Banking on BAFs to counter Volatility

As a Cricket enthusiast and an Investment buff,  I have often found that the lessons learnt on either field are often fungible with the other. It is thus that I am looking forward to viewing an upcoming OTT offering, which chronicles one of the Indian cricket team’s best overseas Test Series wins. 

The Indian team that beat the Australian team in a hard-fought series Down Under benefitted from the youthful bravado of Rishabh Pant,  Shubman Gill, Mohammed Siraj and Washington Sundar. This bravado was nicely balanced by the experience and patience of veterans Ajinkya Rahane, Cheteshwar Pujara and Ravichandran Ashwin. 

The underlying theme clearly is that be it on the cricket field or that of investments, it is necessary to blend caution with aggression and respond appropriately based on the situation. In the past, Balanced Funds (now renamed Hybrid Equity Funds) gained in popularity and rewarded investors seeking the risk profile it offered, fairly well. But the fact remained that with no upside equity holding restriction, some AMCs were running it literally like a pure equity fund, thus, exposing investors to higher risk than they had signed up for. SEBI’s classification of funds helped address this issue to an extent.

But, in more recent years and post the creation of this new category of hybrid funds around half a decade ago, Balanced Advantage Funds (BAF) which are inherently open-ended dynamic asset allocation funds have also become popular. It seeks to use time-tested mechanisms using a hybrid investment model to capture equity upsides even while casting a safety net on the downside.  

The corpus of a BAF is allocated dynamically between equity and debt securities, based on certain pre-determined market valuation and analysis tools. Some AMCs use the Price to Earnings (P/E) Ratio while some others use the Price to Book (P/B) Ratio as their base for determining the asset allocation mix. Then there are some that use a kind of hybrid model, incorporating both, boosted further by trend analysis.  

For the sake of easier comprehension, let us assume that a BAF starts off by investing 33% in pure equity and 33% in arbitrage to keep gross equity investments at or above 65% while investing the rest in debt securities. Their long terms gains thus attract Equity taxation of 10% as against Debt taxation of  20% (with indexation).

However, like any other Dynamic Asset Allocation Fund,  BAFs too have the flexibility to dynamically shift the corpus from equity to debt and vice-versa. The underlying theme though is to seek capital appreciation while guarding against volatility.

To put matters in perspective, it is worth noting that the average fall in returns in the BAF category has been around half of that of the large, medium and small-cap categories of funds since the time the markets slipped a couple of months ago.

Next fortnight, we shall proceed to take a closer look at some of the BAF products on offer from AMCs, their current asset allocation and performances.