What Are Balanced Advantage Funds? – Forbes Advisor INDIA

Balanced advantage funds (BAFs), as the name suggests, are funds that aim at maintaining a “balance” between risk and returns while giving the “advantage” of better timing of investments to the investors. Also known as dynamic asset allocation funds, balanced advantage funds are a category of hybrid mutual funds in which asset allocation between equity and debt is managed or rearranged as per the prevailing market conditions.

Generally mutual funds invest in both – debt and equity – in some proportion. The proportion of debt and equity varies depending on whether they are predominantly equity-oriented funds or debt-oriented. Once invested, they do not change the allocation.

Like all mutual funds, balanced advantage funds, too, invest some portion of their corpus in debt and some in equities. But they automatically switch from equity to debt when equity prices become too high. These funds also have an ‘advantage’ of entering in and exiting from equities at a better time.

How Balanced Funds Work

The very aim of balanced advantage funds is to take “advantage” of higher returns that equities offer while maintaining the “balance” on risk by investing in debt when equity prices are not too advantageous.

The uniqueness of balanced advantage funds comes from the fact that unlike other mutual funds, balanced advantage funds do not have any pre-set limits for investing in debt or equities. These are managed dynamically. That is, the investments are made in equities at a time when they are available at a comparatively cheaper price.

Alternatively they buy equities at a high price and sell at an even higher price. And when equities are not available at cheaper prices, only then do they invest in debt. To determine this shift between equity and debt, fund managers use a process driven approach known as the Asset Allocation Model.

Asset allocation models are in-house mathematical models that asset management companies use to determine the perfect mix of equity and debt allocations keeping in mind prevailing market conditions. Generally, these models are created based on a fund manager’s hypothesis about future profit projections, historical data and other factors that can help in providing maximum returns to investors over a long term period. This happens dynamically depending on the strategy the funds follow.

Strategy of Balanced Advantage Funds

Balanced advantage funds either follow a strategy that “bulls” or stock market optimists follow—invest at a high price and sell at an even higher price. The strategy is also known as “pro-cyclical”. These funds are riskier and may have to face the risk of stock prices falling just after buying them at a high price. Such funds are not for the short term and weak-hearted investors. A medium term or a long term investor who has holding capacity can look at investing in these funds.

For a risk-averse investor, there are balanced advantage funds which follow a bear strategy. These funds invest in stocks when their prices are low and sell when their prices begin to go up. This strategy is known as “counter-cyclical” as the investments are sold when the market goes up and are bought at a time when the market begins to fall. These are less risky. The strategy each fund follows for investing its corpus is generally specified in the documents.

Balanced Advantage Funds Vs Hybrid Funds

Balanced advantage funds should not be confused with balanced or hybrid funds. In the case of balanced or hybrid funds, there is a pre-decided ratio of equity and debt investments. The allocation of funds between equity and debt in balanced or hybrid funds does not change during the entire lifetime of the fund. This means that the ratio of debt and equity mentioned in the fund’s documents remains unchanged throughout the tenure of the mutual fund.

Returns earned by balanced advantage funds are naturally higher than a debt hybrid fund primarily because their investments are largely in equities. Compared to a pure equity fund, however, returns offered by balanced advantage funds could be lower as they have some – however little – component of debt

Taxation of Balanced Advantage Funds

Balanced advantage funds are structured like equity funds. To maintain this character, balanced advantage funds ensure that even when these funds lower their equity exposure, the equity and arbitrage together are at least 65% of the corpus.

As such, long-term capital gains on balanced advantage funds are taxed at 10%, whereas short-term capital gains are taxed at 15%. This is better than pure debt or other investment options like fixed deposits.

Who Should Invest in Balanced Advantage Funds?

Investors who want to invest in mutual funds which offer higher returns of equities but do not like the high risk that goes with direct investments in equities or investments in pure equities mutual funds may look at balanced advantage funds. They offer higher returns than a plain debt or a hybrid fund and their risk profile is only slightly higher than those funds.

At the same time, they are not as risky as pure equities or pure equity funds. The risk gets further minimized if the investment is for medium or long term. Investors should consider investing for a minimum of three years to benefit from balanced advantage funds.

You can consider investing in balanced advantage funds as an option if you are looking at earning good returns with capital appreciation but comparatively lower risk.

Things to Remember Before Investing in Balanced Advantage Funds

  • Invest according to the risk profile you have and financial goals you have set for yourself.
  • Read the documents of the mutual fund carefully and understand the strategy that they are going to adopt while investing their corpus.
  • Check the past performance of the asset management company and the track record of the fund manager that is going to manage the fund.
  • Aim at keeping yourself invested for 3-5 years if you are looking for capital appreciation along with regular returns.
  • And always, just always monitor the investments you have made of your hard earned money.

Bottom line

For new risk averse investors willing to park their funds for a minimum of three to five years, Balanced Advantage Funds are the best form of hybrid mutual funds to invest in. They not only provide an opportunity to generate consistent and regular passive income but can also be a beneficial contribution to an individual’s retirement fund.

Before choosing a balanced advantage fund, investors should thoroughly consider their risk appetite, financial goals and liabilities. If needed, investors should also seek help from financial advisors to help you go through the available options more clearly.

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