6% in this analysis), the portfolio is likely to sustain future income generation. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, we started with Rs.1 crore and ended with Rs.1.57 crore. For a period of 17.5 years, that is a growth of 2.63% per annum.
- Final Withdrawal: The annual withdrawal rate in the last month under observation based on the balance capital. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, the final redemption is Rs.1.35 lakh, the remaining capital is Rs.1.57 crore. This is 0.855% per month or 10.26% per year.
- Withdrawal Risk: The percentage of observations throughout the income generation period (17.5 years in this analysis) where the annual withdrawal rate exceeded the initial withdrawal rate. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, out of the 211 months when a withdrawal was done, only 11 times the withdrawal was below 6% (annual rate) of the remaining capital. At 200 months, the withdrawal amount was above 6% (annual rate) of the remaining capital, resulting in a withdrawal risk of 94.8% (200/211).
Among the metrics, one needs to make the distinction between final withdrawal rate and withdrawal risk. Withdrawal risk points to the stress the portfolio underwent in generating retirement income during the period under observation. The lower the value, the less the risk. Final withdrawal rate points to future risk. A higher final withdrawal rate compared to the initial withdrawal rate indicates capital erosion in the portfolio, risking future income generation.
Findings
Case: 4% withdrawal
All three portfolios comfortably sustained the 4% initial withdrawal rate, as evidenced by the growth in remaining capital above the 6% annual increment in withdrawals. The final withdrawal rates were lower than the initial rate set for all portfolios. However, when examining withdrawal risk, the Balanced Advantage fund portfolio exhibited a higher risk (41.7%) compared to the asset-allocated portfolios.
Case: 5% withdrawal
In this case, the Balanced Advantage fund portfolio appears stretched in its ability to provide retirement income. The remaining capital grew below the rate of increase in withdrawals, and the final withdrawal rate exceeds the initial 5% withdrawal rate. The withdrawal risk is very high at 94.3%, indicating high stress in the portfolio to generate income in the period.
In the asset-allocated portfolios, the 30:70 Equity:Debt portfolio managed to maintain its sustainability for retirement income withdrawals. Its capital grew at nearly 6%, and the final withdrawal rate was slightly below the initial rate. However, with a withdrawal risk of 56.87%, there was notable stress in meeting income needs during the period.
Meanwhile, the 50:50 Equity:Debt portfolio has comfortably managed to withstand the withdrawals.
Case: 6% withdrawal
In this case, both the Balanced Advantage fund portfolio and the 30:70 Equity:Debt portfolio faced stress due to higher withdrawals. However, the Balanced Advantage Fund portfolio experienced more stress than the 30:70 Equity:Debt portfolio, as evidenced by a final withdrawal rate 2.5% higher than the latter. Additionally, the withdrawal risk of the Balanced Advantage fund portfolio was over 10 percentage points higher than that of the 30:70 Equity:Debt portfolio.
Meanwhile, the 50:50 Equity:Debt portfolio managed to withstand the higher withdrawals in this scenario as well, although its performance was not as strong as in the 5% withdrawal case.
It is interesting to note that the asset allocated portfolios fared better than the Balanced Advantage fund portfolio, even the one with just 30% Equity allocation. If we look at the weighted average return of a 30:70 ICICI Prudential Value Discovery Fund:ICICI Prudential Short term fund for the period of analysis, we get 10.85%, which is less than the 11.49% the ICICI Prudential Balanced Advantage Fund has generated. To see what worked in favour of the asset allocated portfolios, we looked further at the portfolio rebalancing for various withdrawal cases. The below are the years in which the portfolio was rebalanced, or redemption from Equity was carried out to add to Debt.
In general, in the two equity and debt portfolios we have given, withdrawals are from debt. But since they undergo rebalancing, given below are years when Equity was redeemed as part of rebalancing in the asset allocated portfolio.
There are some interesting observations here.
