Why balanced advantage funds are back in focus for moderate risk investors

Mint

25-05-2025

Dynamic asset allocation funds (DAAFs), also known as balanced advantage funds, invest across equity and debt in a flexible, market-responsive manner. In theory, these funds increase equity exposure when valuations are low and shift towards debt when equity valuations appear stretched.
This ability to dynamically balance risk and reward makes them particularly attractive to moderate-risk investors looking for inflation-beating, tax-efficient returns, without the need to time the market.
Historical data reveals that dynamic asset allocation funds (DAAFs) have offered strong downside protection, relatively low volatility, and consistent returns, especially appealing for moderate-risk investors.
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On a 5-year daily rolling CAGR basis since each fund's inception (as of 30 April 2025), none of the DAAFs delivered negative returns, even during major market downturns like the 2008 global financial crisis and the 2020 Covid crash.
In absolute terms, during the 2020 Covid-led market crash, DAAFs declined by 12.7% to 33.9% (average: –22.4%), notably better than the Nifty 50 TRI, which fell by 38.3%.
These figures underline the ability of well-managed DAAFs to cushion downside risk and deliver inflation-beating returns with lower volatility—particularly beneficial for moderate risk takers. Additionally, since they are taxed as equity funds, their post-tax returns are more efficient than many traditional alternatives.
However, not all DAAFs are equally suitable for moderate investors. Some can exhibit considerable volatility depending on their strategy. Hence, selecting a fund that stays true to its label, dynamically adjusts allocations, and consistently balances equity and debt exposure is critical.
Choosing the right strategy: Pro-cyclical vs counter-cyclical
Dynamic asset allocation funds typically follow one of two approaches. Pro-cyclical strategies take aggressive equity positions when markets are rising—essentially buying high with the aim of selling higher. Counter-cyclical strategies, on the other hand, are more conservative and valuation-conscious, increasing equity exposure when markets are falling, and thus following a buy-low-sell-high philosophy.
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Both approaches have proven effective in different market cycles, and a combination of the two has historically offered a good mix of inflation-beating returns, lower volatility, and more consistent outcomes. However, this doesn't mean investors must own both. Moderate risk takers may find counter-cyclical funds more suitable, given their focus on downside protection. Aggressive investors, seeking to maximise upside in bull markets, might prefer pro-cyclical funds. Those who fall somewhere in between could consider holding a mix of both.
Given the inherent market exposure in these funds, investors should ideally have a three- to five-year investment horizon and treat DAAFs as part of their equity portfolio. They are not substitutes for pure debt instruments.
That said, the presence of debt and arbitrage components does lend them a degree of stability, making them especially attractive for those using systematic withdrawal plans (SWPs). A key advantage is that investors don't need to time their entries, especially in counter-cyclical funds where the strategy itself is designed to respond to valuation shifts.
Why DAAFs are well-placed in the current market
Today's market environment makes a strong case for DAAFs, particularly for moderate risk takers seeking inflation-beating, tax-efficient returns. Equity markets remain volatile and are currently in a corrective phase, which is beneficial for both long-term equity investors and arbitrage strategies. Large-cap valuations appear reasonable, especially when compared to the stretched valuations of mid- and small-cap stocks.
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Meanwhile, on the fixed income side, although policy rates have come down, AAA bond yields remain elevated at around 7%. More rate cuts are expected through 2025 and 2026, which could push bond prices higher, adding to debt portfolio returns.
DAAFs, as a category, appear well-positioned to tap into this dual opportunity. The average fund has a 55% allocation to equities—largely tilted towards large-cap stocks—and a 45% allocation to debt and arbitrage. The average yield-to-maturity of the debt component stands at about 7%, with maturities around 4.8 years.
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Together, this asset mix offers a compelling risk-reward balance, giving investors a shot at both capital appreciation and income stability. While DAAFs aren't a complete replacement for traditional debt products—especially for highly risk-averse investors—they are becoming increasingly relevant in a falling interest rate environment, where beating inflation after taxes will likely require hybrid strategies.
Rushabh Desai is founder of Rupee With Rushabh Investment Services. Views expressed are personal.