Balanced advantage funds: A must-have for your investment portfolio

The Indian stock market has a history of both significant peaks and subsequent corrections; be it the Dot-Com Bubble and the subsequent crash, or the global financial crisis of 2008. 

Market trends are clearly influenced by both domestic and international events, and investor sentiment and behaviour are critical components of these market cycles.

Market volatility

Indian equity market valuations have reached high levels, with the Nifty 50 and the Sensex surpassing 25,000 and 82,000 benchmarks, respectively. 

Despite the market’s elevated status, heightened volatility underscores the importance of diversification and strategic fund allocation to mitigate risks and uncertainties. 

Risks may not have materialized yet, but they still exist; hence, understanding the underlying dynamics is crucial, as it underscores the importance of maintaining the right asset allocation.

Financial ratios, such as price-to-earnings and price-to-book, can reveal if a company’s stock price is inflated compared to its earnings, book value, or revenue, potentially indicating a market bubble. 

Investor sentiments, too, play a crucial role, and periods of low volatility in markets can lead to overconfidence among investors.

Suitability & asset allocation

Asset allocation, diversification and portfolio suitability will always be the go-to principles for maintaining sanity in most markets.

Maintaining long-term financial objectives while limiting exposure to market swings depends critically on this risk-reward balance. Here are some perils of poor asset allocation.

An improperly balanced portfolio can be severely impacted by market downturns, leading to substantial financial setbacks.

For instance, if you have a significant liquidity event, such as a child’s wedding or education expenses within the next 6-12 months, staying invested in a heavily equity-oriented portfolio can be extremely risky. 

Should market volatility impact your portfolio, it could delay meeting these financial goals until the portfolio recovers.

A portfolio lacking diversification can experience heightened volatility, making it more susceptible to market fluctuations, which in turn can erode investor trust and possibly lead to impulsive or less rational investment decisions.

A dynamic approach

What draws investors to balanced advantage funds (BAFs)? 

The answer lies in their ability to mitigate risks associated with market volatility and the potential for significant losses. BAFs’ dynamic asset allocation between debt and equities makes them especially appropriate for investors with moderate to low-risk profiles. 

Unlike traditional hybrid funds, BAFs offer a dynamic approach to investing. This adaptive strategy aims to harness the growth potential of equities while incorporating the stability of debt securities.

BAFs use pre-defined algorithms or models to continuously assess and adjust the allocation between equity and debt based on the market conditions. These models consider various factors such as market valuations, volatility, economic indicators, and sometimes even investor sentiment to determine the optimal asset mix​.

When equity valuations correct, the model might increase the equity exposure to capitalize on attractive valuations. Conversely, when valuations surge, the model would shift towards debt to provide stability and reduce risk. Sometimes the model could be pro-cyclical.

Uncorrelated asset strategy

Furthermore, BAFs operate with degree of flexibility compared to other fund categories. Unlike their counterparts with predefined asset allocation boundaries, BAFs are unbound by restrictions on equity or debt composition. 

This unrestricted mandate empowers fund managers to dynamically steer the portfolio, resulting in a diverse range of investment strategies and outcomes. In essence, each BAF offering possesses a distinct character, shaped by its unique management approach.

Moreover, BAFs often qualify for tax benefits as equity-oriented funds, potentially leading to favourable capital gains taxation compared to traditional hybrid funds. This tax-efficiency can enhance overall returns for investors.

If you seek to confidently navigate the current market complexities, while ensuring sustained growth and reducing potential losses, BAFs could be an ideal choice. Their balanced approach, dynamic strategy, and ability to adapt to volatile conditions by leveraging both equities and debt make them well-suited for investors with moderate to low-risk profiles.

Tarun Birani is founder and chief executive officer of TBNG Capital Advisors