- Date : 14/02/2023
- Read: 5 mins
A Balanced Advantage Fund (BAF) gives exposure to equity that can provide growth and debt that provides stability during market falls. BAF is taxed as an equity fund.
Investors should always diversify their investment portfolio into different asset classes to spread the risk. You can do this by investing in different financial products across asset classes such as equity, fixed income, gold, real estate, etc. The other option is to invest in hybrid mutual funds that can give you exposure to multiple asset classes through a single mutual fund scheme.
One such hybrid scheme is the Balanced Advantage Fund (BAF) or dynamic asset allocation fund. This article explains what balanced advantage funds are, how they work, and the tax advantages they offer.
What is a balanced advantage fund?
A balanced advantage fund is an open-ended mutual fund scheme that invests in a mix of debt and equity. The equity-debt ratio is managed dynamically based on market conditions. The fund manager may increase or decrease the proportion of equity based on certain parameters such as price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, or some other pre-determined criteria. Most BAFs are managed in a manner that the equity component does not fall below 65% at any point. As a result, they are treated as equity funds from a taxation point of view.
How does a balanced advantage fund work?
A BAF invests in a mix of equity and debt. The equity component may vary on a parameter such as the price-to-earnings (P/E) ratio. So, when the markets are doing well or are in euphoria mode, the P/E ratio usually goes higher. When it exceeds a specified limit, the fund manager will sell equities and reinvest the proceeds in debt. During times of high P/E, the fund manager will rebalance the scheme portfolio by reducing equity and increasing debt allocation.
Similarly, when the equity markets are down sharply, the P/E ratio usually falls below the long-term average. So, when the P/E ratio goes below a specified limit, the fund manager will sell debt instruments and reinvest the proceeds in equities. During times of low P/E, the fund manager will rebalance the scheme portfolio by increasing equity and decreasing debt allocation.
What is the tax advantage of investing in balanced advantage funds?
Investing in balanced advantage funds gives you two tax advantages:
1) Tax advantage at the time of portfolio rebalancing
Suppose you invest separately in an equity fund and a debt fund. In such a scenario, at the time of portfolio rebalancing, you will have to either sell equity fund units and reinvest in debt fund units or vice versa. During such times, whenever there is a sale of equity/debt fund units, there will be capital gains tax implications.
However, in the case of a BAF, when the fund manager rebalances the scheme portfolio between equity and debt at the scheme level, there are no capital gains tax implications for you as a scheme investor. So, whenever the fund manager sells equity/debt and reinvests in the other asset class at the scheme level, you, as a BAF scheme investor, will not have any capital gain tax implications.
There is a capital gains tax advantage to be had at the time of rebalancing when you invest in a BAF rather than investing in an equity and debt scheme separately and doing the rebalancing at your end.
2) Taxation of an equity fund
Most balanced advantage funds are managed in a manner in which the equity and arbitrage component is always 65% or higher. As a result, they are treated as equity funds from a taxation point of view. The taxation of equity mutual funds is favourable as compared to those of debt funds. In the case of an equity fund, if the holding period is more than a year, the capital gain is categorised as a long-term capital gain (LTCG). In a financial year, the first Rs 1 lakh LTCG is exempt. The incremental LTCG is taxed at 10% without indexation benefit.
In the case of a debt fund, if the holding period is more than 3 years, the capital gain is categorised as long-term capital gain (LTCG). The LTCG is taxed at 20% with an indexation benefit. Balanced advantage funds can have a debt component of up to 35%, yet they enjoy the benefit of equity fund taxation (provided the equity component is higher than 65% at all times). Hence, when you invest in a BAF with a combination of equity and debt, you still get the tax advantage of an equity fund.
Also Read: How To Choose An Equity Mutual Fund
Performance of top balanced advantage funds
Note: The above returns are as of 10 February 2023. The returns are for direct plans with growth option. The funds are ranked based on 5 year returns. The 3 and 5 year returns are CAGR.
Who should invest in a BAF?
As an investor, if you want exposure to equity and debt, where the allocation is dynamically managed by an expert, you may invest in a BAF. With a BAF, you will get exposure to equity, which has the potential to give high returns that can help you accomplish your financial goals. It also gives you exposure to debt, which provides stability to the portfolio when the equity markets are falling. Finally, you will also get the better taxation advantage of an equity fund, even though there can be a debt component of up to 35%.
Actionable insights
- Balanced advantage funds give you the benefit of equity and debt in a single scheme.
- The equity and debt exposure are managed dynamically by an expert fund manager. The rebalancing within the scheme has no capital gains implications for you.
