Weekly Musings – NFO Pick (UTI Balanced Advantage Fund)

17 Jul 2023 , 12:34 PM

Balanced advantage funds (BAFs) or dynamic allocation funds are funds that have a rule based approach to allocation between debt and equity. For instance, when the P/E ratio automatically goes above a certain threshold, the BAF would reduce equity and increase debt. Similarly, if the bond yields crossed an upper limit, then the BAF would reduce exposure to debt and increase to equity. As the name suggests, these are dynamic allocation funds and the allocations to equity and debt may vary vastly. However, while these funds do give discretion to the fund manager, they also are rule based so investors have a broad idea what they are getting into and the rule book for such changes in allocation. 

About the UTI Balanced Advantage Fund

It is said that over longer periods of time, 85% of your returns are determined by asset allocation. That means, you must be invested in equity when it is cheap and in debt when equity is expensive. The best way to achieve this level of investment panache is through a set of rules that define a dynamic allocation fund or a BAF. The UTI Balanced Advantage Fund (BAF) intends to provide long-term capital appreciation and income by investing in a dynamically managed portfolio of equity and debt instruments. However, the fund does not give assurance or guarantee that the investment objective of scheme will be achieved.

Since the BAFs are also called dynamic asset allocation funds, let us understand what dynamic asset allocation is all about. Dynamic asset allocation is about changing asset allocation as per market conditions. This not only reduces risk but also generates risk adjusted returns. Actually, it is quite logical. If you reduce equity asset allocation when equity valuations are high and increase equity allocation when valuations are down, it ensures automatic profit booking at high levels and also ensures you have cash on hand when the markets are at lows. Where the balanced advantage fund (BAF) scores are that it is the only mutual fund category, which dynamically manages asset allocation according to market conditions; and based on a very well set body of rules and methodology.

Idea of investing in Balanced Advantage Funds (BAF)

Balanced advantage fund is a hybrid fund (debt plus equity), which changes its asset allocation dynamically. In other words, it toggles between more equity and more debt based on market conditions. The good part is that these are quantitative models based on a formula so the element of human discretion is reduced. Normally, the BAFs reduce equity and increase fixed income allocations when equity valuations are high. On the other hand, they will add to equity and reduce fixed income allocations when equity valuations are low. The triggers need not come only from equity valuations but can also come from interest rates. For example, after 250 bps of rate hikes by the RBI, the dynamic allocation fund may decide on increasing debt to play the downslide in interest rates and bond yields. By using a model based approach, balanced advantage funds eliminate behavioural biases in investing. This is one of the biggest advantages of the dynamic allocation approach.

That brings us to the main question, why to invest in Balanced Advantage Funds (BAF)? Firstly, the BAFs are less volatile compared to aggressive hybrid funds because they tend to have lower equity allocations at market peaks. Balanced advantage funds combine equity, debt and derivatives in a way that not only manages risk, but also earns risk-free arbitrage returns in the process. Also, since these are predominantly equity based funds, they enjoy concessional rates of capital gains tax. 

Three components of Balanced advantage funds

It is interesting to note that the portfolio of Balanced Advantage Funds (BAFs) is divided into 3 parts. The first part is Net Active Equity: This is the un-hedged equity exposure of the fund. This allocation is also model driven. The second important component of the BAF is the fixed income (debt) portion. This is usually capped at 35% to maintain the definition of equity fund for concessional tax treatment for unit holders. This is the stable fixed earning part of the portfolio. The third part of the BAF portfolio is the Hedged Equity Portion. Here, the equity holdings are hedged by taking contrasting position in the stock futures. For instance, if the fund holds 75,000 shares of State Bank of India, it would be perfectly hedged by selling 100 lots of SBI Futures against that. Alternatively, the BAF may also choose to do beta hedging, where a portfolio of stocks is hedged by selling equivalent lots of Nifty Futures based on the beta hedging concept. This helps maintain the 65% equity exposure.

Here is how the BAF generates returns or here are the sources of returns. Firstly, the equity portion (hedged and unhedged portion) generate dividend income. In addition, the unhedged equity portion may also generate capital gains from trading. Secondly, the fixed income portfolio generates returns from interest payouts and based on the interest rate movements, it also generates capital gains from sale. Finally, what about the hedged portion. We already saw that hedged equities earn dividends. In addition, the arbitrage positions are unwound resulting in gains. In addition, the arbitrage spreads generate steady returns through short roll premium on stock futures. All these add up to generate total returns on the Balanced Advantage Fund. 

Balanced advantage funds available in India

There are several dynamic allocation funds or Balanced Advantage Funds (BAFs) that are active in India. These BAFs have been floated by most of the large fund houses with some of the BAFs from AMCs like HDFC MF, ICICI Prudential MF, SBI MF and Kotak MF managing more than Rs10,000 crore of AUM each. Check out the table below which his indexed on 1 year returns.

