MF Tracker. Balanced Advantage Funds: Juggling equity and debt, dynamically

Balanced advantage funds (BAFs) do what the name suggests — they try to strike a balance between equity and debt allocation, based on market conditions and valuation metrics, to achieve optimal returns at less risk.

This, they do in a dynamic manner unlike the static allocation of other hybrid category funds. So, BAFs are also called dynamic asset allocation funds.

BAFs are categorised as equity-oriented funds — eligible for concessional tax treatment — with the overall equity component in the portfolio being at least 65 per cent.

The overall equity component comprises stocks and derivatives/arbitrage opportunities, with the stocks position referred to as net equity. So, BAFs essentially comprise net equity (stocks) that provide high return potential, derivatives that give a hedge, and debt instruments that contain risk.

Hence, the category could generally give relatively moderate returns but with lower risk, compared with relatively riskier pure equity fund categories. The benchmark of BAFs is generally the Crisil Hybrid 50+50 Moderate Index.

Leading the pack

There are many BAFs in the market with varying vintage and track records (see table below). Most funds in the category follow a value-investing strategy (increase equity exposure when markets fall and decrease it when markets rise) that seems intuitive.

Edelweiss Balanced Advantage fund, though, follows a seemingly counter-intuitive momentum approach (increase equity exposure when markets rise and decrease it when markets fall). Many BAFs follow a model-based asset allocation strategy that can help reduce biases such as greed and fear in decision-making.

The Edelweiss BAF with its momentum approach is among the best performers in the category over the past year with returns of about 11.5 per cent. Over the long term, too, the fund has done well with annualised returns of 8-10.5 per cent over five to 10 years. On the other hand, ICICI Prudential Balanced Advantage — the top long-term performer in the category — with annualised returns of 8.5-11 per cent follows a value-investing approach.

The return of the Edelweiss and ICICI BAFs, with relatively lower risk, compares well with the Nifty 50 TRI’s 8-10 per cent annualised returns over longer periods. The funds’ returns are better than the category average over both short and long terms. The funds have also done well on an annual and rolling return basis.

Edelweiss pro-cyclical model

Edelweiss BAF follows a pre-defined asset allocation approach based on a pro-cyclical model — trying to capture the upside during a bull market and containing downside in a bear market.

So, the fund’s average net equity levels have been high during bull markets and low during bear markets. For instance, the fund reduced its average net equity exposure from 59 per cent in January 2020 to 40 per cent in March 2020 when the market crashed; swiftly raised it to 63 per cent in April 2020 when the market looked up; and took it up to 70 per cent by August 2020.

The pro-cyclical approach does well in markets that have trends — up and down — and the fund believes that over the long term, markets move in trends. The fund takes 30-80 per cent net equity exposure with a multi-cap approach (large-cap bias) in quality, good growth stocks available at attractive valuations; it has a large portfolio of about 80 stocks.

In its debt portfolio (0-30 per cent exposure), the fund focusses on accrual and active duration management in relatively high quality corporate bonds.

The fund’s pro-cyclical asset allocation model is based on quantitative factors coupled with fundamentals. It considers factors such as daily moving averages, market volatility and downside deviation of the Nifty 50, market valuations and macro-economic factors.

As of September 2020, the net equity exposure is about 57 per cent, mostly in large-caps — with bluechips such as Reliance Industries, Infosys, ICICI Bank, HCL Technologies and Bharti Airtel being the top holdings. The portfolio is currently overweight on defensives and companies with strong balance sheet, given the uncertain times.

ICICI P/BV model

ICICI Prudential Balanced Advantage fund, on the other hand, follows a model of ‘buying low and selling high’ to capture market upside and limit downside.

The stock selection is a blend of large and mid-cap stocks, with net equity level in the 30-80 per cent range based on an in-house price-to-book value (P/BV) model.

The fund reduces net equity exposure as valuation goes up, and increases exposure as valuation comes down. For instance, when the Nifty 50 P/BV crashed in March 2020, the fund’s net equity allocation went up to about 74 per cent from about 45 per cent in the prior months.

It has since come down to about 60 per cent now with the P/BV rising. The equity portfolio as of September 2020 has about 35 stocks, mostly large-caps while the debt portfolio comprises mostly AA and above rated securities.