Can a BAF Really Protect Your Capital?
This post is about the Balanced Advantage Funds (BAF). You might have seen advertisements for these on TV. I want to dive a little deeper into this and help you figure your way around it.
Firstly, what is a Balanced Fund?
A balanced fund is a mutual fund that contains a component of equity and debt. Typically, Balanced Funds(BF) stick to a fixed asset allocation of equity and debt. In India, SEBI defines the boundaries for BFs. Equity can vary from 60% to 40% and debt from 40% to 60%.
SEBI does not allow BFs to invest in Arbitrage.
You can check out this article on ET to read more about it.
The Balanced Advantage Funds
A sub-type is the Balanced Advantage Fund (BAF). The difference is the amount of equity allocation allowed to the Fund Manager. SEBI defines it as – Investment in equity/debt that is
managed dynamically. Basically, each fund house can define for itself how to allocate funds between equity and debt.
This makes it a completely open fund for the fund house/manager to decide how to invest.
No wonder all fund houses are launching Balanced Advantage Funds rather than Balanced Funds.
This article on ET makes a very useful comparison of BAFs.
Equity allocation was seen to wary from under 50% to 84%. Similarly, Debt varied from 0% to 27%.
This article on MoneyControl tells us that this category of funds have attracted more than 71K Crore in the year 2021.
Understanding what they do
If you read the documents from these fund houses you will find that each one of them has evolved a model for asset allocation. As is the norm, the models sound complex and impressive but they don’t really tell us much about how they will invest our money.
I found global statements such as (these are from actual scheme documents) –
- The Scheme will dynamically allocate its net assets to equity and equity related securities and debt instruments. The portfolio construct of the Scheme will be dependent on various factors such as market conditions, economic scenarios, global events, valuation parameters such as Price to Book Value, Price to Earnings, interest rate movement, etc
- We follow a process driven approach to shift the portfolio between equity and debt depending on market conditions
You get the drift…
I could not find a clear and simple method noted anywhere about how the fund manager will make his decisions.
Basically, the way many of these are worded, the fund manager gets quite a free hand to invest wherever he wants to. Some of the funds include derivatives up to 50% allocation. I cannot fathom, how that would make a Balanced Advantage fund less risky than a straight-up Index fund.
Now let us look at some of the returns. As usual, I referred to ValueResearch.
Notice the fees, an order of magnitude higher than Index funds. The Edelweiss Regular one is almost 2%, which makes their 5-year average return closer to 10%. The comparable return and fees for an Index fund would be 14.5% and 0.2%.
I know the entire selling premise of the Balanced Advantage Funds is to protect capital during downtime etc. However, I am not entirely convinced that there are sufficient guardrails for this particular category. The way I see it the fund manager has a lot of discretion on how to invest the funds. This creates a disparity between fund returns. You cannot actually compare one BAF to another, because they all use different proprietary strategies.
Also, their strategies don’t seem to agree about when the market is doing well and when it is not. The MoneyControl article above shows how the equity investment across funds varies wildly. If you track it over time as done by this article, it shows a wide variation of equity allocation strategy.
Do they deliver capital protection?
The capital protection that is being talked about does not seem to deliver either. The way the funds are advertised a customer is led to believe that his capital is completely protected. The high fees you pay is in return for this capital protection.
The biggest shocker in recent times was the post lockdown fall in markets. Nifty 50 dropped by ~30% in March 2020. The BAFs have fallen between 15% – 28%. So, if you were looking for capital protection when the stuff hit the roof, it did not happen.
Another aspect is the upside cap. Due to the inbuilt diversification, none of these funds have delivered close to Nifty 50 returns since that drop. Nifty 50 from 15th March 2020 to 22nd March 2022 has given an annualized return of ~32% (this is after the market fell from its all-time highs).
The BAFs meanwhile have given returns in the 20% range (annualised). Only 1 fund is at 30% and that one had a drop of 27% in March 2020. Basically, it is like a large-cap equity fund.
I was also looking at articles talking about BAFs. As expected the popular magazines all talk about how the BAFs protect capital. They do not however share any data of actual capital protection during market events.
I found one article which was balanced, it can be found here.
So, in summary, don’t fall for marketing speak, do your own homework. You cannot even believe what many of the regular mainstream magazines and newspapers write. There just isn’t enough research being done into these topics before writing mass media articles.
Do your own research. Invest in the simplest of things – Index funds and some simple debt funds. Do your own diversification. Equity markets will be volatile in the short term but in the long term, they have given better returns than any other form of investment. If you want to benefit from the returns be ready for a measure of short term volatility.
Key Takeaways:
- Balanced Funds are a kind of mutual fund where SEBI provides strict guidelines of how much equity and debt can be held by the fund
- Balanced Advantage Funds give a free hand to the fund manager to invest as per their own strategies
- BAFs are meant to protect capital, because of this, they tend to give lower returns than pure equity funds and charge higher fees
- However, there is no clear evidence of BAFs providing capital protection
- The upside possible through a pure equity fund is not available in a BAF due to the diversification
- There is no ready reckoner of how to compare and evaluate BAFs for the lay investor
- In recent times a lot of money has flown in to BAFs
- I would not recommend BAFs to a smart investor who can manage his own diversification
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
