Mutual Funds: Are balanced advantage funds perfect for you?

In any investment planning, one should have the ability and willingness to switch from underperforming assets to those that outperform.

Prices of a wide range of commodities including crude oil have gone up and bond yields are moving up. This probably may lead to higher inflation which may be causing anxiety among investors. However, there exists some positivity owing to better corporate earnings numbers. In such a situation, investors should prefer funds that follow a balanced approach towards allocation in equities as well as debt.

What are balanced advantage funds?
In any investment planning, one should have the ability and willingness to switch from underperforming assets to those that outperform. Balanced advantage funds are such types of funds that achieve this switching and are well-suited for retirement planning. So, these funds according to the valuations within the equity markets, increase or decrease their allocation between debt and equity. Normally they use criteria such as price to earnings ratios, price to book value, market to cap to GDP, etc.

Advantages
As the name suggests, these funds follow the investment philosophy of buying low and selling high. So, these are generally expected to offer good returns to the investors over a longer period of time. As these change their equity and debt allocations according to prevailing market conditions, they reduce the volatility that investors experience in pure equity funds or in aggressive hybrid funds. Further, the rebalancing happens in a tax efficient way. For instance, when an individual investor sells equity or debt, tax liability occurs. But when the funds are doing it for their investors, there is no tax liability accruingd to individual investors.

Limitations
Asset allocation proportion in these funds are generally model based ones. So, these funds may not be suitable for certain types of investors. The above funds maintain an equity plus derivative exposure of 65% or above whereas there are some investors who have a higher risk appetite and would like to hold 70% equity and 30% debt. In such cases, in the long run they will outperform the balanced advantage funds. Similarly, allocation among large cap, mid-cap and small cap is not within the control of the investors. Further, with reference to debt fund, duration risk is also within their control on the debt side of the investment.

How to choose the right fund?
Before choosing a balanced advantage fund, check out the fund manager’s strategy, especially on the debt side. The debt portion should target to provide steady return and stability. On the equity side, the fund should be flexi cap in nature. One should choose a fund with a transparent asset allocation model which provides limited discretion to the fund manager. One should look at not only the past returns but also the volatility of the fund which is reported as standard deviation.

To conclude, these funds are best suited for passive investors who do not want to get into rebalancing their funds often. Also, expect a reasonable return from these funds as over the long-term, these offer returns that are higher than debt funds but lower than that of equity funds.

Balancing the odds
Balanced advantage funds are best for passive investors who do not want to rebalance their funds often
Choose a fund with a transparent asset allocation model which provides limited discretion to the fund manager
Since these funds change equity and debt allocations as per market conditions they reduce the volatility that investors experience in pure equity funds or in aggressive hybrid funds
These funds follow the investment philosophy of buying low and selling high

The writer is a professor of finance & accounting, IIM Tiruchirappalli