- Even an asset allocated equity debt plan can cause stress to the portfolio by way of high withdrawals. Take the case of 6% withdrawal for the 30:70 equity:debt portfolio - it saw a final withdrawal of 7.7% and in 83% of the instances the withdrawal was higher than the initial rate of 6%. Not a good thing. But here is the big positive. A rule based asset allocation strategy prevented redemption of equity at crucial points like beginning of 2009, during the global financial crisis, beginning of 2012, Eurozone crisis, beginning of 2017, post demonetisation, when equity markets were under stress. All these points were followed by a market rally, although to be known only in hindsight.The fact that withdrawals were from debt prevented unnecessary tampering of equity, allowing it to once again settle and grow. In any managed portfolio, periods when equity is available cheap is when we should avoid redeeming from equity and if possible, add to equity.
- In a balanced advantage portfolio too, it is likely that a fund manager will increase equity at this point and rightfully so (though we don’t have portfolio data for the older periods). However, if an investor has mandated a withdrawal from this fund, more equity will inadvertently be redeemed at this point, not allowing the same to be added/deployed (in equity). This has likely caused the balanced advantage fund portfolio to underperform 30:70 Equity:Debt asset allocated portfolio, despite having higher equity allocation, generating high internal returns, and having a fund manager oversight to assign equity and debt.
Simply put, not withdrawing from equity, when the market is low has allowed the equity:debt portfolios to outperform the balanced advantage fund. That leaves these portfolios with higher corpus for future income generation.
If you wish to do more analysis on this, by tweaking asset allocation, withdrawal rates etc; please use the spreadsheet below:
Conclusion
Here are the takeaways from this analysis:
- In a robust retirement plan, it is essential to implement checks and balances to avoid redeeming equity during unfavourable market conditions. Opting for a balanced advantage fund portfolio forfeits this flexibility available to portfolios with separate equity and debt components.
- Our analysis reveals that a rule-based withdrawal and reallocation strategy can potentially extend the lifespan of your retirement portfolio with lower risk compared to a simplistic portfolio solely reliant on balanced advantage funds.
When it comes to critical goals like retirement planning, it's crucial to develop a comprehensive plan that considers personal circumstances and market uncertainties. Consider seeking assistance from financial planners, where necessary, to ensure your plan is well-suited to meet your long-term financial objectives.
We have also separately written about the shortcomings of using balanced advantage funds for SWP (Systematic Withdrawal Plans) in an earlier article, Should you use balanced advantage funds for SWPs? - PrimeInvestor.
38 thoughts on “Should you use balanced advantage funds for generating retirement income?”
Thanks for article. i did this calculation for 6% withdrawal case for 17,5 years exactly in the manner described for icici BAF which had CAGR of 11.58% in the time period taken. Still after all withdrawals as mentioned at the end one was left with significantly higher amount close to 2.18cr instead of 1.57cr as mentioned in the article table. This is a significant difference !
Also for the 50:50 allocation rebalance case DIY portfolio in 6% withdrawal case the end corpus was only around 3cr instead of 3.31cr stated. (the internal return XIRR in this case is 12.7% which is made up of 50% eq 17.04% and a 50% debt of 8.1x% resp for time period.
Hello,
Looks like you applied constant returns throughout the period; when you do like that, it takes away the volatility, which is the real risk when we have to make constant withdrawals.
For example, when we assume constant returns, the ICICI Bal advantage fund’s NAV will be approximately up 27% between 5-Jan-2007 and 5-Mar-2009, in reality, it was 24.7% down during the period. You can imagine what is the impact of this when we apply fixed rupee value redemptions on that NAV.
The core point of this article was that in real life, if we set a blind withdrawal strategy, it may force you to sell equity at unfavourable points. When we do an analysis without accounting for volatility, there are no unfavourable points as the investment grows at a steady rate. This is one reason why analysis where consistent withdrawal is involved, it is better to be done with actual historical data or with some other methods that accounts for volatility.
