The decline in the markets since the October 2021 peak gives an opportunity to gauge the performance of these funds, especially since weavers/DAAFs rely on asset allocation – the transfer between equity and debt, depending on what the investor is expected to deliver better. And the post-October period has been marked by a combination of choppy equity markets and falling debt returns.
While a fund’s performance over a short period may not be an indicator of long-term outperformance or underperformance, it is certainly worth a look if the trend persists. Also, the decision should 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 the changing market conditions. They increase their equity exposure when the markets are looking attractive and vice versa. This results in less volatility in returns as compared to pure equity funds.
Today, there are around 25 BAF/DAAF offered by AMCs that manage Rs. 1.2 trillion assets. In this article, we look at the recent performance of some large and older funds.
Selected BAFs/DAAFs have given negative returns of around 2% to 9% between 18 October 2021 to 24 June.
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strong on value
Launched in December 2006, ICICI Prudential BAF has been using a value-to-book (P/B) valuation-based model to dynamically manage its equity-debt allocation since inception.
Unlike many other BAFs that use a P/E (price-to-earnings) multiplier or a combination of P/E and P/B, the ICICI Prudential BAF depends entirely on the P/B ratio. Elaborating on the choice of this valuation metric, Chintan Hariya, Head, Product Development & Strategy, ICICI Prudential AMC, says, “P/B is a more stable indicator than P/E, indicating an upgrade in earnings. And is prone to more volatility with downgrades. Estimate”.
The fund is down just 2% from its October 2021 peak. “We are disciplined about implementing the valuation model. Also staying away from very expensive stocks and less weight on high beta areas helped us in this downtrend,” says Hariya, explaining the fund’s weak downtrend. Between October 2021 and May 2022, the fund had only Had a net equity exposure of 32-36 per cent. Large caps form 90% of the fund’s total equity allocation.
One of the market experts we spoke to highlighted the fact that value stocks have performed extremely well in the last 7-8 months and this reflects the performance of funds like ICICI Prudential BAF that have invested in such stocks . He said it may not always work.
In short, 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 speed
Unlike the valuation-based BAF, on the other hand, the Edelweiss BAF has a trend or momentum-based cyclical model, which has declined by minus 9% since its October 2021 peak. The model combines quantitative metrics such as daily moving average (average of daily index values over a specific period) and downside divergence (the extent of decline in index value over a period of market downtrend) for Nifty 50 to measure the market trend. Based on that, if the market is trending strongly and vice versa, the fund starts adding to its equity allocation. While such a model can provide good downside protection during periods of market downturn, it can limit the upside somewhat compared to a valuation-based model once the market begins to correct.
More importantly, while the model is designed to work well, it may not distribute in range bound markets when the market is either moving up or down. Elaborating on the fund’s recent poor performance, a person familiar with the matter said on condition of anonymity that the model is not suitable for volatile but range-bound markets, as seen in the past 6-8 months. . According to him, the model performs well when the market is either moving up or down, i.e. moving up or down by more than 8-10% during a year. A market that is volatile without moving meaningfully in any direction does not conform to a trend-based BAF model.
High returns, high volatility
with assets under management of 43,836 crores as at the end of May, HDFC BAF is the largest scheme in the category which has generated the highest returns in the category across various holding periods of 1, 3 and 5 years. The fund’s significantly higher unhedged equity exposure as compared to its peers has helped it deliver better returns. But with this there is far greater volatility (wider range of returns) than peers across different holding periods.
Unlike most other BAFs, HDFC MF’s BAF does not work on a model basis, though it takes into account factors such as valuations, interest rates and outlook of different asset classes to revise its equity and debt allocation. Furthermore, historically, it has kept its entire equity allocation unhedged (no derivatives risk) and largely stable, and at a much higher level than peers. This made it more like an equity fund instead of a BAF. However, from January 2020 onwards, the fund started managing its equity allocation dynamically and started 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, after minor changes, it was increased to 65% by May 2022.
Thanks to this significantly lower net equities (unhedged equities) than before, HDFC BAF has fallen only 5% from its October 2021 peak, not the sharpest in the category. In the past, the fund has seen a sharp decline in comparison to its peers.
model holds the key
Although not among the largest funds in this category, DSP DAAF stands for strictly following its model since its inception in 2014. So much so, that the Scheme Information Document presents the model with all its details-it takes into account largely the trends in P/E and P/B for Nifty 50 to ascertain whether the market is attractive on valuation. There is, and to a lesser extent, technical factors as well. The construction of the model has helped DSPs manage downsides (low volatility in returns) well, but overall fund returns have lagged behind many peers across different holding periods. While a negative return of 7% appears slightly sharper than peers since its October 2021 peak, it is 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 without any human intervention,” says Sahil Kapoor, Head of Products and Market Strategist, DSP Mutual Fund. According to Kapoor, with valuations approaching the historical average, the model is indicating an increase in equity allocation in the recent past.
Price mix, market trend
Kotak Mutual Fund’s BAF follows a two-factor model that primarily relies on Nifty 50 P/E: higher the valuation multiple, lower will be the equity allocation. In addition, it also takes into account the market trend or sentiment using parameters such as long-range rolling returns, volatility, market breathability, etc. The fund has fallen 5.6% since its October 2021 peak. Between October 2021 and now, the fund has increased its net equity exposure from 31% to 51%, as valuations softened and sentiment moved from peak levels.
Harish Krishnan, Fund Manager, Kotak Mutual Fund, explains that BAFs derive returns primarily from asset allocation, and (within equity) from investment style and stock selection. “Asset allocation is usually the biggest return facilitator, followed by investment style (e.g. price, growth etc.) and then stock selection. Over the past few months, the price style has seen outperformance especially in sectors such as energy,” he says.
At Kotak BAF, the equity investment style is diversified multicap, with focus on growth businesses at fair valuations, he added.