UTI Balanced Advantage Fund NFO Highlights

Power of balanced advantage funds

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.

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Highlights of the UTI balanced advantage fund NFO

Here are some basic features of the upcoming NFO of UTI Balanced Advantage Fund.

1. Like every NFO, the UTI Balanced Advantage Fund will also be open for a fixed period of time. The NFO will open on July 21, 2023, and shall close for subscription on August 04, 2023. It is an open-ended fund, so it will offer continuous purchase and redemption at NAV-linked prices.
    
2. There are no Entry loads for mutual funds in India. However, exit loads do exist if the fund is redeemed or switched before a threshold date. In this case, there is no exit load of up to 10% of holdings for any redemption or switch out. However, if you redeem more than 10% of your holdings before 365 days, an exit load at 1% is charged.
    
3. The minimum investment in the UTI Balanced Advantage Fund (BAF) NFO will be Rs5,000 in the NFO. The fund offers Regular and Direct plans for investors; who can also choose between the Growth option and IDCW (income distribution cum capital withdrawal) option. The fund is ranked High Risk on the SEBI Riskometer risk scale. 
    
4. How will the fund performance be measured and benchmarked? The UTI Balanced Advantage Fund will be benchmarked against the Nifty 50 Hybrid Composite Debt 50:50 Index. UTI Balanced Advantage Fund (BAF) will be managed by Sachin Trivedi and Anurag Mittal as fund managers.
    
5. Who should opt for the UTI Balanced Advantage Fund? This fund is best suited to investors looking at a dynamic asset allocation model. The investor must be comfortable with using quant models to tweak exposures to equity, debt, and derivatives. Investors must be prepared for a longer time frame of 5-7 years.

How UTI balanced advantage fund will benefit investors?

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. 

Balanced advantage funds combine equity, debt and F&O

There are 3 components in the portfolio of balanced advantage funds (BAF) viz. net active equity, fixed income, and hedged equity. 

1. The first part of the BAF portfolio is the Net Active Equity. Now, this is the un-hedged equity exposure of the fund. Normally, the fund manager will use mathematical models to determine how much of the assets will be allocated to net active equity.
    
2. The second key component is fixed income or bonds. This is the stable portion of your portfolio and does not exceed 35% to maintain the equity fund definition. This allocation is also generally model-based.
    
3. Finally, there is the Hedged Equity Portion or the Arbitrage Portion of the BAF. Here, equity holdings are hedged by taking contrasting positions in stock futures i.e., selling equivalent futures against long cash market positions. 

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.

Segment perspective of balanced advantage funds in India

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.

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.