Balanced advantage funds also known as dynamic asset allocation funds are a category of mutual fund schemes that invest in a mix of equity and debt instruments. The asset allocation keeps shifting depending on market conditions.

Here is a breakdown of how it works – when the markets are soaring and stock prices go up, fund managers would pivot towards debt and when stock prices are low the asset allocation formula can tilt more towards equities. Fund managers deploy a process driven approach (also known as asset allocation model) to determine the weightages of the two asset classes in a way that maximizes gains and minimizes risk in accordance with existing market conditions.

This ensures that the investors do not see a sharp drop in their investment value when stock prices exhibit a steep ascent as the component of investment in debt securities would be larger. Similarly during periods when the markets recover after a steep fall, investors can reap benefits because the fund managers would have gravitated towards equities when stock prices were low.

Fund houses also have internal valuation systems in place to facilitate the shifts in asset allocation. These are mathematical models that are formulated based on the fund manager’s ideas of asset allocations at various valuation levels so that investment objectives can be achieved and maximum returns can be generated in the long term. The two commonly used models are

• Counter-cyclical model: In this model, equity allocation is increased by reducing debt allocation in falling markets and equity allocations are decreased in rising markets. Essentially, these models focus on buying at low points and selling high. Fund managers may use different valuation metrics for dynamic asset allocation though such as e.g. P/E, P/B etc.
• Pro-cyclical model: In these models, market trends are followed which entails raising equity allocation in rising markets while bringing it down in falling markets. Pro-cyclical models depend on market trend indicators like daily moving averages and indicators of the trend strength / health and some of these models may use other parameters like valuations, macro-economic factors etc.

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Mutual fund investments are subject to market risks, read all scheme related documents carefully.