- Even though a BAF is a hybrid scheme, it has the advantage of getting taxed as an equity fund (provided the equity component is more than 65% at all times).
Investors should always diversify their investment portfolio into different asset classes to spread the risk. You can do this by investing in different financial products across asset classes such as equity, fixed income, gold, real estate, etc. The other option is to invest in hybrid mutual funds that can give you exposure to multiple asset classes through a single mutual fund scheme.
One such hybrid scheme is the Balanced Advantage Fund (BAF) or dynamic asset allocation fund. This article explains what balanced advantage funds are, how they work, and the tax advantages they offer.
What is a balanced advantage fund?
A balanced advantage fund is an open-ended mutual fund scheme that invests in a mix of debt and equity. The equity-debt ratio is managed dynamically based on market conditions. The fund manager may increase or decrease the proportion of equity based on certain parameters such as price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, or some other pre-determined criteria. Most BAFs are managed in a manner that the equity component does not fall below 65% at any point. As a result, they are treated as equity funds from a taxation point of view.
How does a balanced advantage fund work?
A BAF invests in a mix of equity and debt. The equity component may vary on a parameter such as the price-to-earnings (P/E) ratio. So, when the markets are doing well or are in euphoria mode, the P/E ratio usually goes higher. When it exceeds a specified limit, the fund manager will sell equities and reinvest the proceeds in debt. During times of high P/E, the fund manager will rebalance the scheme portfolio by reducing equity and increasing debt allocation.
Similarly, when the equity markets are down sharply, the P/E ratio usually falls below the long-term average. So, when the P/E ratio goes below a specified limit, the fund manager will sell debt instruments and reinvest the proceeds in equities. During times of low P/E, the fund manager will rebalance the scheme portfolio by increasing equity and decreasing debt allocation.
What is the tax advantage of investing in balanced advantage funds?
Investing in balanced advantage funds gives you two tax advantages:
1) Tax advantage at the time of portfolio rebalancing
Suppose you invest separately in an equity fund and a debt fund. In such a scenario, at the time of portfolio rebalancing, you will have to either sell equity fund units and reinvest in debt fund units or vice versa. During such times, whenever there is a sale of equity/debt fund units, there will be capital gains tax implications.
However, in the case of a BAF, when the fund manager rebalances the scheme portfolio between equity and debt at the scheme level, there are no capital gains tax implications for you as a scheme investor. So, whenever the fund manager sells equity/debt and reinvests in the other asset class at the scheme level, you, as a BAF scheme investor, will not have any capital gain tax implications.
There is a capital gains tax advantage to be had at the time of rebalancing when you invest in a BAF rather than investing in an equity and debt scheme separately and doing the rebalancing at your end.
2) Taxation of an equity fund
Most balanced advantage funds are managed in a manner in which the equity and arbitrage component is always 65% or higher. As a result, they are treated as equity funds from a taxation point of view. The taxation of equity mutual funds is favourable as compared to those of debt funds. In the case of an equity fund, if the holding period is more than a year, the capital gain is categorised as a long-term capital gain (LTCG). In a financial year, the first Rs 1 lakh LTCG is exempt. The incremental LTCG is taxed at 10% without indexation benefit.
In the case of a debt fund, if the holding period is more than 3 years, the capital gain is categorised as long-term capital gain (LTCG). The LTCG is taxed at 20% with an indexation benefit. Balanced advantage funds can have a debt component of up to 35%, yet they enjoy the benefit of equity fund taxation (provided the equity component is higher than 65% at all times). Hence, when you invest in a BAF with a combination of equity and debt, you still get the tax advantage of an equity fund.
Also Read: How To Choose An Equity Mutual Fund
Performance of top balanced advantage funds
Note: The above returns are as of 10 February 2023. The returns are for direct plans with growth option. The funds are ranked based on 5 year returns. The 3 and 5 year returns are CAGR.
Who should invest in a BAF?
As an investor, if you want exposure to equity and debt, where the allocation is dynamically managed by an expert, you may invest in a BAF. With a BAF, you will get exposure to equity, which has the potential to give high returns that can help you accomplish your financial goals. It also gives you exposure to debt, which provides stability to the portfolio when the equity markets are falling. Finally, you will also get the better taxation advantage of an equity fund, even though there can be a debt component of up to 35%.
Actionable insights
- Balanced advantage funds give you the benefit of equity and debt in a single scheme.
- The equity and debt exposure are managed dynamically by an expert fund manager. The rebalancing within the scheme has no capital gains implications for you.
- Even though a BAF is a hybrid scheme, it has the advantage of getting taxed as an equity fund (provided the equity component is more than 65% at all times).
