Balanced Advantage Funds to tackle volatile market

The uncertainty revolving around coronavirus outbreak has led to fairly high market volatility during the last three months. In spite of this, the investment behavior of retail investors has been mature, as is generally gauged by the level of monthly SIP inflows that were impacted only marginally from March 2020 to May 2020.

This is in contrast to the earlier times when the investors used to pull out their investments as and when markets gave a correction. These days only those investors with some cash flow disruptions during such period have been seen to discontinue any fresh commitments.

However, the inclination to invest in relatively safer investments is indeed to be expected during the volatile times. This is where dynamic asset allocation helps the investors. It is always a prudent investing strategy to ‘buy low and sell high’. However, this is not easy to execute. The emotional biases coupled with greed and fear psychosis often take over the rationalism out of the investor.

As such, the investors generally tend to stay away from the markets when the markets are falling and chase the markets when they are going higher. Equity markets are inherently volatile, making it unsuitable for short term goals and investment horizon. However, it is important to stay invested in equity for achieving long term financial goals, so as to benefit from the potential of long term wealth creation and the power of compounding.

On the other hand, debtinvestments may help keep the portfolio stable, but carry the potential of only modest returns in the long term. It often boils to the fact that it is not just about investing, but investing with the right asset mix for the investors aiming for the right investment solution to achieve their financial goals. This also assumes importance due to the fact that the returns through different asset classes are not linear. As such, it becomes imperative for the investors to steer through the market ups and downs with ease.

This is where the Balanced Advantage Funds (BAF) which use the strategy of dynamic asset allocation, emerge as a savior, making the process of investing across equity and debt easier for the investors. Dynamic asset allocation denotes the flexibility to choose across different asset classes depending upon their relative valuations. The strategy typically adopted by such funds is to increase the allocation to unhedged equity when the markets are relatively inexpensive. Similarly, the allocation shifts towards debt when equity markets trade at higher valuations.

Balanced Advantage Funds, in fact, benefit from the market volatility, as the opportunities to buy low and sell high are higher during such times. They tend to emerge as all-weather funds as they aim to reduce volatility within the portfolio, thereby achieving the objective of generating returns in a less-risky manner. Such funds will fall lower during markets corrections due to the presence of non-equity investments in the portfolio.

Similarly, when the markets rebound, such funds typically start at higher levels and thus, may generate similar returns as equity funds over the long term. However, with lower inherent risk embedded in such funds, the investors are able to achieve the desired returns in a relatively safer manner. Further, since the asset allocation is decided in a systematic manner (in some cases, through in-house valuation models), such funds also eliminate the subjectivity and
biases from the decision making process.

The inherent advantage of dynamic asset allocation also takes away the timing risk, since the timing function is managed within the fund itself. As a result, these funds
are suitable for lump-sum investments as well. However, it becomes important for the investors to gauge the fund performance only through the market cycles, and not
through a single phase.

Since such funds invest only partially in equity, a single bull run may make them seem like an underperformer, while a bear market may make it look like an outperformer due to better downside protection. Hence, a complete market cycle is required to evaluate them in an objective manner. With BAF offering better downside protection and risk mitigation, such funds can be considered by the investors to continue to stay invested across the market cycles.

One final word: they are essentially equity based funds, hence use them for investment horizons of more than three years.

(The writer is CEO, Union Asset Management Company Private)