The usual strategy is that the fund invests at least 65 per cent of the portfolio in equity, to be eligible for equity taxation.

There are a set of schemes categorised as Dynamic Asset Allocation or Balanced Advantage Funds (BAFs). Market regulator SEBI’s fund management norm says funds in this category should ‘Invest in equity/debt that is managed dynamically.’ Since this is ‘dynamic,’ by definition, there is flexibility given to AMCs (asset management companies) in managing such funds. Some AMCs did run BAF funds even earlier, prior to the coming of SEBI’s fund management norms, which were implemented in April-June 2018. Those older funds have now been shifted to the BAF category.

How does this category work?  The usual strategy is that the fund invests at least 65 per cent of the portfolio in equity, to be eligible for equity taxation. The balance is invested in debt. In the equity component, while there is the ‘long’ exposure, i.e., purchase of stocks in the portfolio, there is a ‘short’ exposure wherein some of the shares have been sold in the stock futures segment.

Allocation in BAFs

Let us take an illustration. Let us say a BAF fund has a corpus of Rs 100. Of this, Rs 80 is in equity, referred to as the ‘long’ position earlier, and Rs 20 in debt. The fund manager is of the opinion that the equity market is richly valued and intends to reduce the effective equity exposure. Accordingly, s/he goes ‘short’ on, say, half the equity exposure, i.e., takes a sale position of Rs 40 in the stock futures market. The implication of the move is that equity price volatility, either favourable or unfavourable, is cancelled out for half of the equity exposure. The fund has 80 per cent long and 40 per cent short exposure; hence, 40 per cent is the net long equity position. You would ask, how does that help? It helps in two ways.

One, for the unfavourable volatility, i.e., share prices coming down, you are protected for 50 per cent in this example. Two, provided the fund manager’s calls it right, the effective equity exposure (net of short position) is increased when equity valuations are attractive and the protection (i.e. short position or debt allocation) is increased when valuations are stretched.  The concept is like driving speed; in good roads you increase the speed and in bumpy roads you ride carefully.

Does the concept work?

Having seen the concept, let’s come to the usefulness. This calendar year, the equity market has been volatile, which makes a case for checking if this category really works. The equity market peaked on January 14 and bottomed out on March 23.

Did the effective equity exposure modulation offer protection from downside volatility? Between January 14 and March 23, the average return from 24 BAF funds was minus 21.6 per cent. However, this is still better than the minus 34.9 per cent on an average managed by 32 large cap funds, minus 34.6 per cent from 23 small cap funds and minus 34.8 per cent from 36 multi-cap funds.

There are, however, two sides to a coin. BAF funds would lose relatively less on the downside, but would gain less on the upside. During the period March 23 to July 21, the average return from BAF funds was 26 per cent, while that from large-cap funds was 39.8 per cent. Small-caps managed 36.4 per cent, while multi-cap schemes delivered 39 per cent over this period. From another perspective, in this volatile phase from January 14 to July 21, BAF funds have yielded, on an average, minus 1.5 per cent, against minus 9.1 per cent of large-cap, minus 10.6 per cent of small-cap and minus 9.4 per cent of multi-cap.

Deciding on the right fund

How should you pick your BAF? The method followed by various AMCs for deciding the effective equity exposure varies. The parameters used are Price to EPS (earnings per share), Price to Book Value, momentum, trend, volatility, dividend yield, earnings yield, market cap to GDP ratio, etc. Some AMCs have a more objective strategy: the output of the model followed by them, which is a combination of the factors mentioned above, decides the net equity exposure. In some AMCs it is a fund manager-driven approach. So, the fund manager decides the effective equity exposure based on his/her reading of the market. Others will have a strategy combining objective (model-driven) and subjective (fund manager driven) factors.

If you think this strategy of varying the net equity exposure works for you, you have to zero-in on the funds for your allocation. The parameters are the strategy followed and long-term track record. For most of the funds in this category, the track record in the real sense is available for only about two years since the implementation of the SEBI norms. Some AMCs giving a longer track record have a repositioned fund since mid-2018. The ones with a relatively long track record are: (1) ICICI Prudential BAF, which is the pioneer of the concept, moves the effective equity exposure in the range of 30 per cent to 80 per cent, and came into existence in December 2006; it has delivered a 10-year return of 11 per cent annualized as of July 21, 2020 and has a corpus size of Rs 25,400 crore as of June 2020; (2) Franklin Dynamic Asset Allocation Fund has been around since October 2003, and is a Fund of Funds investing in Franklin Templeton’s schemes, but is going through a makeover currently; (3) DSP Dynamic Asset Allocation Fund’s inception was in February 2014; its five-year return is 7.24 per cent annualized, and corpus size is Rs 1,300 crore; (4) IDFC Dynamic Equity Fund started off in October 2014, has a five-year return of 5.9 per cent annualized, and its corpus size is Rs 860 crore; and (5) SBI Dynamic Asset Allocation Fund began in March 2015; it delivered a five-year return of 5.7 per cent annualized, and its asset size is Rs 570 crore.

Source: https://www.moneycontrol.com/news/business/personal-finance/scorecard-of-balanced-advantage-funds-winners-when-markets-correct-laggards-in-rallies-5608121.html