In a market brimming with excitement, Balanced Advantage Funds (BAFs) have stood out as a beacon of stability. These hybrid funds, designed to adjust their asset allocation based on market conditions, have demonstrated resilience during tumultuous periods.
BAFs employ two primary strategies to mitigate risks and protect investors’ capital:
Dynamic Asset Allocation: BAFs continuously monitor market conditions, including valuations, interest rates, and macroeconomic factors. They adjust their exposure to equity and debt accordingly, shifting towards debt when markets are overvalued and increasing equity exposure during downturns.
Hedging Strategies: BAFs often use derivatives to hedge a portion of their equity holdings. This helps protect against downside risks and can provide tax advantages.
BAFs vs. Aggressive Hybrid Funds:
While some BAFs may maintain an equity allocation above 65% for tax efficiency, they generally adopt a more cautious approach compared to aggressive hybrid funds. BAFs prioritize capital preservation and risk management, even if it means sacrificing some potential upside.
The Recent Performance:
According to Value Research, June and July 2024 offered a glimpse into the resilience of BAFs. During the Lok Sabha election results in June, the broader equity market experienced a significant decline, falling by 6.8%. However, BAFs witnessed a much milder drop of just 3.8%. Similarly, in July, when the market was rattled by the Japan Yen carry incident, BAFs outperformed the broader market.
So, how do the BAFs fall less?
“Broadly speaking, they use two strategies to pull the handbrakes during a falling market. Flexibility BAFs adjust their exposure to equity and debt based on market valuations,interest rates and other macroeconomic factors. For instance, when the equity market is riding high and stock valuations are stretched, BAFs may reduce their exposure here and increase their allocation to debt or derivatives. The opposite is true, too. When the market is low, they may turn their attention back to equity,” said Pankaj Nakade of Value Research.
Despite the overall market optimism, many BAFs have adopted a more cautious approach. Over the past seven months, approximately half of BAFs have reduced their net equity allocation. While this reduction might not seem dramatic, it signals that BAFs are doubling down on their cautious stance.
Out of 29 BAFs analyzed by Value Research, 14 have reduced their net equity allocation since December 2023. Six funds have reduced their equity exposure by more than 10%, while eight have reduced it by 5-10%. Twenty funds have over 50% net equity exposure.
Note: Value Research has considered funds with at least a one-year history. Change in equity allocation from last December to this July. Current net equity allocation as of July 31, 2024.
The Table Below by Value Research Outlines the Equity Allocation Changes for Selected BAFs:
In a note last month, SBI Mutual Fund said its proprietary indicator for Indian equities was showing stretched readings amid rich valuations.
“The sentiment index works as a contrarian measure and has an inverse correlation to expected forward returns, especially at extremes, as is the case now. Further, while we stay constructive on earnings in the medium term, the near-term trajectory has been decelerating as commodity price tailwinds abate. This mix we believe is ideal for a reduction in the thus-far-unabated speculative action in equity markets,” it said.
Quant and Nippon: Quant and Nippon’s BAFs have also pared down their equity exposure, albeit to a lesser extent.
Key Findings:
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Reduced Equity Exposure: Many BAFs have lowered their equity allocation, with some funds decreasing it by over 10%. -
Ultra-Defensive Stance: SBI and DSP Balanced Advantage Funds have adopted particularly cautious stances, maintaining low equity allocations. -
Market Valuations: The overall market is trading at higher valuations compared to long-term averages, prompting BAFs to exercise caution. -
Cash Holdings: Many BAFs have increased their cash holdings, indicating a preference for a more defensive stance. -
Investor Preferences: Despite the cautious stance, BAFs remain popular among investors seeking a balance between growth and risk mitigation
First Published: Sep 03 2024 | 10:00 AM IST
