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Funds under the balanced advantage category (also called dynamic asset allocation funds) aim to generate returns by managing their equity exposure dynamically, depending on the market conditions.
These funds increase their allocation to equities when the equity markets look under-priced, and vice-versa.
In-house models
Currently, there are 19 funds under the category. Each fund follows an in-house valuation model to determine their equity allocation. These valuation metrics use various quantitative criteria such as price-to-earnings (P/E), price-to-book (P/B) or dividend yields.
The equity portion of the portfolio is always maintained at above 65 per cent; hence, they are treated as equity funds for tax purposes.
Most of these funds follow a hedging strategy by taking equity derivative positions when the equity market valuation appears high. This helps limit the downside while maintaining the equity allocation at above 65 per cent. The allocation to equity (unhedged) is 30-80 per cent in most of the funds. However, their participation in equity rallies is limited. Investors who wish to participate in equity markets with a relatively conservative approach can invest in this category of funds. .
Performance, as measured by three-year rolling returns, shows that the top-performing funds under this category — such as L&T Dynamic Equity, ICICI Prudential Balanced Advantage, HDFC Balanced Advantage and Invesco India Dynamic Equity — have delivered 13-14 per cent CAGR returns over the past seven-year period. The Nifty 50 TRI index posted 11 per cent in the same period.
In the risk-return pyramid, the balanced advantage category is placed between equity savings and aggressive hybrid funds. One cannot compare balanced advantage funds with aggressive hybrid funds as the latter allocates 65-90 per cent to equity (unhedged).
ICICI Pru Balanced Advantage has outperformed its category over one-, three- five- and seven-year time-frames.
The fund invests predominantly in equities and uses derivatives to hedge the downside risk of its portfolio. It juggles its equity portion dynamically by using an in-house model that is based on a long-term historical mean price-to-book value (P/BV).
The scheme has maintained a long (buy) position in equity stocks for 65-69 per cent of the portfolio over the past five years. When the equity market has moved up, the fund manager has gone short (derivative position) on most of the equity exposures to make the portfolio defensive.
For instance, in January 2015 and January 2018, the fund increased its hedged position to 34-36 per cent and brought down its net equity exposure to around 30 per cent. That acted as a buffer to the fund in the overheated market. Currently (as of May 31), the net equity exposure of the fund stands at 42 per cent.
Investment approach
On the equity side, the fund follows a multi-cap approach, though tilting towards large-cap stocks. On its fixed income portfolio, the scheme uses both the accrual and duration strategies, based on the market conditions. Currently, the fund follows the accrual strategy with a portfolio average maturity of 2.5 years, and has higher exposure to good credit quality instruments.
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