Q. I am a 38-year-old dentist working with a private hospital in Lucknow. My wife is a housewife. I have been investing in equity mutual funds for the past 10 years. I now wish to diversify and invest in hybrid funds too. Many of my acquaintances have suggested investing in balance advantage funds. Can you please elaborate on the pros and cons of balance advantage funds.
Afzal Khan, Lucknow, Uttar Pradesh
If you are looking for a mutual fund that can offer you the best of both worlds - equity and debt - then you might want to consider balance advantage funds. These are hybrid funds that use a dynamic asset allocation strategy to switch between debt and equity without any constraints. This means that they can increase or decrease their exposure to equity depending on the market conditions and their own valuation models. The aim is to take advantage of the growth potential of equity while reducing the risk by investing in debt when equity is overvalued or volatile.
How do balance advantage funds work?
Balance advantage funds, also known as dynamic asset allocation funds, do not have any fixed allocation to equity and debt. Instead, they use various indicators such as price-to-earnings ratio, price-to-book value ratio, dividend yield, interest rates, macroeconomic factors, etc. to determine the fair value of equity and debt. Based on this, they decide how much to invest in each asset class.
There are two main strategies that balance advantage funds can follow:
Counter-cyclical: This strategy involves buying equity when it is undervalued and selling it when it is overvalued. This way, the fund can benefit from the low entry point and high exit point of equity, while also earning steady returns from debt. This strategy is suitable for long-term investors who want to avoid timing the market and reduce volatility.
Pro-cyclical: This strategy involves buying equity when it is overvalued and selling it when it is undervalued. This way, the fund can ride the momentum of the market and capture the upside potential of equity, while also switching to debt when the market corrects. This strategy is suitable for aggressive investors who want to maximise returns and are willing to take higher risks.
What are the benefits of balance advantage funds?
Balance advantage funds offer several benefits to investors, such as:
Flexibility: Balance advantage funds can adjust their asset allocation dynamically according to the market conditions and their own valuation models. This gives them the flexibility to take advantage of the opportunities in both equity and debt markets.
Diversification: Balance advantage funds can invest in a mix of equity and debt instruments across sectors, market capitalizations, durations, credit ratings, etc. This helps them diversify their portfolio and reduce the overall risk.
Tax efficiency: Most balance advantage funds have an equity exposure of 65% or above and therefore are consequently treated as equity funds for tax purposes, as long as they invest at least 65% of their assets in equity on an average annual basis. This means that they enjoy lower tax rates than debt funds. The long-term capital gains (LTCG) from balance advantage funds are taxed at 10% (plus surcharge and cess) if they exceed ₹1 lakh in a financial year. The short-term capital gains (STCG) are taxed at 15% (plus surcharge and cess). There is no dividend distribution tax (DDT) on balance advantage funds.
Suitability: Balance advantage funds are suitable for investors who want to invest in a balanced portfolio of equity and debt without worrying about market timing or asset allocation. They are also suitable for investors who want to reduce the volatility of their portfolio and earn stable returns over a long-term horizon.
What are the risks of balance advantage funds?
Balance advantage funds also have some risks that investors should be aware of, such as:
Market risk: Balance advantage funds are exposed to fluctuations in the prices of equity and debt instruments due to various factors such as economic conditions, political events, corporate actions, etc. This can affect their performance and returns.
Model risk: Balance advantage funds rely on their own valuation models to determine the fair value of equity and debt. These models may not always be accurate or reliable and may fail to capture the changing dynamics of the market. This can lead to sub-optimal asset allocation and underperformance.
Fund manager risk: Balance advantage funds depend on the skill and expertise of the fund manager to execute the dynamic asset allocation strategy effectively. The fund manager may make wrong decisions or judgments that can affect the performance of the fund.
Who should invest in balanced advantage funds?
Balanced advantage funds are suitable for investors who:
- Have a moderate risk appetite.
- Are seeking a balance between capital appreciation and income generation.
- Do not have the time or expertise to actively manage their portfolio.
Things to consider before investing in balanced advantage funds
Investment horizon: Balanced advantage funds are best suited for long-term investment horizons of at least 5-7 years.
Risk profile: While balanced advantage funds offer lower risk than pure equity funds, they are still subject to market volatility.
Fund costs: It is important to compare the expense ratios of different balanced advantage funds before investing.
In conclusion, balance advantage funds are hybrid mutual funds that use a dynamic asset allocation strategy to switch between equity and debt without any constraints. They can offer you the benefits of flexibility, diversification, tax efficiency, and suitability. However, they also have some risks such as market risk, model risk, and fund manager risk. Therefore, you should invest in balanced advantage funds only if you understand their working and are comfortable with their risk-return trade-off.
Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
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First Published:
19 Feb 2024, 10:02 AM IST
