Financial literacy in India has picked up bigtime. Credit goes to the telecom companies making the data cheaper and more affordable for people to browse on the internet & learn new things. Also in the pandemic period, people had more time to study about markets & equity linked asset classes. This was a great combination that led to pick up in financial literacy amongst all. The COVID period started with a huge correction in the stock market and a very sharp recovery post that.
After the things have settled, the market as always has displayed sideways movements & the easy money is gone. Investors now are looking for stable returns from a product that provides equity exposure but with lower downside and better tax efficiency.
In today's post, we are going to deep dive into a category of mutual funds that offers better than fixed deposit returns with lower volatility than equity oriented mutual funds.
Balanced Advantage Funds, also known as dynamic asset allocation funds are a category of mutual fund schemes where the fund manager has a flexibility to heavily move the exposure between debt, equity & arbitrage.
Unlike aggressive hybrid funds where the equity exposure has to be a minimum of 65% of the portfolio, balanced advantage funds move the exposure dynamically from 30%-80% in equity depending upon the market conditions. An interesting difference between an aggressive hybrid fund & balanced advantage fund is the flexibility to take arbitrage position in order to reduce equity exposure without selling it.
Let us assume that the fund manager wants to reduce equity exposure without affecting the tax structure of the scheme. If the equity exposure is 70% and he wants to reduce it to 50%, then he can simply cover the 20% equity by taking an opposite position in futures market against his holdings. We have discussed about how arbitrage works here.
The fund manager rebalances the portfolio to maintain the allocation as per overall market conditions & tries to deliver superior risk adjusted returns.
Let’s discuss important aspects of balanced advantage funds:
Multi-dimensional approach: A balanced advantage fund has flexibility to invest across market caps, sectors, asset classes in terms of equities & also towards debt instruments to ensure lower volatility. The arbitrage calls can help them reduce risks without losing the equity taxation status of the scheme.
Lower volatility: A balanced advantage fund is less volatile in nature when compared to a pure equity fund that consists of 80-100% equity.
Beginner friendly: A new investor in the stock market looking to take equity exposure can invest in a balanced advantage fund to test waters before building a diversified equity portfolio.
Who should invest in balanced advantage funds:
- Investors with an objective of generating better returns with lower volatility.
- Investors with a minimum investment horizon of 5 years.
- Investors looking to take equity exposure with lower downside risk.
Tax treatment on gains from balanced advantage funds, being a fund with minimum 65% exposure to equity & arbitrage, the gains are taxed as equity oriented mutual funds in following manner:
Short-term capital gains: If you redeem your investments within 1 year, then the gains will be taxed as short term capital gains at a tax rate of 15%
Long-term capital gains: If you redeem your investments after 1 year, then the gains will be taxed as long term capital gains at a tax rate of 10%. However, there is an exemption of Rs. 1,00,000 per annum on long term capital gains from equity oriented mutual funds. Hence the tax rate of 10% will apply on gains above Rs. 1,00,000.
Investor should keep following things in mind before investing in a balanced advantage funds:
- Over 20 mutual fund houses are offering balanced advantage funds to investors. However, each one of the schemes, though sounds similar, are very different from each other. It becomes very important to understand the dynamics of the scheme by evaluating each one separately. Some schemes rebalance on a daily basis while others do it on weekly or monthly basis. So schemes invest in short duration debt only while other schemes take long duration calls too.
- Balanced advantage funds offer lower volatility when compared to equity oriented schemes. However, they cannot be considered as an alternative to fixed deposits or debt mutual funds. Debt exposure in these schemes can protect the downside to a certain extent only. If there is turmoil in equity markets then it could lead to negative returns in these schemes as well.
We will be posting articles on various balanced advantage funds where we will try to explain the fund management style & how they differentiate from other schemes in the same category for our readers to compare & invest. Stay tuned & keep watching this space.
CA Rohit J. Gyanchandani is Managing Director, Nandi Nivesh Private Limited, A Pune based Wealth Management Company.
Follow the entire series on Emergency Funds here.