The Balanced advantage or Dynamic Asset Allocation funds have found favour among a section of investors. These funds are hybrid funds and have been marketed as a low volatility alternative to pure equity funds. The narrative is that you earn equity-like returns at low volatility. It is no small promise.
What are Balanced Advantage or Dynamic Asset Allocation Funds?
Do not mistake these funds for regular aggressive hybrid funds (balanced funds). Under aggressive hybrid funds, the equity allocation in the portfolio ranges around 65%-80%. In the case of balanced advantage or dynamic asset allocations, the equity exposure in the portfolio can range from 0% to 100% depending on the market outlook.
The equity exposure in the portfolio can be increased or decreased based on fund manager discretion (outlook) or could be based on an asset allocation model.
The asset allocation model could be based on fundamental parameters (PE, Price-to-book, or any other method) or technical parameters (moving average based, trend following, etc) or a mix of both. In fact, it can be anything under the sun. All SEBI says about Balanced Advantage Funds is “Investment in equity/debt that is managed dynamically”. Therefore, there is a fair bit of discretion in AMC’s hands.
In this post, I pick up a popular fund in this category ICICI Prudential Balanced Advantage Fund and compare its performance and volatility against Buy-and-hold Nifty. It is the largest fund in this category and has been following the dynamic asset allocation strategy for a long time. The rest of the funds are relatively new, or I am not sure if those have been dynamic asset allocation funds for a long time.
At least a few AMCs converted funds from other categories to Balanced Advantage Fund after SEBI introduced classification rules in 2017. ICICI Prudential Balanced Advantage Fund keeps equity allocation between 30% and 80% based on a Price-to-Book (P/B) model. The exact model is obviously proprietary.
Over the past few months, we have tested various investment strategies or ideas and compared the performance against the Buy-and-Hold Nifty 50 portfolio. In some of the previous posts, we have:
- Compared the performance of Nifty Next 50 against Nifty 50 over the last two decades.
- Assessed whether adding an International Equity Fund and Gold to an Equity portfolio has added returns and reduce volatility.
- Compared the performance of Nifty 50 Equal Weight vs Nifty 50 vs Nifty 50 over the last 20 years.
- Considered the data for the past 20 years to see if the Price-Earnings (PE) multiple tells us anything about the prospective returns. It does, or at least has in the past.
- Tested a momentum strategy to shift between Nifty 50 and a liquid fund and compared the performance against a simple 50:50 annual rebalanced portfolio of Nifty index fund and liquid fund.
- Used a Simple Moving Average Based Market Entry and Exit Strategy and compared the performance against Buy-and-Hold Nifty 50 over the last two decades.
- Compared the performance of 2 popular balanced funds against a simple combination of an index fund and a liquid fund.
Performance Comparison: ICICI Prudential Balanced Advantage Fund
Let us plot the performance of the following 3 portfolios and compare.
- Buy-and-hold Nifty 50 Total Returns Index (Nifty 50 TRI)
- ICICI Prudential Balanced Advantage Fund-Direct Plan
- 50% Nifty 50 TRI + 50% Liquid Fund (rebalanced annually on January 1)
Direct plans started in January 2013. Thus, we do not have long enough active data. The ICICI Balanced Advantage Fund-Regular plan has been around since December 2006 but the fund AUM was only about 200 crores before 2013. Moreover, I was not sure if they were following a dynamic allocation strategy.
Let us start with performance since the beginning.
ICICI BAF comes out on top. CAGR is 11.68% p.a. (January 1, 2013-August 5, 2020).
Nifty 50 TRI has given a CAGR of 9.82% p.a.
ICICI Balanced Advantage Fund avoids extremely poor returns.
More importantly, it beats Nifty + Liquid (50:50) portfolio in 7 out of 8 years (including the current year).
Now, to the rolling returns.
ICICI Balanced Advantage Fund (BAF) did better in the initial years. Nifty 50 has done better in the last few years. In 2020, ICICI BAF has fallen less than Nifty 50.
Drawdowns and Rolling Risk
A major selling point for Balanced Advantage Funds is that you get equity-like returns at lower risk. Lower drawdowns help maintain investment discipline and stay the course.
Clearly, the volatility and the drawdowns are lower than the pure equity portfolio (Nifty 50 TRI). Therefore, if the intent was to offer equity-like returns at lower volatility, the fund has clearly achieved the purpose.
However, not everything is hunky-dory. In March when the markets crashed, the fund went down by over 17%. The maximum drawdown in the fund is over 25% in the last 7 years. While the fall is much less than Nifty 50 TRI, it is a big fall nonetheless. Perhaps, trend-based allocation models would have worked better when there are such steep declines.
Dynamic asset allocation funds or balanced advantage funds can be a decent choice for new investors or those investors who are looking for a single fund with reasonable returns and low volatility (and want asset allocation to be on autopilot). By the way, portfolio volatility can be handled through asset allocation at your level too.
At the same time, do not be under the impression that you cannot suffer losses with balanced advantage funds. I reproduce the monthly performance of some of the balanced advantage funds. Look at the returns for the month of March 2020.
- Past performance does not guarantee future performance.
- I have considered data for just 7 years. Not enough to draw a meaningful conclusion.
- ICICI Balanced Advantage is an active fund. There are active calls on both asset allocation and security selection. Appreciate the usual risks associated with active funds.
- Balanced Advantage Funds are not just about the asset allocation model. There is active security selection too. For a deeper analysis, we need to check how much of the performance can be attributed to asset allocation and how much to active security selection. I have not done that.
- Balanced Advantage Funds or dynamic asset allocation funds can be created using index funds too. For instance, a balanced advantage fund can use an index fund for equity exposure. None of the funds does that. There is a tax roadblock too in this angle. For the fund to qualify for equity tax treatment, it would need to have at least 90% in the equity index fund or ETF. If it holds stocks, the requirement is just 65%.
- You can argue whether Nifty 50 TRI is an appropriate comparison benchmark. ICICI BAF can invest in a wider spectrum of stocks. Hence, I could have considered Nifty 100 or Nifty Large & Midcap 250 for comparison.
- In the case of hybrid funds, consider the quality of the fixed income portfolio. All of us are prepared for hits in the equity portfolios but fixed income portfolios of hybrid funds can deliver nasty surprises. Therefore, if you want to sleep peacefully, consider the credit quality of the fixed income portfolio before selecting a hybrid fund. Do not just go by past returns or the aspects that I have shared in this post.
- The asset allocation models are proprietary. Different asset allocation models will do well at different times. If you must invest in a Balanced Advantage fund, read the Scheme Information document to understand the asset allocation approach.
Technically, HDFC Balanced Advantage Fund (erstwhile HDFC Prudence) is the largest fund in this category currently. However, I have not considered the fund because this fund was a regular hybrid fund until mid-2018. As I understand, even now, it is run like a normal aggressive hybrid fund. The change in category was simply to get around SEBI rules.
This is not a recommendation to invest in ICICI Balanced Advantage Fund.
I do not have any balanced advantage fund in my portfolio. A few clients have such funds in the portfolio.