Scheme  Name	Return 1 Year  (%) Direct	Return Since  Launch Direct	Daily AUM  (Cr.)
HDFC Balanced Advantage Fund	26.43	14.80	58,750.89
Baroda BNP Paribas BAF	22.55	15.57	3,263.16
Motilal Oswal Balance Advantage Fund	20.51	9.37	640.55
PGIM India Balanced Advantage Fund	20.51	12.13	1,417.28
Invesco India Dynamic Equity Fund	19.72	12.35	622.47
SBI Balanced Advantage Fund	19.12	10.63	23,004.71
Edelweiss Balanced Advantage Fund	18.16	12.57	9,357.36
LIC MF Balanced Advantage Fund	17.66	9.05	1,027.11
Mahindra Manulife BAF	17.59	8.41	588.50
Bank of India Balanced Advantage Fund	17.48	8.45	100.91
Aditya Birla Sun Life BAF	17.34	11.96	6,726.08
Kotak Balanced Advantage Fund	16.66	11.47	15,025.97
Sundaram Balanced Advantage Fund	16.65	10.03	1,556.91
Tata Balanced Advantage Fund	16.58	13.62	7,185.58
Bandhan Balanced Advantage Fund	16.37	9.36	2,452.68
Axis Balanced Advantage Fund	16.09	9.19	2,009.01
NJ Balanced Advantage Fund	16.03	4.95	3,901.52
Nippon India Balanced Advantage Fund	15.11	11.93	6,926.64
Union Balanced Advantage Fund	14.45	10.27	1,653.41
ICICI Prudential Balanced Advantage Fund	14.38	12.79	48,110.65
HSBC Balanced Advantage Fund	14.37	11.49	1,416.62
ITI Balanced Advantage Fund	13.72	5.63	361.98
DSP Dynamic Asset Allocation Fund	13.64	9.67	3,464.90
Shriram Balanced Advantage Fund	13.52	10.99	46.74
UTI Unit Linked Insurance Plan Fund	10.88	8.99	5,300.34

Data Source: AMFI

Thanks to the appeal of the Balanced Advantage Funds, the response has been quite good. In fact, the NFO of the SBI BAF in 2021 has the record for the highest collection in any NFO in Indian mutual fund history. Mutual Fund AMCs in India manage about Rs2.05 trillion of AUM in Balanced advantaged funds and remains the category of hybrid funds with the highest AUM. While there is a total of 25 Balanced Advantage Funds in India, the top 4 BAFs floated by HDFC MF, ICICI Prudential MF, SBI MF and Kotak MF account for 70% of the overall AUM of the entire BAF segment.

How did the BAFs perform in terms of returns? The average returns over a 1 year period have been 17.02% while the average returns since inception for all the 25 BAFs has been 10.63% on CAGR basis. Clearly, the longer period returns have not been too impressive, but the BAFs are able to deliver the best performance ideally over a time frame of 6-7 years. BAFs are best suited to the sophisticated investors with a long term perspective and willing to bet on a formula based approach to investing. It is quasi active and quasi passive approach and that is what makes this category of funds very interesting.

Glance at the UTI Balanced Advantage Fund NFO

Here are some details of the UTI Balanced Advantage Fund (BAF) NFO you must be aware of before you decided on investing in the fund.

1. The fund opens for subscription on July 21, 2023 and the NFO subscription will close on August 04, 2023. It is an open ended fund that offers continuous purchase and redemption available at NAV linked prices.

    

2. Entry loads do not exist in India, but if the fund is redeemed or switched within 365 days from the date of allotment, then there is no exit load for up to 10% of your holdings. However, if you redeem more than 10% of your holdings, exit load at 1% is charged.

    

3. The minimum investment in the UTI Balanced Advantage Fund (BAF) NFO will be Rs5,000 in the NFO and in multiples of thereafter. The fund does rank high on the SEBI Riskometer risk-scale.

    

4. The fund offers Regular and Direct plans for the investors. In addition, investors can either choose the Growth option or the IDCW (income distribution cum capital withdrawal) option, based on what suits their needs.  

    

5. How will the fund be benchmarked? It will be benchmarked Nifty 50 Hybrid Composite Debt 50:50 Index. Sachin Trivedi and Anurag Mittal will be the fund managers for the UTI Balanced Advantage Fund (BAF).

The UTI Balanced Advantage Fund (BAF) NFO is an opportunity for investors to invest in a fund based on a dynamic asset allocation model. It can be effective over the long run as it uses a quant model to tweak exposures to equity, debt, and derivatives. Investors in the NFO must be prepared for a longer term perspective of 5-7 years for full benefits of this approach.