10 mins read . 27 Jul 2023
An interesting mutual fund new fund offering (NFO) opening shortly is the UTI Balanced Advantage Fund. The Balanced Advantage Fund or the BAF were among the most sought-after products in the Indian markets about two years back. However, the category of funds started underperforming, leading to lower interest in these BAFs. The UTI Balanced Advantage Fund is a rule-based or formula-based approach to allocating between equity and debt. That is why, the BAFs are also called dynamic allocation funds. Normally, the dynamic allocation is based on a set formula. For instance, the rule can be that if the P/E ratio crosses 15X, the BAF will reduce its equity exposure by 5% for every 1X up move in the P/E ratio. The reverse logic can be applied if P/E ratios go down. Such rules can be based on P/E ratio, P/BV ratio, Dividend Yield or even interest rates.
Here are some basic features of the upcoming NFO of UTI Balanced Advantage Fund.
The key to long term portfolio returns is asset allocation and that is what the balanced advantage fund seeks to address with its dynamic allocation approach. Asset allocation means that you must be invested in equity when it is cheap and in debt when equity is expensive. That is easier said than done since even the best of investors cannot time the market consistently. The answer is to adopt a formula-based approach to asset allocation. That is exactly what the Balanced Advantage Fund (BAF) does. Let us spend a moment understanding the very idea of dynamic allocation.
Dynamic asset allocation is essentially about changing asset allocation as per market conditions. There are many ways to do it but the most popular is to use valuations for dynamic allocation. Dynamic allocation reduces risk and generates risk adjusted returns. We all hear the wisdom in markets like sell when it is high and buy when it is low. The question is what is high and low? Since there is no definite answer, you use proxies like P/E ratio. This ensures lower equity allocation when equity valuations are high and higher equity allocation when valuations are low. More importantly, it ensures automatic booking of profits at higher levels, and leaves you with cash when markets have fallen sharply.
There are 3 distinct advantages of BAFs you must be familiar with. Firstly, the BAFs tend to be less volatile compared to aggressive hybrid funds since they don’t bet on a trend but against popular logic. Secondly, the Balanced advantage funds combine equity, debt, and derivatives (futures & options) which creates a double benefit. It manages risk and also generates risk-free arbitrage returns. Last, but not the least, the BAF is normally tweaked to have at least 65% in equity (thanks to the use of derivatives). This ensures that the BAFs are classified as equity funds and get favourable tax treatment compared to non-equity funds.
There are 3 components in the portfolio of balanced advantage funds (BAF) viz. net active equity, fixed income, and hedged equity.
The next question is the returns that these 3 components of the portfolio will generate. Firstly, the equity portion (both hedged and unhedged portion) generates dividend income. In addition, the unhedged equity portion also generates capital gains from trading, if any. The fixed-income portfolio generates returns from interest payouts and also from capital gains when the bond yields move lower. Lastly, what about the hedged equity portion? This generates returns on two fronts. There are arbitrage profits arising through the rollover of short futures positions. In addition, there are gains when arbitrage positions are unwound in the market.
There are several dynamic allocation funds or Balanced Advantage Funds (BAFs) already active in India and with substantial AUMs. Here we have identified the top 10 BAFs by AUM in India based on 1-year returns.
Return 1 Year
|HDFC Balanced Advantage Fund|
|Baroda BNP Paribas BAF|
|SBI Balanced Advantage Fund|
|Edelweiss Balanced Advantage Fund|
|Aditya Birla Sun Life BAF|
|Kotak Balanced Advantage Fund|
|Tata Balanced Advantage Fund|
|Nippon India Balanced Advantage Fund|
|ICICI Prudential Balanced Advantage Fund|
|UTI Unit Linked Insurance Plan Fund|
Data Source: AMFI
Overall, the BAFs manage close to Rs2.05 trillion of AUM in India and is the largest category of hybrid funds available. Out of the 25 BAFs available in India, the top 4 account for 70% of the AUM. Over the last 1 year, BAFs have generated impressive average returns of 17.02%, but if you look at CAGR since inception, the BAF returns have been lower at 10.63%. The UTI BAF is interesting more because of its part-active and part-passive approach.