SBI Balanced Advantage Fund NFO - Can you create a perpetual cash flow out of this fund?

The crux of all financial planning is to live a 'Financially Independent' life. This literally means that all your basic expenses are taken care of even if you don't work. This can only happen if you build your investments in such a way that they give you regular monthly cash flows that take care of all your basic lifestyle needs.

If you are starting your career, you can aim to reach this stage at the age of 40. If you are ending your career, you have no other option but to reach this stage at 60. But honestly, is such a thing as Perpetual cash flow even possible? Read along.

It is NFO season. ICICI Mutual Fund completed an NFO last month where they collected almost Rs.10k crore in a span of 2 weeks. They were followed by a series of other fund houses launching their NFO's in various categories. All in all, Mutual funds have collected more than Rs.30k crore this year till July'21.

Enter SBI Mutual Fund. One of the largest fund houses in India has recently launched an NFO of SBI BALANCED ADVANTAGE FUND which is expected to be one of the largest NFO's this year. Wondering whether you should invest in it?

I generally do not advocate investing in NFO's since there are already existing mutual funds in the same category with a past track record available. So investing in any NFO will only make sense if the fund brings something new and unique for the investor.

Read this actual conversation I had with a fellow investor where I answer all her queries on SBI Balanced Advantage Fund and how to build perpetual cash flow out of it.

Q. What are Balanced Advantage Funds?

A. ??BAF's allocate your money dynamically between Equity and Debt (including Arbitrage) based on various parameters such as valuations (P/E, P/B, etc.) and interest rates. This helps reduce the volatility of the portfolio. Currently, most BAF's have ~35% allocation to Equities.

Q. Does the reduced volatility impact my returns?

A. ??Definitely. Risk and return go hand in hand. If you want to reduce risk, you reduce your return expectations. A better way would be to look at Risk-Adjusted Returns and not absolute returns.

Q. What do you mean by Risk-Adjusted Returns?

A. ??Good question. If you assume that each day since the fund started, a new investor invests into a mutual fund, and exits exactly after 5 years, you will be able to capture the 5Y returns of all investors in that Mutual fund. This is called rolling returns.

Since data for the BAF universe is not available since 2004, I have considered the Hybrid Equity category. Here, you can see, that no investor has earned a negative return if invested for 5Y. The probability of earning a return of 8% and above was almost 80% in these funds. These are called risk-adjusted returns. BAF's are more conservative than Hybrid Equity funds.

Q. Why SBI Balanced Advantage Fund?

A. ??A balanced advantage fund will dynamically allocate your investment between Equity and Debt (+Arbitrage) depending on market valuations (they have various parameters to assess valuations and interest rates). This reduces the downside risk of such funds and also reduces their volatility.

????????SBI Balanced Advantage Fund can potentially go up to 0% equity, a feature that is not available with most of the existing mutual funds. It also has an option to add up to 10% allocation to REITs and InvITs. This feature too is not available with most existing mutual funds in this category.

Q. What factors drive the asset allocation in the fund?

A. ??There are various factors that affect the asset allocation decision. Sentiment indicators like market breadth, retail participation, mutual fund flows, primary market activities, and Valuation metrics like Trailing P/E, Shiller P/E (cyclically adjusted P/E), Earnings Yield, Bond yield spread, etc.

Q. I am about to retire in the next few years. Can I get a systematic cash flow out of this?

A. ??Yes! You can take a fixed monthly cash flow (like a reverse SIP) out of this fund. To ensure that the cash flow lasts forever, you can explore the following 3 options.

1. Start a cash flow after 1 year, take 0.5% of the invested amount per month.
2. Start a cash flow after 3 years, take 0.75% of the invested amount per month.
3. Start a cash flow after 5 years, take 1% of the invested amount per month.

So if you have invested Rs.10L today, and plan to retire 5Y from now, you can get a cash flow of Rs.10k per month till perpetuity and also see your portfolio value grow.

Q. Is this cash flow of 0.5% / 0.75% / 1% per month guaranteed?

A. ??If you start taking 0.5% per month from an asset with 0% returns, you will still receive this cash flow for 200 months (16-17Y) post which there will be nothing left in the portfolio.

????????Even if the fund delivers a 6% CAGR, the cash flows can last till perpetuity. Here we are talking of an asset class with potential 10% returns. In this case, the cash flow can last till perpetuity and the asset value also will grow. The cash flow will stop if the mutual fund returns are consistently negative for over 5 years. Historically, since 2004, on 80% days, balanced funds have given returns above 8%, and on the rest 20% days, they have given 0-8% returns. They have never given negative returns over a period of 5 years.

Hence, the chances of cash flows stopping at a point in the future are virtually NIL. In a strict arithmetic sense, they are negligible.

This is the actual performance of ICICI Prudential Balanced Advantage Fund since Inception in 2007. On an investment of Rs.1Cr. the investor started a cash flow of Rs.50k per month. After 13 years, the investor has already received Rs.82L via cash flows, and still, her portfolio value is Rs.2.6Cr.

Q. Can’t I take higher monthly cash flows?

A. ??Yes definitely. But if you want your portfolio to last for perpetuity, you will have to take a cash flow lesser than the returns. Assuming a 10% CAGR means you can take a cash flow of less than 10%.

????????Secondly, returns are never linear. So your portfolio needs to build a cushion first so that the cash flows do not come out of your principal invested. A 1y/3y/5y delay in taking cash flows will help in building that cushion.

?Q. What are the tax implications?

A. ??This fund will be taxed as Equity, i.e. 10% of gains (above 1 year). The fund manager has indicated that they can manage the Equity + Arbitrage allocation above 65% comfortably. Only if the allocation goes below that, will the taxation change to debt.

Q. What is the worst-case scenario we are looking at?

A. ??The right way to approach an investment is to always prepare for the worst. History never repeats but definitely rhymes. If we assume that this fund was launched in Feb 2020 (just before COVID hit us), then the maximum drawdown of such funds saw was around 20% when markets corrected by 40%. It took funds in this category 3-5 months to recover this lost ground.

Historically, markets have given a 10% correction almost every year, 15% correction every 3 years, 20% correction every 5 years, and 40% correction every 10 years. The chances of a correction are high when the last 1 year returns are above average. This is why BAF's are required in every investor's portfolio since by their inherent structure they reduce the volatility of returns.

Q. Is there a lock-in?

A. ??No. You can exit whenever you wish to. Partial and complete redemption is allowed. However, if you enter, please do so with a 3-5 year view.

Q. There are other funds too in this category?

A. ??Definitely. SBI BAF is not the first or last one to enter this category. Other funds which we recommend are

????????1. ICICI Pru Balanced Advantage Fund

????????2. Kotak Balanced Advantage Fund

????????3. DSP Dynamic Asset Allocation Fund

????????4. Edelweiss Balanced Advantage Fund

Though there are many existing funds in the BAF category, SBI BAF does bring in some features that are not being offered by other Fund houses. Hence, I will consider investing in this fund if I have a long-term horizon.

If you also add to that the possibility of a perpetual - systematic - liquid - tax-efficient cash flow through SWP then you are looking at an investment that can make a meaningful difference to your lifestyle with better risk management.

The views I have shared are personal and for educative purposes. Please consult your financial advisor before investing.?