Hybrid funds are a mixture of two or more
asset classes.
They try to strike a balance between
returns and risks.
The equity portion strives for capital
appreciation to beat inflation and the debt portion strives for stability.
Hybrid funds can be either equity-oriented funds or debt-oriented funds.
Hybrid funds can be divided in the
following manner:
- Aggressive hybrid fund
- Conservative hybrid fund
- Multi asset allocation
- Equity savings fund
- Dynamic asset allocation fund
- Arbitrage fund
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What is a balanced
fund?
A dynamic asset allocation fund is more
popularly known as a balanced advantage fund.
A balanced advantage fund is a type of
hybrid fund.
It invests in debt, equity and arbitrage
positions although the allocation is not fixed and can also sit on cash if the
fund manager desires so.
Unlike other hybrid funds like multi asset,
aggressive and conservative, a dynamic asset allocation or a balanced advantage fund does
not have a fixed mandate to follow.
The fund manager can move across different
asset classes based on the prevailing market conditions.
The importance of a balanced advantage fund is more
felt during a bearish market phase since it can cut down its equity portion and
at the same time make periodic equity purchases in the dip.
This is unlike other pure equity funds who
at all times have to maintain their mandate irrespective of the market
situation.
How does a Balanced Advantage Fund
work?
The allocation in a balanced advantage fund
can be divided into 3 different categories:
Active
Equity
This refers to the un-hedged equity
exposure portion of the fund
Hedging
A portion of the equity allocation is
hedged using derivatives, this method reduces volatility as well as the active
equity portion.
The totality of the two, that is the hedged
as well as the active equity portion at any given time should not fall below
65% to make sure the fund qualifies as an equity fund for tax calculation
purposes.
Fixed
Income
This would include the portion that invests
in fixed deposits, government securities, etc. The idea is to generate returns
while keeping volatility on the lower side, it is usually kept at 35% in order to make sure the remaining 65%
is invested in equity so as to allow the fund to qualify as an equity fund.
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Should you in a Balanced Advantage Fund?
A Balanced Advantage can invest in both
equity and debt, the exposure to which can be dynamically managed based on the
prevailing market conditions.
Such funds help in the sense they do your
job of rebalancing which is necessitated by volatility which is a given with
equity investing.
This should never be the only fund in your
portfolio though but should rather be a part of it.
Every balanced advantage fund will a
strategy of its own and that is usually based on valuation metrics like price
to earnings (P/E), price to book (P/B) and dividend yield.
This is not an exhaustive list but only the
usual factors are stated.
Such funds are slightly on the conservative side due to the option of cutting down their equity exposure in a falling market.
This creates an illusion that they are
safer since they can up their allocation to debt which is not true since with
debt you still need to be on the look out for credit and interest rate risk.
Balanced advantage funds can be considered
for your initial steps into the world of equity investing but picking the one
most suited for you is where the real planning comes into the picture.
Benefits of a Balanced Advantage Fund
Most balanced advantage funds follow the
age old investing pattern of buying low and selling high, therefore as an
investor you need not worry about valuations when investing in a balanced
advantage fund.
Balanced Advantage Funds are generally less
volatile than aggressive hybrid funds and equity funds, therefore they can be a
great first step for someone just starting out with equity investing.
Investing in any equity fund is not enough,
one needs to monitor their investments periodically but this is not the case
with a balanced advantage fund since the fund itself manages volatility by
increasing and decreasing equity allocation depending upon the prevailing
conditions.
A balanced advantage fund invests in
equity, debt and fixed income instruments dynamically and therefore as an
investor you need not worry about investing in various assets individually.
Disadvantages of a Balanced Advantage Fund
A balanced advantage fund will have some
exposure to equities at all times which is subject to market risks.
The fixed portion of its portfolio will be
subject to interest and credit risk.
Every balanced advantage fund will have its
own strategy, the two most common of them being counter cyclical and pro
cyclical.
A pro cyclical balanced advantage fund
usually increases its equity allocation in a rising market whereas a counter
cyclical balanced advantage fund decreases its equity allocation.
Therefore no two balanced advantage funds
function in the same manner and one would need to be cognizant of the strategy
applied and whether that strategy is aligned with their risk profile or not.
On top of this fund houses also have their
own in house model to determine the equity allocation and quality of equity
based on P/E & P/B ratio, dividend yield ratio.
If you’re someone who prefers stability
over high returns than a counter cyclical fund would make sense and vice versa with
a pro cyclical fund.
The issue is when a fund combines several
strategies or consistently changes strategies making it difficult for you to
gather the underlying approach in play.
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