Many times, young investors get confused between the names and types of funds. They wonder if Flexi-cap funds are the same as multi-cap funds or if balanced funds and dynamic asset allocation funds are the same or different. Likewise, they may get perplexed between balanced and balanced advantage funds due to the similar names they bear. Both are two different types of funds and we shall have a detailed comparison between the two in this blog.
What are Balanced Funds?
Balanced funds are a type of hybrid funds that invest in both equity and debt asset classes in almost equal proportions. All hybrid funds allocate the fund assets to equities and debt securities in a fair ratio but they may be bent towards one asset class by a higher percentage of investments. On the other hand, balanced funds allocate the fund corpus to both asset types in a balanced ratio.
They follow the 60%-40% ratio of investing where one segment is allocated 60% of the funds and the rest 40% is allocated between equity and debt segments. While this allocation can be interchanged but only by 20%, that is, 60% allocation to one asset class can be brought down to a minimum of 40%, and 40% allocation of the other asset type can be raised to a maximum of 60%.
What are Balanced Advantage Funds?
Balanced advantage funds are also a type of hybrid funds that invest in both equity and debt components. Unlike all other hybrid funds, they are highly flexible and need not follow a fixed proportion of asset allocation. They can invest the fund assets in any money market instrument and in any ratio. Also, unlike other hybrid funds, they do not have a static fund allocation rule, but they can switch between asset classes dynamically according to the market movements. Hence, balanced advantage funds are also known as dynamic asset allocation funds.
When markets have reached a peak and are overvalued, these fund values may see a decline. Hence, the fund allocations are moved from equities to debt, keeping the capital gains intact and also generating a stream of fixed income.
Balanced Funds Compared to Balanced Advantage Funds
As we draw a comparison between the two types of funds, let’s look at the similarities and differences between both funds. We will then compare which fund draws more advantages over the other.
Some of the similar attributes noticed in both kinds of funds are:
- Both are a type of hybrid funds that invest in equity and debt
- Both of these funds are diverse and aim at giving risk-reward balance through growth and fixed income securities
- Both these funds limit the downside of equity markets by creating a stream of income and providing security of debt and bonds that are not market linked
- Although it majorly depends on the fund houses and fund strategies taken by the fund managers; both funds usually spread the investment in stocks across all types of capitalizations to avoid concentration risks
- Both are advisable for an investment horizon of a minimum of 3-5 years
The factors that mark the difference between the balanced and the balanced advantage/dynamic asset allocation funds are:
Asset Allocation: Balanced funds have to follow the static asset allocation rule of 60/40 to equity and debt. Either of the two asset classes can have a 60% fund allocation and the other 40% is allocated to the other money market instrument. Balanced advantage funds have no such mandate by the SEBI Securities and Exchange Board of India) to maintain a definite ratio. They can allocate the fund to debt and equities in any proportion acting upon the market movements.
Rebalancing Asset Composition: Balanced funds have limited scope for asset reallocation where they can only switch between the asset types by a margin of 20%. This means they may rebalance the asset allocation from one component to another from a maximum of 60% to a minimum of 40%. Whereas, the balanced advantage funds have full flexibility to switch the fund allocation between the debt and equity asset classes. There is no upper and lower limit for rebalancing the fund corpus between debt and equity segments.
As they can dynamically switch between the asset classes, they are termed dynamic asset allocation funds. Also, as these funds balance the asset composition between equities and debt components to take advantage of the upheavals of the complete cycle of the market, they are termed as balanced advantage funds.
Fund’s Objective: Both funds aim to strike a risk-reward balance, however, balanced funds focus on stability and long-term growth. Balanced advantage funds on the flip side, aim at beating market volatility to give risk-adjusted returns. The latter uses the market dynamics and its flexibility to adjust according to earning optimum returns.
Returns: Balanced advantage funds have the potential to yield higher returns in favorable markets and offer more security and steady income during unfavorable times than balanced funds. This is because the latter cannot allocate the fund corpus to any asset class after a specified limit. So, even when the markets are topsy turvy, they must have a minimum equity investment of 40% whereas balanced advantage funds can dynamically switch from equity to debt. Likewise, even when markets are soaring, balanced funds can have a maximum exposure of 40% to equities whereas dynamic asset allocation funds can increase the equity exposure to any limit.
Risks: Both funds will have the risks associated with equity and debt components in their portfolios. Equities have the market risk and if not well-diversified across different caps, they may also bear concentration risks. However, balanced advantage funds can shed off exposure to equities when markets are down giving them an edge over balanced funds. Debt funds are associated with credit and interest risk so the bonds and debt securities must be A-rated ones.
Tax Treatment: Balanced funds are taxed like debt funds as their equity allocation even at a maximum of 60% lies below 65% that qualify for equity-oriented funds and get the tax treatment alike. On the other hand, balanced advantage funds are taxed like equity or debt depending on the asset allocation at the time of redemption. However, most funds try to maintain the 65% allocation to equities so that they are taxed like capital gains of equity funds. They usually keep 65% in equities by allocating 33% to equities and 33% to arbitrage or unhedged equities. The arbitrage opportunities benefit the fund from price differences in the cash and futures market and the returns are not hampered by market volatility.
Which one to choose?
Both funds have their pros and cons but balanced funds are more suitable for conservative investors and balanced advantage funds for investors with moderate high-risk appetites. So investors should choose according to their risk appetites and investment goals. They should compare the objective of both funds. Consider the following factors:
- Balanced funds are considered apt for investors seeking long-term wealth creation with stable returns and less risk tolerance. Many experts feel that balanced advantage funds do not give uniform returns and vary as per market conditions whereas balanced funds are right. The short-term volatility can be overlooked in long-term investment goals
- The expense ratio of balanced funds is usually lower than the balanced advantage funds as the latter is dynamic in asset allocation
- Balanced funds are often considered by financial advisers as the right choice, especially for beginners as these funds eliminate the need to time the market. Most equity or debt funds require investors to assess the market conditions before investing but as these funds have the flexibility to change asset allocation as per the market swings, they refrain the investors from assessing the market time
- Balanced advantage funds may also suit a large bandwidth of investors as they have the potential to give better returns in highly evaluated markets. They are more protective towards beating volatility, can also perform in flat markets through arbitrage opportunities, and can even act like balanced funds maintaining an equitable ratio between both asset segments
Wrapping it up:
Balanced funds and balanced funds are both a type of hybrid funds where the former has a set limit of minimum and maximum asset allocation to debt and equities. On the other side, balanced advantage funds have no such higher or lower limits. This allows the dynamic asset allocation funds to have broader flexibility of dynamic switch than the balanced funds.