Balanced advantage funds is a good risk mitigator

Investing in equity always is difficult, not only due to the volatility in equities but also remain stoic during such periods. Though the long-term benefits of investing in equities outlast most other asset classes, the lack of consistency ie, volatility is disrupting. Also, for the investor to decide on approaching the equity markets ie, aggressive or otherwise is not easy and that’s where hybrid equity funds come to rescue.

To achieve right balance and the diversification is not easy. The proportion of various funds should be in-line with the individual investor’s objectives. Also, the portfolio should be in sync with the market conditions to generate better returns. This is not an easy exercise and needs a detailed effort. To ease this whole process, some of the fund houses have come with a strategy of portfolio creation by offering through mutual fund portfolio management services.

As the name suggests, hybrid funds are a combination of assets ie, usually equity and debt. Though it’s a broader classification, it could include dynamic asset allocation funds and multi asset funds where they include beyond the traditional investment asset classes of equity and debt, which include other asset classes like gold, silver, etc or even derivatives like equity futures and options, alternatives like Real Estate Investment Trusts (REIT), Infrastructure Investment Trusts (InvIT). This not only reduces the risk of equity investment but also enhance the returns of the portfolio.

Balanced advantage funds (BAF) are dynamic asset allocation funds which use equity and debt instruments to generate better returns. In trying to retain the benefit of equity taxation, the overall allocation to equity is maintained at 65 per cent or higher in most of these funds. These funds are a bit different from the plain vanilla hybrid funds, depending upon the aggressiveness or conservativeness have allocation to equity and debt, use equity arbitrage to ensure the gross equity allocation is higher.

The net equity could be much lower at 30-35 per cent but use the equity derivatives to enhance the limit up to 65 per cent or higher so that the equity taxation comes to play for the benefit of the investor. The use of derivatives brings down the equity exposure to 20-40 per cent of the portfolio reducing the volatility associated with the equity investments.

The utilisation of derivatives is to hedge the equity portfolio against any downside while the rest of the debt portfolio would provide a stable return. This fund is a bit different from the pure balanced funds where the mix is of only debt and equity with no hedge. In volatile markets with higher equity valuations, the fence sitters are better off investing in these funds. In the event of any fall, the hedge would contain the loss while following the uptrend.

From a risk perspective all the hybrid funds fall in the category between the equity and debt while the return would be a tad higher than the pure debt funds. Also, some of these funds have equity taxation that would eventually better the post-tax returns. These funds could be well employed while building portfolios to bring better risk to rewards in the portfolio. Some of these funds could also take advantage of the market cyclical opportunities and so be employed thus.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])