Do not shun equities, go for Balanced Advantage Funds (BAF)

A volatile phase in equities market is a cause of worry for many. After two years of unidirectional upward movement in the stock prices, many are wondering if the bull run is over. This is especially for true many first-time investors who have not seen volatility in stock prices. Expected delay in interest rate cuts, economic slowdown, change of guard in the US, slower corporate earnings growth and rising geo-political tensions are adding to investors’ anxiety. Stocks are getting battered if the earnings reported fail to match analysts’ expectations for the quarter.

In this backdrop, we have seen some stocks falling as high as 30-40% from their recent highs. No wonder, we have investors in two minds about investing in equities. While a few may want to run away from equities, there is a large chunk of investors who keep thinking about a method of taking advantage of this volatility and invest at lower levels in a disciplined manner. While the former is not a seasoned investor the latter understands the equity markets well enough to remain invested. Exposure to equities is warranted in portfolios of most of the households.

Investors can look at balanced advantage funds (BAF).?Let us understand why exposure to BAF makes immense sense now:??

Also known as dynamic asset allocation schemes, BAF invests in a mix of bonds and shares, depending on their relative attractiveness. These schemes’ asset allocation is decided by a rule-based model. This ensures a disciplined approach to investing. Some of these models are counter-cyclical. They invest less in stocks when valuations rise and vice versa. They use valuations parameters such as price to earnings multiple, market cap/ GDP, price to book value, yield gap, to ascertain the attractiveness of stocks. Some BAF follow allocation models which deal with momentum in the markets. If the equities are in demand and they are fundamentally attractive, then the model calls for higher allocation to equities.

To put it simply, whichever model is being employed, a fund manager allocates more to stocks when equities are relatively attractive. If equities are less attractive then the money moves to fixed income. This fixed income exposure is attained in two ways – by purchasing bonds and by investing in spot-future arbitrage. A fund manager allocates money to spot-future arbitrage opportunities to an extent that the net equity exposure and the arbitrage allocation, put together, adds up to minimum 65% of the total assets under management of the scheme. This ensures that a fund is treated as an equity scheme for the purpose of taxation. Gains booked on units sold after holding for minimum one year are taxed at 12.5% rate of tax.

Equity portfolios of BAF include stocks of companies of all sizes. Most of these are fairly liquid stocks. The bond allocation of a BAF includes high quality corporate bonds, government securities and money market instruments such as treasury bills and commercial papers. The approach is to maintain a fairly liquid portfolio which facilitates moving from stocks to bonds and the other way round.

In a range-bound market with interim volatility, these schemes can create volume with relatively less volatility compared to equity schemes. In past three and years ended November 7, 2024, BAF as a category have given 11.31% and 12.82% respectively, as per Value Research. The performance appears muted compared to consistently high equity exposure hybrid schemes such as aggressive hybrids which gave 13.24% and 16.25% respectively. This is because in the past three years equities have been unidirectional with no big corrections.

Investors worried about downside in equities will also find BAF attractive. These schemes can contain downside, compared to diversified equity schemes.

At the current juncture, BAF can be an effective way to invest in stocks. If the markets go down fund managers will have some money hand to buy more. And if stocks offer flash spikes, then fund managers are more likely to book profits. This approach can be beneficial for most moderate risk-taking investors.

Investors can consider investing in BAF offered by ICICI Prudential, Invesco, WhiteOak and Edelweiss mutual funds houses. They can allocate lump sum amounts to these schemes. Systematic investment plans can supplement lump sum investments.

Invest with a minimum three to five-year timeframe. In the longer timeframe, these schemes offer potential to generate reasonable risk adjusted returns compensating investors for risks they take.?

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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