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Balancing equity play with Balanced Advantage Fund

Risk-averse investors looking for wealth creation in long-term can opt for these funds as they carry lower risk than pure equity funds

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Even though the premise of a mutual fund (MF) scheme is to reduce risk by investing in a wide variety of stocks, this too may not always be safe. A category of funds, however, maybe the solution for first-time investors into the equity spectrum, which will dilute the risk even further by adding a debt component.

But analysts note that the combination of investment classes also has its own challenges.

"Balanced and BAF (balanced advantage funds) both have a conservative approach, with a preference or doctrine to hold debt or other instruments, along with equity (investments) based upon the market conditions," explains Rajani Tandale, head of mutual fund &TPD at LKP Securities.

"The (equity) markets by its nature are volatile and asset allocation is the key to trounce the uncertainty," said Radhika Gupta, CEO, Edelweiss AMC, who also explained about the utility of such funds.

"A balanced advantage fund is suitable for those investors who wish to participate in equity markets with a relatively conservative approach," explains S Naren, ED and CIO, ICICI Prudential AMC. Both balanced and balanced advantage fund categories can be considered by first-time equity investors.

Any investment growing by 15-20% in a year will make an investor happy, but few of them can take the risk of losing 20%. "Investors who are looking for wealth creation in the long-term with lower volatility in returns and are risk-averse should opt for these funds as they carry lower risk than pure equity funds," notes Gupta. With balanced advantage funds managing equity levels, according to market cycles, the volatile equity ride smoothens and helps new investors gain confidence in equities.

"All investors have emotional biases of greed and fear. When things are good, investors get more greedy and vice versa. Thus to remove these biases, we (MFs that offer these sorts of fund categories) use a model that reduces these biases," explains Harish Krishnan, senior VP & fund manager (Equity), at Kotak Mahindra Asset Management Company.

Adopting Safe Strategy

  •  The advantage of Balanced Advantage Funds is they generate superior risk-adjusted returns over pure equity funds and have delivered a compounded annual growth rate of 10-13% over a 10-year period
  •  With balanced advantage funds managing equity levels, according to market cycles, the volatile equity ride smoothens and helps new investors gain confidence in equities

So, how do you rate BF and BAF categories vis-à-vis their pure-play counterparts, i.e. pure equity or pure debt MFs?

In pure equity funds, you should be ready for high risk and volatility. Generally, equity investments have to be for a longer duration period.

Under pure debt funds, it generally generates single-digit returns and should be invested for a minimum of three-year period for taxation benefits.

"BAF and hybrid could be best of both the worlds," notes Tandale, adding that such funds have given a CAGR (compounded annual growth rate) of 10-13% over a 10-year period.

In the long run, pure equity has always delivered higher absolute returns compared to any other asset class but the same might not be true in different market cycles. "The advantage of Balanced Advantage Funds is they generate superior risk-adjusted returns over pure equity funds," notes Gupta.

But to be sure, there are challenges too with this sort of scheme.

"These funds lose out on optimising their returns on debt component. Almost, all funds are managed by equity fund managers and, hence, debt fund management isn't as actively done as is needed," says Jharna Agarwal, head, Anand Rathi Preferred, noting some of the institutional lacunae about the BF and BAF fund categories.

"Hybrid (funds) are always an underperformer compared to equity funds in a bullish market," says Tandale.

"In the near-term, when equity or debt markets move significantly, these funds will tend to under-perform pure equity or pure debt funds," says Krishnan, who notes that such funds are best suited for equity investors with a long-term investment horizon.

"We have seen many clients go for dividend payout options while investing in balanced funds. This is counterproductive for their returns," says Agarwal.

There is a 28% dividend distribution tax which is deductible by the mutual fund company – the company that operates the MF). Hence, every time when a dividend is paid as returns, a significant amount is paid by the AMC in the form of taxes from the fund's corpus.

Instead of this, if clients choose a Systematic withdrawal plan on the equity funds they would pay only 15% and 10% respectively in the short- and long-term. On debt component, they pay marginal tax and 20% with indexation benefit in the short and long-term, respectively. Thus, the systematic withdrawal plan has a positive impact on post-tax returns of the portfolio.

"These funds (BF, BAF) enjoy equity taxation as they fulfill the criteria of having a minimum 65% exposure in equities which is mandatory to classify as an equity fund," explains Gupta.

Even when these funds reduce equity levels to 30% it is through hedging that gross equity levels remain more than 65% and hence, they qualify for equity taxation. If the investment tenure is more than one year, long term capital gain tax of 10% is applicable after Rs. 1 lakh of capital gain. If these funds are held for less than 12 months, gains are treated as short term capital gain and taxed at 15%.

There is certainly a dividend option that is available for such funds. "However, it is important to remember that payment of a dividend is subject to availability of distributable surplus and Trustee approval," says an expert.

"Investors need to look at their risk appetite, before going in for such funds," ends Tandale.

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