Balanced advantage funds aim to limit the downside and optimise the potential upside in a volatile market
Managing volatility is a function of finding the most opportune time to invest in the market with an asset mix that is expected to generate better risk adjusted returns. However, this is easier said than done. Finding the right time to enter or exit the market and the appropriate asset allocation to benefit from the volatility requires a level of financial understanding and expertise that evades most investors.
This is where a balanced advantage fund steps in. These funds are an open-ended hybrid fund belonging to the dynamic asset allocation or balanced advantage fund category. These schemes aim to limit the downside and optimise the potential upside in a volatile market. This is done by investing in both equity and debt instruments and by managing this exposure dynamically.
This strategy of buying when the markets are low and selling when the markets are scaling highs could help the scheme fall less and gain more than the overall market. Depending on the market sentiments and other factors such as macro-economic data, earnings, valuations, among others, the fund manager decides on the debt and equity exposure in the scheme to make the most of the volatility in the market.
The need for BAF
A balanced advantage fund should be an ubiquitous part of every investor portfolio for the following reasons:
Volatility is here to stay: Financial markets around the world will continue to remain volatile, not least because of the Covid-19 pandemic. Growth uncertainty, geo-political issues, as well as various domestic factors are set to keep both equity and debt markets volatile. To counter volatility, investors need to invest in a fund like the balanced advantage fund which navigates it with expert ease.
Asset allocation: It is difficult for most investors to constantly monitor the asset allocation of their portfolio. The balanced advantage fund manages this dynamically and maintains an appropriate asset mix suited to the prevailing market conditions.
Limiting downside: While everyone is always eager to earn extraordinary returns in a rising market, what is essential for the long-term wealth creation in a portfolio is to limit the losses or declines in a falling market. The basic idea behind a balanced advantage fund is to limit the downside in a falling market. It does this by paring its equity exposure in a rising market and then increasing its equity exposure as markets start to bottom-out.
Eliminates need to time market: Appropriate asset allocation can be achieved by closely monitoring markets and finding the opportune time to invest or exit the market. Investing in a balanced advantage fund does away with this need to time the markets as the fund does it for you and plans your investments accordingly. Investors can leave it to the expert fund managers to find the right opportunities in the market.
Benefits of equity taxation: If the BAF has about 65% of gross exposure in equity and equity-related instruments then the fund will have equity taxation. If it is debt-oriented then debt taxation rules will apply. Most industry BAF schemes follow the equity taxation rules. This means that even at relatively low net equity exposure (long equity plus arbitrage), say 30%, BAF investor can benefit from equity taxation.
By DP Singh, Chief Business Officer, SBI Mutual Fund