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Balanced Advantage Funds

ICICI Securities 22 Jul 2022

The stock market is highly volatile now. The Nifty index reported a 6.56 per cent fall since the beginning of the year or year to date (YTD), as on July 11, 2022. In comparison, the average return from balanced advantage funds (BAFs) stands at -3.18 per cent, in the same period. Since BAFs have only partial equity exposure, it is not fair to compare the returns of BAFs and Nifty, but it does provide a useful perspective when deducing whether or not BAFs are worth investing in.

The idea behind the concept of BAF is to tackle market volatility by dynamically allocating the portfolio in an asset class according to varied market condition. This is a time-tested strategy to tackle volatility and deliver returns. During period of big drawdowns like the market fall in March 2020 at the onset of Covid 19, BAFs helped in protecting downside and thus the overall investor experience has been good. Post Covid, BAF caught the fancy of investors and have become one of the largest categories in the mutual fund industry.

Let’s understand what BAFs are, how they have grown in the last couple of years and whether you should invest in them or not.

What Are BAFs?

In simple terms, BAFs are a form of hybrid mutual funds which invest in different asset classes, including equity and debt. They promise to take care of asset allocation needs of investors by rearranging the allocation according to the market movement. By investing in these funds, investors neither have to keep a constant eye on the changing market behaviour nor worry about any tax incidence.

Normally, switching from equity to debt or vice-versa entails short-term or long-term capital gains tax, which is not the case with hybrid funds.

How Do BAFs Work?

From the regulatory point of view, BAFs are free to decide on their asset allocation and investment strategy. This, technically, means that 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. But this gross allocation is tricky. This gives the fund manager the flexibility to invest in arbitrage and hedge portfolios through derivatives. This helps BAF fund managers to maintain 65 per cent equity allocation despite net equity allocation being much lower than 65 per cent. The hedged portfolio and arbitrage give BAF fund managers room to protect the downside and maintain the equity exposure of 65 to qualify as equity funds.

Since, typically, BAFs keep equity exposure up to 65 per cent of their total portfolio, it makes them eligible for equity taxation, which is lower than debt funds taxation. For equity funds, short-term capital gains are taxed at 15 per cent, plus cess and surcharge. Long-term gains up to Rs 1 lakh are tax-exempt; any gains above Rs 1 lakh are taxed at 10 per cent, plus cess and surcharge. On the other hand, short-term capital gains of debt funds are taxed at the individual’s tax slab rate; long-term gains are taxable at 20 per cent, plus cess and surcharge. Hybrid funds with equity in excess of 65 per cent are taxed as per the rates for equity funds.

Should You Invest?

The best way to tame market volatility is asset allocation as different assets behave differently in varied market conditions. Often, investors throw caution to the wind when one asset class starts performing well and start putting more and more money in that asset. For example, during the 2020-2021 market rally, when debt was not doing well, people redeemed and invested the proceeds in equity and burnt their fingers when the market changed its course. For, such investors BAFs would be the right choice.

Disclaimer: ICICI Securities Ltd.( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400025, India, Tel No : 022 - 2288 2460, 022 - 2288 2470.  AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds and all disputes with respect to the distribution activity would not have access to Exchange investor redressal or Arbitration mechanism

Please note that Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. I-Sec does not assure that the fund's objective will be achieved. Please note. NAV of the schemes may go up or down depending upon the factors and forces affecting the securities markets. Information mentioned herein is not necessarily indicative of future results and may not necessarily provide a basis for comparison with other investments. Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

The information provided is not intended to be used by investors as the sole basis for investment decisions, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific investor. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. Investors should make independent judgment with regard suitability, profitability, and fitness of any product or service offered herein above. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.

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