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The fall in the markets from its October 2021 peak gives an opportunity to gauge the performance of these funds, especially since BAFs/ DAAFs rely on asset allocation—shifting between equity and debt, depending on what is expected to deliver better for the investor. And the period since October has been marked by a combination of choppy equity markets and falling debt returns.
While the performance of a fund over one short period may not be an indicator of long-term outperformance or even underperformance, it is definitely something to watch out for, if the trend persists. Also, the decision has to be based on a combination of overall returns and the extent of volatility in returns.
BAFs invest in a mix of equity and debt instruments, managing this allocation dynamically with changing market conditions. They raise their equity exposure when markets are looking attractive and vice versa. This results in reduced volatility in returns compared to a pure equity fund.
Today, close to 25 BAFs /DAAFs offered by AMCs manage Rs. 1.2 trillion worth of assets. In this article, we look at the recent performance of some of the larger and older funds.
The selected BAFs / DAAFs have generated negative returns of around 2% to 9%, between 18 October 2021 and 24 June.
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Strong on value
Launched in December 2006, ICICI Prudential BAF has been using a price-to-book (P/B) valuation-based model to manage its equity-debt allocation dynamically since inception.
Unlike several other BAFs that use the P/E (price-to-earnings) multiple or a combination of P/E and P/B, ICICI Prudential BAF relies solely on the P/B ratio. Elaborating on the choice of this valuation metric, Chintan Haria, head, product development & strategy, ICICI Prudential AMC, says “P/B is a more stable indicator compared to P/E which is prone to greater volatility with upgrades and downgrades in earnings estimates”.
The fund has fallen just under 2% from the October 2021 peak. “We are disciplined about applying the valuation model. Also staying away from very expensive stocks and being underweight on high beta sectors helped us in this fall.” says, Haria, explaining the fund’s subdued fall. Between October 2021 and May 2022, the fund had net equity exposure of only 32-36%. Large caps accounted for 90% of the fund’s total equity allocation.
One of the market experts that we spoke with highlighted the fact that value stocks have done very well over the past 7-8 months and this shows in the performance of funds such as ICICI Prudential BAF that have invested in such stocks. He added that this may not work always.
In summary, while ICICI Prudential BAF has not generated the highest returns in the category, it has managed to provide good downside protection in falling markets.
Driven by momentum
In contrast to a valuation-based BAF, on the other end, is the trend or momentum-based cyclical model of Edelweiss BAF that has returned minus 9% since the October 2021 peak. This model combines quantitative metrics such as daily moving averages (average of daily index values over specific periods) and downside deviation (extent of fall in index value in periods of market fall) for the Nifty 50 to gauge the market trend. Based on that, the fund starts adding to its equity allocation if the market is trending up strongly and vice versa. While such a model can provide good downside protection during periods of market fall, it can limit the upside to some extent, compared to a valuation-based model, once the market recovery begins.
More importantly, while the model is designed to work well when the markets are trending either up or down, it may not deliver in range-bound markets. Elaborating on the fund’s recent underperformance, a person familiar with the matter who did not wish to be named, said that the model is not suitable for a volatile but range-bound market, such as the one seen over the last 6-8 months. According to him, the model tends to perform well when the markets are either trending up or down, that is, moving up or down by more than 8-10% over the course of a year. A market that is volatile without moving meaningfully in either direction does not suit a trend-based BAF model.
High return, high volatility
With asset under management of ₹43,836 crore as of end of May, HDFC BAF is the largest scheme in this category which has fetched the highest returns in the category across different holding periods of 1, 3 and 5 years. The fund’s significantly higher unhedged equity exposure compared to its peers has helped it deliver better returns. But this has been accompanied by far greater volatility (wider range of returns) compared to peers across different holding periods.
In contrast with most other BAFs, HDFC MF’s BAF does not operate based on a model, though it takes into account factors such as valuations, interest rates and the outlook for different asset classes to modify its equity and debt allocation. Also, historically, it has kept its entire equity allocation unhedged (no derivatives exposure) and largely static, and at much higher levels compared to peers. This made it more like an equity fund rather than a BAF. However, from January 2020 onwards, the fund started dynamically managing its equity allocation and using derivatives to reduce its effective equity exposure. For example, from 82% in March 2020, the net equity exposure was brought down to 57% by November 2021. Thereafter, this was, after minor tweaks, raised to 65% by May 2022.
Thanks to this significantly lower net equity (unhedged equity) than before, the HDFC BAF has fallen only 5% from the October 2021 peak, not the sharpest in the category. In the past, the fund has seen steeper falls compared to its peers.
Model holds the key
Though not among the largest funds in the category, the DSP DAAF stands out for strict adherence to its model since its inception in 2014. So much so, that the scheme information document lays out the model with all its details—it takes into account largely trends in P/E and P/B for the Nifty 50 to gauge whether the market is attractive on valuations, and to some extent, technical factors, too. The construct of the model has helped DSP manage downsides well (less volatility in returns), but the overall fund returns have lagged those of many peers, across different holding periods. While the negative return of 7% since the October 2021 peak appears a tad sharp compared to peers, it’s worth noting that in the past, the fund has typically fallen less than its peers during down-market phases.
“We follow a numbers driven analytical model with no human intervention whatsoever,” says Sahil Kapoor, head of products & market strategist, DSP Mutual Fund. According to Kapoor, with valuations coming down closer to historical averages, the model has been indicating an increase in equity allocation recently.
Mix of value, market trend
The BAF from Kotak Mutual Fund follows a two-factor model that relies primarily on the Nifty 50 P/E: higher the valuation multiple, the lower is the equity allocation. Apart from that, it also takes into account the market trend or sentiment using parameters such as long-range rolling returns, volatility, breath of market, etc. The fund has fallen 5.6% since the October 2021 peak. Between October 2021 and now, the fund has increased its net equity exposure from 31% to 51%, as valuations have moderated and sentiment has moved from extreme frothy levels.
Harish Krishnan, fund manager, Kotak Mutual Fund, explains that BAFs derive returns mainly from asset allocation, and (within equity) from investment style and stock selection. “Asset allocation is usually the biggest return facilitator, followed by investment style (such as value, growth etc.) and then stock selection. In the last few months, value style has seen larger outperformance, especially in sectors like energy,” he says.
At Kotak BAF, the equity investment style is diversified multicap, with focus on growth businesses at reasonable valuations, he adds.
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