Balanced advantage funds are winning hearts; should you invest too?

Since this rebalancing is done using derivatives, they continue to be treated as equity funds for tax purposes and hence attract a 10% long-term capital gains tax for holding periods above 1 year on gains above ₹1 lakh. According to Amol Joshi of Plan Rupee Investment Services, holding a BAF trumps doing one’s own allocation by investing separately in equity and debt funds on grounds of tax efficiency. This is because buying and redeeming from separate equity and debt funds attracts capital gains tax, while the same action has no tax implications if done inside a BAF. In addition, there is a behavioural element. Investors can fall prey to greed in bull markets and fear in market drops and fail to rebalance. In a BAF, the investor takes this decision out of his or her hands and gives it to the fund manager.

Let’s take a look at some popular approaches to BAF management.

DSP AMC: DSP Asset Management Company takes a highly conservative model-driven approach to its balanced advantage fund, placing great emphasis on price to earnings and price to book. The fund manager does not exercise much discretion. DSP BAF hiked its equity allocation following the covid-19 driven market correction in April 2020 and then pared it down in 2021. Its unhedged equity exposure peaked at around 80% in May 2021 but the market continued to rally after this point. At present, the unhedged equity exposure of DSP BAF is around 30% of the portfolio.

Size: ₹4,396 crore

Edelweiss BAF: Edelweiss BAF runs a ‘pro cyclical model’, also known as ‘momentum’ in popular parlance. It uses technical indicators such as moving averages to follow the trend. This causes the fund to dramatically outperform in bull markets such as the post covid-19 rally. However, the inherent risk is the model failing when the market suddenly changes direction. Presently, Edelweiss BAF has 60% unhedged equity exposure.

Size: ₹5,845 crore

ICICI Prudential BAF: Like DSP AMC, ICICI Prudential AMC also runs a countercyclical model. However, the 4 fund managers in the scheme, Sankanran Naren, Manish Banthia, Rajat Chandak and Ihab Dalwai, take active calls. The fund tilted towards mid and small caps even as it hiked equity allocation when the market went through its first covid-induced correction. More famously, it took on credit bets at a time when the credit markets were in a state of turmoil and Franklin Templeton had announced a shock winding up of its schemes. At present, ICICI Prudentuial BAF has a roughly 31% unhedged equity exposure.

Size: ₹35,737 crore

HDFC Balanced Advantage Fund: HDFC Balanced Advantage Fund, unlike most of its peers, maintains a relatively ‘static’ model. It does not make big shifts between equity and debt through derivatives. Its unhedged equity exposure moves between 65% and 80%. This keeps its returns high during bull markets, but it drops a lot further when markets go down.

Size: ₹43,247 crore

Despite their obvious advantages, BAFs have some limitations. First, their expense ratios tend to be higher than what you can secure by investing in separate equity and debt mutual funds. Second, they tend to be large cap focused on the equity side. Third, most BAFs do not take exposure to international equity or commodities like gold; restricting their ability to generate returns when both Indian stocks and bonds fall. According to Radhika Gupta of Edelweiss, investors should supplement a BAF allocation with separate allocations to international feeder funds, for instance. Fourth, industry insiders allege instances of mis-selling. Persistently low FD (fixed deposit) rates have spurred a hunt for yield and BAFs are sometimes sold as an ‘FD plus’ product.

Finally, Neil Parikh, CEO of PPFAS Mutual Fund, feels that BAFs are not needed because flexicap funds have sufficient leeway to invest in debt or cash under Sebi rules. According to Parikh, if a flexicap fund invests up to 35% of its assets in cash, it can hedge away another 50% equity exposure using derivatives. In 2017, PPFAS Flexicap was 40% in domestic equities, 30% in foreign equities and 30% in cash. “We aimed to build a Swiss army knife with this fund. It can go into foreign stocks when they are attractive and cash or arbitrage (hedging) when they are not, up to 85% of the corpus. We don’t want to complicate the lives of our investors by launching fund after fund."

For now, BAFs have won the argument among investors with recent launches seeing huge traction. SBI Balanced Advantage Fund has swelled to ₹20,000 crore within 2 months of collecting ₹14,676 crore in its new fund offer in August. However, investors should enter this category by keeping various complexities in mind.