Balanced Advantage Funds in a way are all weather products given the dynamic nature of rebalancing

What is your outlook on equity market from a 3+ year perspective? What are the risk factors for equity in India in the current scenario?

We remain constructive on equities in the medium term. We see a lot of new trends providing additional growth levers in the post-pandemic world. Rapid shift of consumer preference towards organized players, market share gains for companies with digital capabilities and emergence of disruptive distribution channels acting as tailwinds for growth in several segments, shift to cloud and digital technologies across the globe, measured supply-response in traditional commodity sectors given increased climate focus are notable trends amongst many. Added to this, emergence of India as a credible supply chain alternative in industries such as specialty chemicals and pharma and the recent Govt-incentivization to create scale and capabilities in identified sectors through PLI-schemes are medium term growth engines for the economy. In this context, we remain fairly optimistic on the medium-term growth landscape in India and expect an earnings-driven value creation in this cycle with bottom-up stock selection having greater impetus in this phase.

Balanced Advantage Funds are often recommended by financial advisors in highly volatile markets. In our view these funds are not very understood by average retail investors. For the benefit of retail investors please explain how these funds work in different market conditions

As the name suggests, the Balanced Advantage Fund (BAF) balances its investments between asset classes primarily equities and fixed income instruments based on a well-tested framework. The strategy focuses on increasing or decreasing equity allocations dynamically based on the behaviour of identified fundamental variables such as Price-to-Earnings, Price-to-Book etc. that act as a reasonable barometer of market expectations. When markets see rapid price action without corresponding improvement in the corporate fundamentals over a period, these indicators tend to expand euphorically, providing signals to reduce equities. Likewise, should there be deep corrections in market, without corresponding deterioration in fundamentals such as earnings, these indicators contract to levels lower than their median range, triggering a signal to buy into equities. In the process of adhering to a well-tested valuation framework and monitoring its behaviour along with price action, the discipline forces to invest at times of fear and book profits when there are euphoric valuations and sentiments. These funds are well-suited to navigate volatile market conditions, as they dynamically move between equities and debt based on the behaviour of the indicators and helps investors minimize drawdowns.

Balanced Advantage Funds are sometimes compared with Aggressive Hybrid Funds. Is it a fair comparison? What are your views?

BAFs are asset-allocation funds which dynamically move between equities and debt. There is flexibility for net long equity position to range between 30 percent to 100 percent depending on market conditions. Aggressive Hybrid Funds, by mandate, provide a blend of equity and debt and operate with a minimum equity component of 65 percent. The risk-reward of both these categories are different across various market phases. BAFs focus on an investment solution for investors by dispensing away the market timing risk, while hybrid funds focus on a stable equity experience for investors with medium-term horizon, by blending a certain proportion of debt.

Hence, the way the funds operate being different, it wouldn't be fair to compare these categories.

Between them, through a market-cycle, Balanced Advantage Funds as a category tend to experience lower volatility and a lower portfolio drawdown, given the constant rebalancing done.

Please describe the dynamic asset allocation model of Sundaram Balanced Advantage Fund.

Sundaram Balanced Advantage Fund dynamically allocates between equities and debt based on assessment of market behaviour using Price-Earnings framework. For this purpose, the market prices are assessed against recurring earnings of underlying constituents, thereby removing impact of exceptional items. Based on study of past cycles, the PE-bands are determined against which the range of equity allocation is decided. The framework provides flexibility to move to equity allocations of 100 percent when markets trade at the lowest end of identified PE-bands and similarly move equity allocations to 30 percent when market valuations are at the highest end of the identified trading bands. Essentially it follows the investment philosophy of buying low and selling high in equities using price-to-earnings as guiding principle. The rebalancing of equity allocation to the desired range is done every month, using the average trading market valuations of the preceding month.

Even if net equity allocation is at 30%, the fund would use arbitrage to maintain gross equity at 65% levels.

What is the investment strategy (stock selection) for the equity portion of the fund?

For the equity component of Sundaram Balanced Advantage Fund, we follow a diversified portfolio across sectors and cap-curves. In the current phase, we expect earnings recovery to be broad based across sectors - hence a diverse approach to investing. Emphasis is on being sector agnostic and focus on bottom-up stock selection. Stock selection is based on companies which have simple businesses and possess scalable business opportunities, strong competitive advantages, sustainable cash flows and sound promoters.

The valuation differential between large-caps and mid-caps are weighed upon when selecting stocks within a sector. Currently the fund is invested ~67% towards largecaps, 26% towards midcaps and 7% towards smallcaps. The portfolio is fairly diversified across sectors with moderate overweights in banking and financial services, discretionary consumption, chemicals, and industrials and small underweights in consumer staples and utilities. The portfolio has blend of companies benefitting of a recovery in domestic and global economies.

What is the fixed income strategy of the fund?

The fixed income component of the fund focusses on creating a high-quality portfolio of G-secs and AAA-rated securities with average duration of ~4 years. The strategy is to ensure fixed income acts as a strong buffer during phases of equity market volatility and keeps accruing steadily to the overall portfolio.

It has usually been seen that, arbitrage returns are higher in bull markets compared to bear markets. Do you tweak your arbitrage strategy in different market conditions and how?

Returns from the arbitrage category is clearly linked to an interplay of prevailing short-term interest rates and the level of leverage in the equity derivatives segment. During bull markets, as leverage increases, short-rollers such as arbitrage categories tend to benefit from increased spreads. The arbitrage strategy in Sundaram Balanced Advantage Fund focusses on liquid securities where there is steady potential to roll-forward positions at reasonable spreads. The strategy doesn't look to churn heavily except for any opportunities of mispricing available during the time of dividends. During market corrections, when arbitrage spreads are too thin, the fund focuses on keeping the arbitrage exposure to the minimum level to ensure gross equity is above 65% and reallocate capital towards short-term debt instruments.

What is advice for investors looking to invest in Balanced Advantage Funds? What should be the return expectations (clearly these funds may not be able to match returns or aggressive hybrid returns)? What should be the minimum recommended investment tenure for these funds?

Balanced Advantage Funds, in a way, are all-weather products, given the dynamic nature of rebalancing. For investors who wish to dispense away with market timing risk and fear of excessive/insufficient allocation to equities, these funds address them suitably. While an individual's rebalancing of assets between equity and debt carries an element of tax inefficiency, it gets eliminated under Balanced Advantage Fund, given the investment remains under Equity taxation. Balanced Advantage Funds are well-suited for investors with moderate risk appetite with an investment horizon of 3-to-5 years. Over the long-term, the blended portfolio return will have a stable return component stemming from the fixed income portfolio while equity returns align with the pace of economic growth and the underlying earnings growth of corporate India. Our expectations build-in a double-digit corporate earnings growth in the medium term driven by a confluence of recovery in consumption and pick-up in investment cycle. Equities are a long-term asset class and Sundaram Balanced Advantage Fund is one product which allows to experience the equity journey with lower volatility.