Prime Fund Recommendation: 3 balanced advantage funds for your portfolio

Investors, typically, want three things from their investments – low risk, good returns, and low taxes. Now, no mutual fund will tick all three boxes at the same time. So you need to prioritize. And in these current times, if you prioritize moderating risk and tax efficiency, then balanced advantage funds can come in useful.

Balanced advantage funds versus Balanced hybrid funds

With the wide coverage of balanced hybrid funds in recent times in media, let us make a clear distinction in our stance between the two first.

Balanced advantage funds (or dynamic asset allocation funds), as most of you would know, combine equity and debt and use derivatives to offset equity exposure and therefore reduce equity risk. Tax efficiency comes from their equity taxation, which sees long-term capital gains above Rs 1 lakh taxed at 10%. We’ve explained how these funds work in several earlier articles, so we won’t get into that here. These funds sit below aggressive hybrid and above equity savings funds in terms of risk and return.

There’s also a new set of hybrid funds that have recently launched – balanced hybrid funds. Balanced hybrid funds will generally come from new AMCs, as SEBI rules mandate that an AMC can have either an aggressive hybrid fund or a balanced hybrid fund most older AMCs will already have the former). Balanced hybrid funds can have equity allocation between 40-60% with the remaining in debt and derivatives are not allowed. These funds would offer indexation benefits on long-term capital gains (as debt funds used to earlier). As debt funds have lost their indexation benefit, this category has more recently come into the limelight and is being picked by AMCs as a new fund, if they do not already have an aggressive hybrid fund.

Given that there is no return history for these funds, it is not possible to know how they deliver. But even so, there is minimal reason to go for balanced hybrid funds as equity savings and balanced advantage would be better at containing downsides owing to their hedging, aggressive hybrid funds would score on upsides, and all three would offer better taxation. Therefore, we wouldn’t recommend balanced hybrid funds yet.

How to use balanced advantage funds

Coming back to balanced advantage funds – overall, these funds are lower-risk routes to investing in equity and can be held by any investor with a timeframe of at least 2 years. However, in these current times, you may be specifically wondering if you should add them now. Here are a few pointers on how you can use these funds in your portfolio.

• As a diversifier: If you have a large-sized portfolio, balanced advantage funds can be a good way to diversify your portfolio away from pure equity or pure debt, and offer better-than-debt returns without equity risk. 
• For tax efficiency: For those in the 15% and higher tax brackets, part of debt allocation in a portfolio can instead go towards these funds. Do not replace entire debt allocation – debt funds are lower risk, bring in better downside containment, and diversify your portfolio away from equity. Do not also exit debt investments already made for the sake of investing in balanced advantage funds. Invest only additional money. Also, if you hold debt funds for income generation (for example, through SWPs) don’t substitute with balanced advantage funds. These funds need at least 1.5-2 years in holding period before you can make any withdrawals.
• To reduce risk now: In the current market scenario, your portfolio could be high on equity or have a high allocation to aggressive mid/smallcap oriented funds. If you have a surplus to invest, you can make fresh investments in balanced advantage funds. This will help you avoid further increasing equity exposure in volatile times without having to exit equity funds. You can, for example, temporarily divert SIP amounts to these funds until your allocations are more in line with what is ideal for your risk and timeframe. For this purpose, ensure that you choose a conservatively-run balanced advantage fund (see recommendation below), else it would defeat the purpose of reducing risk.
• For nervous investors: For all those of you who are worried about current market conditions, fresh investments can be made in balanced advantage funds if you want to continue to participate in equity but are wary of corrections. Here too, go for conservative-style funds.

The difference in funds

Funds in the balanced advantage category use quantitative indicators to decide direction, volatility and therefore how much to hedge. Typically, these would be index valuations, technical indicators, institutional flows, and so on. However, the manner in which these metrics are used in terms of market indication and the strategy to be adopted varies with each fund.

Therefore, funds in the category are not uniform in the extent to which derivatives form part of the portfolio and the change in derivatives in response to market cycles. This makes the risk and return profiles of each fund different from the other. Conservatively-managed funds tend to maintain higher hedging and do not see big swings in derivative allocation. Aggressively-managed funds can have very low to no hedging, or then can drastically shift their hedging based on market cycles. 

For example, consider the earlier Nifty 50 peak in December 2022. At the time, the net equity (unhedged equity) varied from 32% to 80%, with the average at 56%. The following months saw the Nifty 50 marginally correcting, sending the average net equity dropping to 53% and then back up to 57% by April 2023. This apart, given that falling markets offer more buying opportunities, a few funds which had hedged heavily quickly upped their net equity. But those that were already aggressive and kept hedging very low had to do the opposite.

Therefore, while the former set of funds may have shown comparatively lower returns in the run up to the peak, they would have contained downsides better. The latter set of aggressive funds would have delivered well but would have had to move quickly to contain losses in market falls and, in very steep corrections, these funds would have slipped into bigger losses. In the 2020 correction, for instance, 1-month losses were as deep as 20-30%. It’s important, thus, to know how aggressive a fund is before you add it to your portfolio. 
In Prime Funds, our hybrid recommendations are split into Low Risk and Moderate Risk. Low Risk funds comprise conservatively-run balanced advantage funds, plus arbitrage and equity savings funds. Moderate risk funds house the aggressively-run balanced advantage funds and the normal aggressive hybrid funds.

Prime Fund recommendations

Here is explaining the 3 balanced advantage funds currently recommended in Prime Funds, in both the Low-Risk and Moderate-Risk buckets. Please read the suitability of each fund and decides which ones fit your portfolio, if they do.