You can download the spreadsheet given in the article and go through the sheet ‘Calculation’ for more details.
Thanks
Thanks much again for immediate reply 😉 Got it.
i somehow missed the XLS download link in the article with real NAV values to check it out.
Yes, investor behaviour plays important role in MF redemptions.
thx again
Bipin ji,
1 last Query here (thx in adv) :
1) BAFs use a hybrid Nifty 50:50 composite index or Crisil 50:50 hyb as benchmark . Where do one get the past historical data for these benchmarks say in last 10/15 or 17.5 yrs as in this case?
Just want to know how the 50:50 hyb passive/benchmark index perform in terms of returns, volatility and whether they atleast beat the benchmark in terms of returns
Hello,
Historical data of indices should be available from financial data providers like Crisil itself, or Icra, however, this may not be a free service. Alternatively, if you are looking for a benchmark to do your own analysis, you can look at NSE historical data. Which is available in the public domain. You can use the indices available or use multiple indices to blend and make a custom index that reflects a preferred asset allocation.
Thanks
1. Any specific reason the value fund was considered and not a large or large and mid cap fund?
2. I am wondering why is it that equity was redeemed more often in the 50:50 portfolio than in a 30:70 portfolio. I get that these are two separate portfolios, but it’s the same equity fund.
If the equity valuation was rising and the threshold of 50% was hit, should it not have hit the 30%?
Is this because of the base effect of having a higher equity proportion to begin with, or something else?
In other words, is it because it’s easier to move up 5 percentage points when you start with 50 than with 30?
Hello,
1. No, there is no specific reason. Any fund with NAV history over the period of analysis can be used. NAV history can be replaced in the sheet ‘Calculation’, column B, C, and D and the sheet will calculate results using the news funds history.
2. Your thought is correct. In an example case of 0% increase in debt, a 22.22% rise in equity is required to make 5% excess in a 50% equity portfolio, however for a 30% equity portfolio to become 35% equity with 0% increase in debt, a 25.64% rise in equity is required.
Bipin and team,
Thanks for this wonderful analysis. As you rightly said personal factors and taxation does play a huge part, but the core insight that not redeeming the equity units under stress does play a significant role in the sustenance of one’s retirement portfolio is indeed fantastic.
I was dabbling with the idea of why not a conservative hybrid fund for regular withdrawals (like PP DAA, which additionally has favorable tax treatment). But as you said having separate debt and equity portions does makes great sense. It’s safe to see these hybrid funds (even though conservative) as part of one’s equity portfolio – used for hedging.
With separate equity and debt allocations, during the yearly rebalancing time, one can draw the expenses for upcoming year from equity part if it needs pruning, else one can draw it from the debt portion. Of course there are many variants like having multiple funds in equity part (say passive funds forming core part, hybrid funds for hedging) and debt part (say arbitrage funds for better taxation) etc based on one’s preferences and needs.
Thanks again for this nice analysis.
Thank you! Glad that you find it useful!
Regarding the use of hybrid funds for regular withdrawals, as we’ve seen in this analysis, it is not that it won’t work, but there may be alternatives with different risks and benefits. Of course, one needs to take into account the taxation and the effort they are willing to put in.
As for using inflated equity at rebalancing time for that year’s income, yes, this should also work. Essentially, a dynamic plan that monitors the circumstances on an ongoing basis and makes corrections as needed will likely be better than a totally hands-free approach of putting everything into a hybrid fund and starting withdrawals.
