Emotions and instincts often guide investment decisions, but they can be harmful for your financial interests. For example, age old investing wisdom is buying low and selling high. However, instead of “buying low and selling high” investors usually buy when market is high, thinking it will go higher. Similarly, investors sell when market is low, thinking it will fall even lower. If you buy at high prices, you will see a large reduction in your portfolio value when market corrects. If you sell when market falls, then you may incur a permanent loss. Fear and greed are the dominant instincts in investing. Fear can lead to sub-optimal returns on your investment, while greed leads to excessive risk taking which is equally harmful for your financial interests.
Asset allocation diversifies your investments across different asset classes e.g. equity, fixed income etc, which have different risk profiles. Asset allocation may reduce portfolio volatility and help you remain disciplined in your investments. You should understand that risk and return are related. Asset allocation will balance risk and return, to help you achieve your financial goals. It may provide stability and improve performance consistency of your portfolio. Asset allocation may help you get more tax efficient return and perhaps improve the liquidity of your portfolio.
Dynamic asset allocation, which is changing your asset allocation as per market conditions, can further reduce downside risks and generate risk adjusted returns. If you reduce your equity asset allocation in high markets and increase it in down markets, you not only reduce your portfolio drawdown in down market, you may also get superior risk adjusted returns because you are "buying low and selling high". While different categories of mutual funds can help you get exposure to different asset classes or sub-classes, balanced advantage fund is perhaps the only mutual fund category, which dynamically manages asset allocation according to market conditions.
Balanced advantage fund is a hybrid fund, which changes its asset allocation i.e. equity and fixed income allocations, dynamically according to market conditions. Balanced advantage funds usually reduce equity and increase fixed income allocations when equity valuations are high. They will increase equity and reduce fixed income allocations when equity valuations are low. These funds use quantitative dynamic asset allocation models to change their asset allocation. By using a model based approach, balanced advantage funds eliminate behavioural biases in investing.
There are currently more than 20 balanced advantage mutual fund products in the market. So how will you go about selecting a fund for your needs? The most important consideration should be asset allocation strategies used different funds.
An effective balanced advantage fund is one which is able to minimize downside risks and also generate superior risk adjusted returns in the long term. An effective balanced advantage funds should have minimal equity allocation at market peaks and maximum equity allocation at market bottoms. It is never possible to predict market peaks or bottoms with 100% accuracy, but dynamic asset allocation models are back-tested over multiple investment cycles (bull and bear markets) to check whether the model has produced desired results in different market conditions. You should see the performance of a balanced advantage scheme in different market conditions and see which scheme has performed consistently in different conditions.
Answer: Hybrid equity funds or aggressive hybrid funds have 65 – 80% un-hedged exposure to equity and 20 – 35% allocation to fixed income instruments (debt and money market). There are no asset allocation limits for balanced advantage funds e.g. the un-hedged equity exposure of a balanced advantage fund may be much lower than 65%. The risk profile of balanced advantage funds may be lower than that of hybrid equity funds or aggressive hybrid funds?
Answer: As per SEBI, balanced funds must have 50% to equity and 50% allocation to fixed income instruments (debt and money market). There are no asset allocation limits for balanced advantage funds e.g. the un-hedged equity exposure of a balanced advantage fund can be lower than 50%. Furthermore, since balanced funds have 50% allocation to fixed income, they will be treated like debt funds from a taxation viewpoint. Balanced advantage funds usually enjoy equity taxation because they use derivatives to hedge. Equity taxation may be a major advantage for balanced advantage funds.
Answer: Balanced advantage fund and dynamic asset allocation fund are the same. There is no difference between the two. All balanced advantage funds use dynamic asset allocation strategy.