Learn all about Balanced Advantage Funds with Radhika Gupta

Balanced Advantage Funds (BAF) is a type of mutual fund scheme that invests in both equity and debt instruments and falls under the hybrid mutual fund category. It is important to remember that there is a difference between hybrid mutual funds and balanced advantage funds. Basically, hybrid mutual funds are a broad category under which you can have many funds that invest in both equity and debt instruments. Thus, balanced advantage funds are a type of hybrid fund. These funds dynamically manage their equity and debt exposure such that fund managers can take advantage of market rallies through the equity investments in the portfolio and dynamically increase exposure to debt to protect portfolio downside when markets fall.

Also Read: What are Hybrid Mutual Funds

In this episode of Fun n Learn Fridays with 5paisa, we discuss Balanced Advantage Funds with Radhika Gupta, MD and CEO Edelweiss AMC. In a career spanning over 15 years, Radhika has worked at one of the world’s leading consulting firms (McKinsey & Company), at the world’s largest Systematic Asset Manager (AQR Capital), founded her own alternative asset management firm (Forefront Capital Management), and become the youngest and only woman CEO of an AMC in India and Board Member of the Association of Mutual Funds in India (AMFI).
 

Entire Interview -

1.  Hybrid, as the name suggests, is a mix – in this case, it’s a mix of debt and equity. There are debt hybrid funds, there are equity hybrid funds, and then there are Balanced Advantage Funds. What makes them the star of the category?

Balanced advantage funds have two main attributes that make them the star of the category.
  i.            They solve the needs of a wide range of investors
  ii.            They are timeless

The amount of equity in balanced advantage funds can vary between 30% to 90% and can even go above 90% at times. From that perspective, it gives you exposure to the two main asset classes, i.e., equity and debt and takes care of how much to invest and when to invest.

Most people invest with the objective of generating returns while protecting their portfolios from extreme losses. BAF solves these twin objectives very well. Also, we all know that if we want to create wealth, we should ideally stay invested for a long period of time. However, when markets correct, it can become very challenging to stay put in the market. BAF can help investors stay put as it smoothens the volatility caused by equities.

2.   Often when we read about Balanced Advantage Funds, there are some key phrases that pop out – all season fund, your partner in market ups and downs, etc. What does this really mean? How is BAF managed and how is the allocation moving? Also, how can we choose the best balanced advantage fund?

When you are looking to invest in the best balanced advantage fund, there are three things that you must focus on:

·       How the fund chooses between equity and debt: In most established BAFs, the exposure to equity and debt is model driven. This means that the fund manager does not really take a call on how much to invest in equities and how much to invest in debt. This is a good thing because humans are inherently biased and these biases can have a negative impact on investment decision making. The formula for deciding allocations could be P/E, market momentum, or even proprietary in nature. However, it will impact the type of markets you do well in and the type of markets in which you do not do well. Many BAFs have documentation on this formula and methodology and, while choosing the best BAF, this is something that you must review.

·       How is the equity portion being managed: This is similar to understanding a large-cap mutual fund or a mid-cap equity fund. Look at the number of stocks in the portfolio, understand whether the fund manager is following a growth strategy or a value strategy, etc.

·       How is the debt portion being managed: It is equally important to understand how the debt portion of the fund is being managed. Since the debt portion is primarily for downside protection, you must ensure that it does not have any credit risk or duration risk.

3.  Is it really for every kind of investor? Would a risk averse poet and an aggressive kabbadi player both be able to reap the advantages of Balanced Advantage Funds?

BAF is a great starting point for anyone who is entering equities. To put it simply, it is like the shallow end of the pool as it lets you get your feet wet in equities. Generally, equities are considered as long-term (more than 5 to 7 years) vehicles of growth. However, if you stay invested in BAF for even 3 to 4 years, it is highly probable that you will have a positive outcome. These chances of a positive outcome become even better if you choose to invest in BAF through Systematic Investment Plans (SIPs) since SIPs can help to reduce equity market volatility.

BAF can be used in multiple ways in your portfolio

·       For all investors, it takes care of basic asset allocation as it is a mix of two major asset classes.
·       For a conservative investor, BAF can be used as a core and can take care of your equity exposure. Basically, it can give you large-cap like exposure but with a little more protection.
·       For an aggressive investor, while it cannot replicate the mid and small cap exposure, it can amplify portfolio returns.
·       For young investors, who have not yet had any experience with equity markets, it is a great way to start investing in equities.
 

4.  Can BAF become an ideal replacement for Fixed Deposits?

BAF is not a replacement for fixed deposits (FDs) since FD is a fixed-income instrument, i.e., you are guaranteed an income and you will not lose money. From that perspective, BAF has an equity component and it is possible that your investments in BAF can lose money, especially over a shorter time frame of 12 to 18 months. However, over three years, you are likely to have a really good outcome.

While BAF cannot replace FD investments, it is a good starting point for someone who is looking to move out of FDs and into equities.

BAF can also be used as a Systematic Withdrawal Plan (SWP) if you want to supplement your income. While an SIP helps you to systematically invest in a fund, an SWP can help you systematically withdraw your money from a fund. An SWP can help you supplement your current income if you are a working professional or act like a monthly income in case you are a retiree. However, there are two things that you need to take into consideration if you are planning to set up an SWP.

One, don’t start your SWP on day one because you need to give it time to accrue returns. And, two, don’t set up a very aggressive SWP on BAF. An SWP of around 6% should be good.

5.  What are the risks in Balanced Advantage Funds?

We must always remember that BAF has an equity component – 50% on average. Thus, BAF can lose money. A good outcome is when the equity market is down 30% and your investment in BAF is down 10 – 12%. A bad outcome is when the market is down 30% and your investment in BAF is down 25%. Also, look at the credit and duration risk in the debt portion of BAF.

The bottom line is that BAF is a 3+ year investment and can have negative returns in 1-2 years.