Protect gains by moving them to Balanced Advantage Funds

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30 JUNE, 2023

Active investors have seen significant churn in their portfolios over the course of the last 12 months, with focus shifting from minimising impact of the downturn to maximising returns as the markets have surged sharply over the last few months. As active investors have seen the growth opportunities and taken advantage of these, it is also time to lock in some of the capital gains made in order to hedge them against future uncertainty in the markets. Moving your gains to a separate part of the portfolio that offers some upside from continued rise in stock markets while hedging against losses can be done using Balanced Advantage Funds (BAFs).

While looking to increase returns without significantly increasing risk, a number of options within Mutual Funds can be explored. However, a fund that can leverage the potential returns of a derivative, while being invested in Equity and Debt is a product that could offer multiple benefits from each of the asset classes. This category of funds is broadly classified as Balanced Advantage Fund (BAF).

Structure of a Balanced Advantage Fund (BAF)

SEBI created the category of BAFs as funds that are investing in a combination of equity, derivatives and debt. However, the classification does not put restrictions on the respective percentage of each category of investments, and therefore the fund allocation can vary from one fund to another. The funds maintain a minimum 65 per cent allocation in equity or equity derivatives, while allocating the rest to debt instruments. In this respect, they are aligned with equity based Mutual Funds, while giving investors a possibility of secured returns by using derivatives to lock in profit.

Since the fund allocation is flexible, it allows the funds to organise and manage fund allocation to different assets based on the current outlook of the market. Most funds have an equity exposure which is countered through stock or index options, designed to mitigate the downside risk of market volatility. Essentially, higher the hedged portion of the equity, the lower would be the risk. In short, the risk varies in direct proportion to the un-hedged portion of the equity portfolio of the fund. Different funds follow different strategies and therefore there can be variations in the returns of various funds within the category. To get an understanding of the fund, it is recommended that investors review the fund allocation to see if it fits the profile that they are looking for. Such funds are suitable for investors who are not sure how to balance between Equity & Debt. Further such funds are also a good addition to investors who would want to move their portfolio swiftly between Equity & Debt depending on market circumstances.

Some investors who may not have experienced BAFs, tend to equate them with the earlier balanced funds which had a mix of Debt and Equity in specific proportions, and which are today known as hybrid aggressive funds. However, BAFs fall within a separate sub-category under hybrid funds, since their asset allocation varies over short-term as compared to the hybrid aggressive funds whose allocation remain fairly steady over the mid-to-long term.

What makes BAFs attractive?

Most active investors have a portfolio of 20-30 companies based on their own research, preferences, knowledge of the markets and underlying fundamentals. However, no individual investor can map gains or losses that can impact a single company in the present situation of uncertainty. While direct equity investments and derivatives offer great potential upside, the risk can be equally high in volatile markets. Ideally, a smart investor will look to periodically move gains from higher risk investments to lower risk ones so as to secure the profits on a periodic basis. Therefore, a potential rewarding strategy for active investors might be to convert some of the short-term gains achieved in equities or equity-based Mutual Funds into BAFs, so as to secure the profits.

The advantages of BAFs include the following:

Since they are dynamically managed, asset managers can reduce the exposure to equity in times of extreme downward volatility and move the funds to debt, with lower yet assured returns in order to ride out the potential risk. On the whole, BAFs have a lower net risk on equity and therefore tend to provide more stable returns over time.
A review of historical performance of BAFs indicate that while the returns, as of February 28, 2023, of equity Mutual Funds especially those in mid- and small-cap mutual funds have been negative over the last 6 months, BAFs have shown positive NAV (Net Asset Value) growth over the period.

Therefore, over a short to medium period of time, BAFs manage the volatility of the market better than an equity fund and provide better returns than debt funds, while retaining growth. In the long term, equity funds outperform BAFs, but with the attendant risks associated with any equity investment.

Taxation

Since the Equity component is atleast 65%, these funds are taxed as per the prevailing rules for equity based funds. Dividends from these funds are also taxed as per existing rules for Equity based funds.

Conclusion

While allowing for a higher return, BAFs also help to hedge a portion of the risk associated with market volatility by covering Equity holdings through future derivatives and moving funds to Debt when markets are showing downward trends. For this reason, BAFs span the space between saving deposits and aggressive Equity funds and should be considered as an intermediate category of investments for retail investors for the medium term.

To select a suitable BAF, look for the following aspects:

The allocation of the fund across Equity and Debt at various points in comparison to the market
The percentage of open and hedged Equity positions of the fund, which will provide understanding of the fund management’s risk appetite
Portfolio quality
Although investors may consider historical returns, but since past performance may not continue in the future; investors should not lay sole importance on returns

Some of the Balance Advantage Funds which have shown stable returns are:

Fund Name	AUM (in ₹ crs)	Compound Annualized
Fund Name	AUM (in ₹ crs)	1 Year	3 Years	5 Years
Edelweiss Balanced Advantage Fund - Growth	9,247	16.22%	16.74%	11.47%
ICICI Prudential Balanced Advantage Fund - Reg - Growth	47,662	13.65%	16.36%	10.76%
Kotak Balanced Advantage Fund - Reg - Growth	14,887	15.58%	13.85%	--
Mirae Asset Balanced Advantage Fund - Reg - Growth	1,109	--	--	--
SBI Balanced Advantage Fund - Reg - Growth	22,654	17.82%	--	--
WhiteOak Capital Balanced Advantage Fund - Reg - Growth	452	--	--	--
Index
NIFTY 50 Hybrid Composite Debt 65:35 Index	--	17.835	17.647	12.2237
Data as on June 30, 2023 \| Source: MFI explorer

Data as on Feb 28, 2023 | Source: MFI explorer

To know more about the various BAF options available, please check out our investments section, or get in touch with your Relationship Manager.

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Kotak Mahindra Bank Limited, AMFI Registered Mutual Fund Distributor. AMFI Registration Number (ARN) 1390.

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Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Protect gains by moving them to Balanced Advantage Funds

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