This is truly mind blowing article. Thank you very much for such a detailed master piece!! It would be great if a few of alternatives could be reviewed:
Can following products get considered as part of SWP or profit booking from Equity to debt as part of re balancing:
1. Conservative Hybrid Funds (Tax slab LTCG with 15% net equity but a non issue during retirement)
2. Equity Savings Fund (Favourable LTCG Equity taxation with 30% net equity)
3. Special cases like Parag DAA (Real Estate like LTCG (with new rules) with a potential 15 to 30% net equity)
4. Liquid Fund with 3 year expense (Close to retirement)
Debt is capital preservation but gives poor returns especially if someone is building the debt portfolio for about 10 years. Moving funds to CHF or ES or PPFA DAA like funds during re balancing might make it less riskier during retirement at the same time earning more returns during the process (pre ad post retirement). Also a Liquid Fund with 3 years expense and gets topped up every year to avoid sequence of returns risk from those with Equity exposure.
Your views on this please.
Thanks!
Debt is indeed not the ideal option for the long term. However, it is advised to have some debt allocation in any long-term portfolio to keep overall portfolio volatility at a level the investor is comfortable with, maintaining portfolio hygiene by periodically rebalancing, and the debt allocation can be handy in case of any uncertainties during the accumulation phase.
Regarding moving part of equity to low equity hybrid funds (balanced advantage, equity savings, or conservative hybrid) as a form of profit booking: this is likely to yield better outcomes in a prolonged bull market like the current one, where investors might otherwise book profits too early. However, a detailed analysis is needed to determine if there are advantages in profit booking to low equity hybrid funds instead of debt funds, while maintaining the intended asset allocation.
For example, let’s say an investor is concerned about a huge rally in equity and decides to move Rs. 30 out of the Rs. 100 in equity to a debt fund (case 1).
If they instead move the Rs. 30 to an equity savings fund (case 2), in many such instances, case 2 is likely to outperform case 1.
However, in case 1, we end up with an asset allocation of 70:30 Equity:Debt. If we assume an equity savings fund has a 25% equity allocation, we have a 77.5:22.5 Equity:Debt allocation in case 2.
Now, if we introduce another case of moving only Rs. 22.5 to a debt fund and keeping Rs. 77.5 in the equity fund as part of profit booking (case 3), it has the same asset allocation as case 2.
Will case 2 be better than case 3? That will need a detailed analysis.
Regarding keeping three years of expenses in liquid funds: this is a good strategy to reduce risk in retirement portfolios. In rare periods when both equity and debt markets are correcting together (e.g., August 2013 during the taper tantrum), the investor can use the buffer from liquid funds and allow the long-term equity and debt parts of the portfolio to recover.
Thanks very much for your detailed explanation. I have built my entire core portfolio around Hybrid funds (Aggressive hybrid, BAF and MAF) and this is largely the decision I made after listening to ICICI Pru Shankar Naren that new investors have to be defensive and an easy way to practice asset allocation is choosing hybrid categories that buy ignored assets (debt) at stock market peaks in an unbiased manner and do the opposite at markets crash (like Covid). Unfortunately though some marketed Hybrid products as retirement solutions and a better FD product. Hope articles like yours can bust that myth.
I also realised that products like Equity savings while very good at controlling volatility during known events (recent election result day) do poorly during unknown events like Covid Crash. I compared ICICI Pru Equity savings which did a great job during recent election day volatility but did poorly in Covid crash. For retired I think only way to protect is to ladder by constantly moving from high equity to no Equity allocation via Equity funds & high equity Hybrids to Low Equity exposure hybrids, Debt funds (like dynamic bond funds) and Liquid funds. This way you allow your money to benefit from growth in Equity, reduce your draw downs and have enough cash to live through a market crash.
Your article helped me to solve that one puzzle I had always with Hybrids. I too got carried away that they allow for Smart withdrawal plans but realised now they they won’t work for all seasons. It would be the worst withdrawal plan in a market crash.
It is indeed true that hybrid funds are a good option for beginners, especially in volatile markets. Even for experienced investors, if a hybrid fund’s risk-return profile fits within an investor’s portfolio, they can add the fund. The risk arises when these funds are used as FD alternatives or for periodic income withdrawal, where investors might be taking on more risk than they estimate.
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