How are balanced advantage mutual funds taxed?

Long-term investors who want equity and debt in their portfolios, along with a strategy of buying stocks when they are low and selling them when they are high, can opt for balanced advantage funds.

WHAT ARE BALANCED ADVANTAGE FUNDS?
Balanced advantage funds (BAFs) invest in a mix of debt and equity. The equity allocation is dynamically determined based on the fund manager’s view of the market and could move between 30% and 80%. Fund managers use a documented process to decide the allocation between equity and debt. Typically when market valuations are high, the allocation may tilt more towards debt and when they turn cheap, towards equity. This helps investors maintain asset allocation. In comparison, regular hybrid funds keep allocation between equity and debt static and within the prescribed regulatory limits.

HOW BIG IS THE BAF CATEGORY?
As of January 31, 2024, 34 schemes were in the BAF space, with over 5 million folios managing assets worth Rs 2.83 lakh crore.


WHAT ASSET ALLOCATION MODELS DO BAFS USE?
Fund houses have developed in-house models to decide the allocation to equity and debt. Most fund houses use a pro-cyclical mode which buys more equity when valuations are lower. Fund managers can use a mix of fundamental and technical factors like price-toearnings ratio, price-to-book ratio and trend indicators like daily moving average to arrive at equity allocation. Some fund houses also use a counter-cyclical model which increases equity allocation in rising markets.

WHO SHOULD INVEST IN BAFS?
As many as 10 million new investors have entered the mutual fund space in the last year. Many are moving money from fixed deposits and are not used to the volatility of the equity markets. During sharp corrections, a portfolio with a mix of debt and equity would face lower volatility than a pure-equity fund portfolio. This would give them a better experience than diversified equity funds. These schemes are ideal for first-time investors.

HOW ARE THESE FUNDS TAXED?
The structure of BAFs is such that they are taxed as equity funds. This means investors will be charged a 12.5% longterm capital gains tax if they sell their units after holding for one year. When such a scheme lowers its equity exposure, it ensures that the equity plus arbitrage component of the scheme is at least 65% of the corpus, which helps it qualify for equity taxation.