Photo: iStockphoto
Photo: iStockphoto

Why balanced advantage mutual funds baffle investors

Don't equate new balanced advantage fund category with the earlier balanced funds

Even after Sebi’s mutual fund categorisation norms have been implemented, some pockets of “interpretation" by asset management companies (AMCs) remain. Sebi’s objective of uniformity in parameters has largely been achieved, but there are a few areas of “flexibility" that confuse investors. 

The concept of balanced funds is fairly simple and understood by investors. The fund invests a major component in equities, and the balance in debt instruments. To the layman, the term “balanced" connotes something around 50:50 allocation to equity and debt. Prior to the new fund categorisation norms, AMCs used to maintain 65% or more in equities to be eligible as equity funds and consequent favourable tax treatment. Under the new norms, there is one category called aggressive hybrid funds, with a mandate to maintain 65-80% in equities. Simply put, this is a tax-efficient balanced fund of earlier days. There is another category called balanced hybrid funds, which are mandated to have 40-60% in equities. These are tax-inefficient balanced funds. 

There is another category as per Sebi norms, called dynamic asset allocation or balanced advantage fund (BAF). The norm says that funds in this category should have “investment in equity/debt that is managed dynamically". Since this is “dynamic", by definition AMCs have flexibility in managing these funds. The cause of confusion is that since funds in this category are termed “balanced advantage", investors who are not so savvy equate these with balanced funds of earlier days. It may be noted that erstwhile balanced funds are now aggressive hybrid funds, and that balanced advantage funds belong to a different category. 

Some AMCs used to run BAFs earlier, which have now been shifted to the new dynamic asset allocation or BAF category. A leading AMC that had more than one balanced fund and didn’t want to merge the two, has shifted one balanced fund to this category, but the fund strategy remains as earlier. So this category has become a potpourri of fund strategies. 

Let’s take a look at the strategies adopted by various dynamic asset allocation funds or BAFs, from their portfolios as of end of July 2018. For clarity, in cash-futures arbitrage funds, there is a compulsion to offset the equity long exposure, whereas in BAF there is no such compulsion. 

The leading fund in this category in terms of assets under management, from a leading AMC, has a long (buy) position in equity stocks to the extent of about 66% of the portfolio, which is offset by short (sale) position of about 35% in those stocks and another short position of about 7% in Nifty futures. The remaining part (100% minus 66%) is invested in debt, money market instruments or cash equivalent. The implication of this strategy is that the net long exposure to equity is 66% (long) minus 42% (short), i.e. only 24%, though apparently the fund has 66% of the portfolio in equity and is eligible for favourable taxation as an equity fund. The interpretation of the portfolio construct is that the fund manager’s view on the market is not very bullish at this point of time, given the current stretched valuations. So the fund manager has gone short on most of the equity exposure to make the portfolio defensive. Going forward, if the view on the equity market becomes bullish, the fund will do away with short positions and net (long) exposure to equity will increase. If the short positions are given up, this fund will be similar to balanced funds of earlier days or aggressive hybrid funds of the current regime. 

There are a few other funds in the BAF category that are following a similar strategy—going short to a certain extent of the equity exposure in the portfolio to make it defensive. They maintain over 65% in equity to enjoy favourable tax treatment, except if it is a fund-of-funds which gets treated as a debt fund for tax purposes, irrespective of the equity exposure. The balanced fund from a leading AMC mentioned earlier has now been categorised under dynamic asset allocation or BAF as they wanted to continue both their balanced funds. It does not have any short position in equities and the equity exposure is 76% of the portfolio. 

Net-net, for any investment, the investor should have clarity about what she is getting into. In this case, one should get into dynamic asset allocation funds or BAFs to go with the fund manager’s calls on the net equity exposure as per his reading of market valuations. To avoid confusion, don’t equate a BAF with the earlier balanced funds. Both the categories have their own merits, and both are eligible for equity-related taxation, but the difference is that aggressive hybrid funds have conventional equity exposure, while BAFs may have a lower net exposure to equity. 

 Joydeep Sen is founder,