#1 ICICI Pru Balanced Advantage

ICICI Pru Balanced Advantage is in the Hybrid – Low Risk bucket in Prime Funds. Among our Prime Funds recommendations in the balanced advantage category, this fund has the lowest risk. 

ICICI Pru Balanced Advantage has an in-house valuation-based model to decide hedging and equity allocations. The average net equity (equity not hedged through derivatives) has averaged around 40% in the past 2 years, much lower than the category average of 55%. However, the fund can reduce net equity quite significantly when markets trend towards the expensive or overheated zone; in November 2022, for example, net equity was just 32%. It can also quickly bring this back up if markets correct. In the 6-8 months following the 2020 correction, the fund had low hedging to make the most of the rally. It similarly upped equity exposure from April this year to above 40%.

ICICI Pru Balanced Advantage, thus, has far better downside containment than its category. Instances of losses in 1-month periods over the past 3 years is also lower at 25% compared to the 30% for the category average. Thanks to its strong downside containment and deft handling of market movements, the fund still manages above-average returns. 

On a rolling 1-year basis, the fund beats the category average 73% of the time even as the category includes aggressive funds that can deliver far higher returns. The fund also delivers better risk-adjusted returns.

Suitability: The fund needs a minimum holding period of 1.5-2 years. ICICI Pru Balanced Advantage suits investors looking for a lower-risk option with the aim of bringing down portfolio risk in long-term portfolios. It can also serve as a part-debt replacement for those looking for tax efficiency in long-term portfolios. In short-term portfolios of 2-3 years, it can be used by high-risk investors who want higher returns – combine this fund along with debt funds (or fixed deposits) to balance risk and returns. 

#2 Edelweiss Balanced Advantage

This fund is among the more aggressive in the category, and is listed in the Hybrid – Moderate Risk section in Prime Funds. In the past year, for example, the fund has kept derivative exposure below 10%. The average net equity is well above the category average at 72%. The fund maintains a high open equity exposure when markets are conducive and invests across market capitalisations. It can step up hedging when markets call for it, though; it was on the higher side in mid-2021, for example, after the rapid Covid rally.

As a result, Edelweiss Balanced Advantage clocks higher returns. It beats the category about 68% of the time on a rolling 1-year return basis over the past 3 years. Its margin of outperformance over the category has gone up to even 9-10 percentage points. Of course, owing to its aggressive nature, it falters on downsides where it scores in lowest quartile. Both volatility and propensity to slip into losses is higher in this fund than in others. However, the fund does still manage to use the upsides to deliver above-average risk-adjusted returns.

Suitability: The fund needs a minimum holding period of 2-3 years. Edelweiss Balanced Advantage is better-suited to add return potential to a portfolio without upping risk by much. That is, for investors with long-term portfolios who would like to increase equity allocation for the return potential can opt for Edelweiss Balanced Advantage instead of adding pure equity funds. The fund will be especially useful in larger portfolios to add diversification. More conservative investors can avoid using this fund in short-term portfolios. This fund would also be less suitable as a replacement for the debt component of a portfolio than ICICI Pru Balanced Advantage above.

#3 HDFC Balanced Advantage

This fund is among the more aggressive in the category, and is listed in the Hybrid – Moderate Risk section in Prime Funds. The fund was earlier HDFC Prudence, one of HDFC AMC’s two balanced funds. In the recategorization exercise, it moved into the balanced advantage category but retained both its portfolio and strategy that it had run with, until then. 

That is, the fund uses debt to balance out the equity risk instead of a derivative-debt combination. Further, it takes active calls in debt, moving between accrual and duration which most balanced advantage funds don’t normally do. HDFC Balanced has, in the past few quarters, begun to use small allocations to derivatives to reduce risk. But this remains significantly below peers and the fund continues to primarily use debt to counter equity risk; in this aspect it differs from most peers. In the past 12 months, the average net equity exposure was about 60%. But derivatives were only about 7-10%. The remaining portfolio has been held in a combination of corporate and government bonds. 

As a result, the fund is more aggressive than any of its peers. This has led to bigger losses during market corrections, which impacted overall returns as well as volatility. This apart, in periods such as 2020 to early 2021, the fund’s equity portfolio also underperformed in terms of stock and sector calls; a similar performance dip also showed up in HDFC’s other hybrid and equity funds.

However, returns have since picked up and the fund has clocked sustained outperformance over the past several quarters. HDFC Balanced Advantage has markedly improved consistency in beating category average to 87% of the time now, on a rolling 1-year return basis over the past 3 years. The strong performance of its equity portfolio, as well as timely calls on the debt side, has also sent average returns to the top of the charts. 

Do note that the fund continues to be a highly volatile performer and does not match up to peers in downside containment. Of course, now that HDFC Balanced Advantage has begun to undertake at least some hedging, it could increase this when markets correct – but this remains to be seen.

Suitability: The fund needs a minimum holding period of above 3-4 years. As with the Edelweiss fund above, HDFC Balanced Advantage is a good option to add equity in a portfolio without going for a pure equity fund. In this sense, it should be used like you would an aggressive hybrid fund. The fund would be unsuitable as a replacement for the debt component of a portfolio; it needs to be seen as a lower-risk equity option alone. The fund is also a good fit for those with smaller-sized portfolios or beginner investors who will otherwise find it hard to manage asset allocation using separate equity and debt funds.

The 3 funds mentioned above have varying degrees of risk as mentioned in the suitability. You may pick what suits you the most. And if you already have a BA/DAA fund that is a 'BUY' in our Portfolio Review Pro tool outside of these funds, you need not switch. Do not also switch your debt allocation in to these funds.

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