What Are Balanced Advantage Funds And Should You Invest?
- Balanced advantage funds or BAFs manage volatility on your behalf
- They switch between assets, but this activity attracts no taxability
- If you switch between different assets yourself, there may be tax payable on the gains
- These funds help first-time or new investors build discipline and handle different market movements
Balanced advantage funds (BAFs) are the flavour of the season with the promise of carrying out the task of asset allocation on the investors’ behalf. Though they have been around in the mutual funds industry, it’s only lately that they are so much in focus. Sample this: six BAFs were launched in 2021 alone and garnered Rs 22,021 crore in total.
One of the reasons why these funds have caught everyone’s attention is the fact that the markets have been quite volatile in the last more than a year.
We tell you what these funds, how they can benefit the investor and who are they meant for.
What Are BAFs And Their Benefits?
This category was created when the Securities and Exchange Board of India (Sebi) came with its categorisation rules in 2017. There are many benefits that funds in this category offer.
Balanced advantage funds automatically switch between different asset classes to manage market volatility. It’s not always possible for retail investors to dynamically manage their asset allocation as per the market levels. BAFs use different proprietary models to dynamically switch between assets to move in sync with the markets and as per the fund’s objective. They are free to decide on their asset allocation and investment strategy. This technically means BAFs can take exposure to equity and debt from 0-100 per cent.
However, in order to take advantage of equity taxation they need to have 65 per cent gross allocation in equity. This gross allocation is tricky. The fund manager has the flexibility to invest in arbitrage and hedge portfolios through derivatives. This helps the BAF fund manager to maintain 65 per cent equity allocation despite net equity allocation being much lower than 65 per cent. This whole exercise limits the possibility for a portfolio downside. At the same time, it gives the fund manager the headroom to capture the upside by tilting the portfolio towards equity.
The best part about these funds is that there is no tax incidence for the investors when they switch from one asset to another. Normally, there is a tax incidence on the gains depending on the period of holding. Moreover, switching at short intervals can have a higher tax bite as short-term capital gains tax is higher than long-term capital gains tax.
The returns from this category have also been decent. According to Value Research data, the category average returns in the last one year and three years stands at 13.17 per cent and 12.12 per cent, respectively.
What Should Investors Do?
BAFs are a good option for those who want someone else to manage market volatility on their behalf. It is usually seen as a category that ish2 beneficial for new or first-time investors to give them a flavour of equity while limiting the downside through the debt component. It also helps build discipline among such investors.
However, it is important to check the fund’s mandate before investing as each fund many be different. The capital market regulator allows BAFs to follow their own allocation objective and investment strategy. In case a fund takes more equity exposure than you may be comfortable with, it’s better to steer clear and look at other options within the category.
Moreover, if you already have investments in other debt and equity products, make sure the allocation in the balanced advantage fund fits with your overall goal.
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