Mutual Funds: Ways to manage valuation risk

Balanced advantage funds can lower risk by paring equity exposure.

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Investing in balanced advantage funds can be rewarding for long-term investors as fund managers adjust the equity allocations to capitalise on attractive investment opportunities while maintaining a balance between risk and reward. (IE)

As frothy valuations of many stocks have corrected, fund managers are increasing equity exposure in balanced advantage funds, especially in high-quality companies at reasonable prices. This indicates fund managers’ confidence in the market’s growth prospects and the potential for higher returns.

Investing in balanced advantage funds can be rewarding for long-term investors as fund managers adjust the equity allocations to capitalise on attractive investment opportunities while maintaining a balance between risk and reward. These hybrid mutual fund schemes should be looked at as a part of asset allocation and in the long term, these funds would give better returns than fixed deposits and bonds. Moreover, these funds enjoy equity taxation benefits if their average equity exposure is 65% or more.

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Anil Rego, founder, Right Horizons PMS, says, considering the current market trends, balanced advantage funds are better performing than equity funds. “From the moderate risk profile perspective, balanced advantage funds are highly advisable with the expectation of 8-10% returns.”

Equity valuations tend to swing from favourable to frothy in almost cyclical patterns. Nirav Karkera, head, Research, Fisdom, a wealthtech platform, says while these cycles can present opportunities for upside, they also require effective risk management through allocation. “In this regard, select balanced advantage funds provide investors with a highly efficient and effective route to generate superior risk-adjusted returns in the longer term.”

Most balanced advantage funds are based on valuations. Arun Kumar, VP and head of research, FundsIndia, says, these funds are for people who want higher returns than fixed deposits but are not comfortable with the temporary ups and downs of a fully invested stock portfolio. “It is a compromise between the two, offering lower temporary declines than equities but better returns than fixed deposits.”

Balancing act

These hybrid funds change their asset allocation — equity and fixed income — dynamically according to market conditions. The funds reduce equity and increase fixed-income allocations when equity valuations are high and increase equity and reduce fixed-income allocations when equity valuations are low. “Fund houses are increasing equity exposure in balanced advantage funds as equity valuation is available at a fair valuation compared to the past 18-20 months,” says Hardik Gandhi, chief business officer, Turtle Wealth.

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Investors should consider these funds as they dynamically allocate assets between equities and fixed income instruments. Sonam Srivastava, founder, Wright Research, says this approach allows for capturing market opportunities while managing risk. “These funds’ active management strategy aims to benefit from both upward and downward market trends, thus offering the potential for better risk-adjusted returns compared to conventional equity or fixed income funds.”

What to look out for

Before investing in these funds, investors must factor in the fund manager’s expertise and the investment strategy. It is crucial to assess the fund’s asset allocation approach to ensure that it aligns with one’s investment objectives, risk tolerance, and time horizon. Expense ratios and tax implications are other essential factors to consider.

Balanced advantage funds offer fund managers flexibility, ranging from security selection to asset allocation. While this flexibility can be a valuable asset for fund managers, enabling them to deliver higher risk-optimal returns consistently, there is a risk that such flexibility may lead to incorrect decisions.

Karkera of Fisdom says investors must check how well the fund has performed during different cycles from a risk-adjusted performance standpoint. “This evaluation can help investors gauge the fund’s ability to generate consistent returns while effectively managing risk,” he says.

Right Balance

* In the long term, balanced advantage funds give better returns than fixed income products

* These funds rebalance the portfolio between equity and debt at regular intervals

* Such funds enjoy equity taxation benefits if their average equity exposure is 65% or more

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First published on: 17-04-2023 at 00:15 IST
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