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Why recommend ICICI Prudential Balanced Advantage Fund

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The primary reason I like the ICICI Prudential Balanced Advantage Fund (BAF) and recommend it to my clients is that it is an all-weather fund that does well in all sorts of market conditions. Below I shall elaborate upon my reasons for recommending this fund.

Buying low and selling high

The basic formula for success in the equity markets is that you should buy when the market is low and sell when it is high. Though the concept is simple, practising it in real life is not so easy. In the first place, defining what is a high market and what is a low market is not easy since these are relative concepts. BAF follows a price to book value (P/BV) model wherein it changes its allocation to equities and debt depending on the P/BV ratio of the Nifty. When the P/BV ratio increases, the fund moves out of equities and into debt and vice-versa. For instance, when in September 2013 the P/BV ratio of the Nifty was 2.71, the fund’s allocation to equities rose as high as 77.40. On the other hand, in January 2015 when the market turned expensive and the Nifty was trading at a P/BV ratio of 3.76, the allocation to equities in this fund fell to 34.30%. By adhering to such a model based approach, the fund manages to keep the twin human emotions of greed and fear out of the task of investing.


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An all-weather fund

The great thing about BAF is that it has performed in every market condition. Take one instance. On 25 March 2010 the Sensex was trading at 16,022. Two years later, on 5 June 2012 it was still trading at 16,021. Someone who had invested in an index fund based on the Sensex would have earned zero return over this two-year period. But even in these flat market conditions, BAF managed to deliver an absolute return of 19% and a compounded annual tax free return of 8.75% p.a. Similarly, one can cite several other examples when the market remained flat and yet the fund managed to deliver positive returns consistently.

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The fund manages to perform even in a rising market. Between 31 March 2014 and 31 March 2015 (i.e., in FY14-15), the Sensex rose from 22,386 to 27,957, thus offering a one-year return of 24%. Over this period the fund had an average allocation of only 47% to equities. Even with this low equity allocation, it managed to yield a return of 27% over this one-year period, thereby outperforming the Sensex which gave a return of 24%. What is notable here is that despite taking a low level of risk, as signified by the low equity allocation, it managed to outperform the Sensex. This translates into a superior risk adjusted return for the investors.

Between 3 February 2015 and 30 October 2015, the markets fell with the Sensex giving a return of -8.1%. In this falling market scenario, not only did the fund succeed in declining less than the Sensex, it also managed to turn in a positive return of 4.4%.

And how did the fund perform over the entire market cycle between 26 May 2014 and 30 October 2015, which included both a bull and a bear phase? The Sensex gave an absolute return of 7.8%. Over this period, the fund was miles ahead with an absolute return of 22.4% (the CAGR figures for the Sensex and BAF over this period were 5.4% and 15.2% respectively).

Beating FDs hands down

The most common instrument into which retail investors put their money into fixed deposits (FDs). Hence it becomes important for me to demonstrate to clients how they are much better off investing their money in this fund rather than in FDs. We compared the fund’s performance with that of FDs over different time horizons. The fund beat the returns from FDs over all four investment horizons that we considered (on 30 October 2015): one-, two-, three- and five years. Over the one-year horizon, it gave a return of 9.30%; over a two-year horizon it gave an annualised return of 19.57%; over three years, 17.56%; and over five years, 13.19%. Over all these horizons, an FD would have given an annualised return of 9%. In addition, those returns would have been taxed at the marginal tax rate, while the returns from the fund become tax-free after one year.

The tax advantage

As said earlier, the fund is treated as an equity fund for tax purposes. Long-term capital gains from it attract no tax while short-term capital gains are taxed at 15%.

One question that is posed to us often is that if the fund’s equity allocation ranges from 30-80%, how does it qualify for treatment as an equity fund? Whenever the fund’s allocation to equities goes below 65%, the balance allocation is made up by derivatives. So, if in bullish market conditions the fund’s equity allocation declines to 30%, the balance 35% (you need to have 65% allocation to equities to qualify for equity-like tax treatment) is invested in derivatives.

A 3-in-1 fund

BAF may be considered to be three funds rolled into one. When valuations become expensive the fund’s equity allocation falls to 30%. In such market conditions, the fund resembles a monthly income plan (MIP). When the market becomes fairly valued, the fund raises its allocation to equities to 65%, thereby resembling a balanced fund. And when market valuations decline, it raises its allocation to equities to the maximum limit of 80%. At such times it resembles an equity fund. Thus, it can be viewed as a three-in-one product, with the added benefit of being taxed like an equity fund.

BAF’s ability to perform in all market conditions makes it a very good fund for people with low to moderate risk appetite, who have invested in FDs all their lives but now want a moderate taste of equities. This is a fund for investors who don’t want to be bothered about questions such as: the market has risen (or fallen), should I book profit or stay put? The fund takes care of all these issues on investors’ behalf.

Thanks to BAF’s stellar performance, investors have reposed their faith in it. The fund’s asset under management (AUM) has risen from Rs. 204 crore in March 2013 to over Rs. 10,000 crore in November 2015, a 47-fold growth over just two-and-a-half years.

This fund also has an investor friendly options like consistent dividend history and monthly money back option.

Dividend history

The fund has given consistent dividend since Nov 2013. This consistency gives investor a better cash flow projection for themselves.

Money back option

However, dividend is subject to distributable surplus, therefore, keeping investors’ need in mind the fund also has money back option, which can generates a cash flow of nearly 9 percent per annum of capital invested.

Basically generating a cash flow of 9% p.a. of the capital invested i.e., Rs 90,000 in case of an investment of Rs. 10 lac in a year (for illustration purpose only). This facility allows investors to withdraw a fixed sum of money periodically depending on the frequency option chosen.

Finally, investors must remember that to reap the full advantage of this fund, they must stay invested in it over the entire market cycle and need to have a minimum investment horizon of 3 to 5 years.