‘Balanced advantage fund is ideal for investors with 3 years horizon’

Sensex closed at 51,324 points on February 18, 2021. What is your take on the valuation in the current situation? 

The fund house view is quite constructive on forward outlook and earnings recovery. Hence on normalized earnings trajectory market is trading above average valuations but not expensive.

For Aditya Birla Sun Life Balanced Advantage Fund, we take a conservative approach and do not rely on forward estimates. Our model uses Adj. trailing P/E for BSE100 Index as the preferred benchmark for market valuation, which is on higher side currently (99th percentile). The P/B is at 93rd percentile. If the earnings recovery continues as the economy is recovering from a recession, these levels would show more reasonable valuations. So, for now, our model continues to classify markets as richly valued.

Hence Sensex or Nifty for that matter is just a number for us and a key monitorable would be progressions of earnings growth as well as resultant P/E & P/B

What are the key triggers and risks of the markets?

There could be any number of reasons that could impact economic recovery and consequently the earnings trajectory. For instance, a resurgence in COVID19 infections, spike in oil prices, shortfall on policy execution, rise in real interest rates etc.

Key triggers are a pro-growth budget, progress on vaccination, a growth supportive policy setting globally both on fiscal side as well as monetary policy support. And, basically, that none of these bigger events transpire and earnings trajectory is not in any jeopardy. We really don't need much extra ammunition than what is already there.

Aditya Birla Sun Life Balanced Advantage Fund has consistently outperformed its benchmark. What are the three key factors that contributed to this performance?

The working of ABSL Balanced Advantage Fund is incredibly simple. First, our counter cyclical approach to equity allocation. Second, we work with exposure bands instead of a precise allocation based on valuation. Third, our fund house approach to picking stocks and sectors helps in building a rewarding underlying portfolio.  

Can you take us through the underlying formula to decide asset allocation of the fund? Why do you think the model followed by you has an edge over other balanced advantage model in the industry?

As I mentioned earlier, we follow a counter cyclical approach to equity allocation. In other words, we endeavour to reduce equity pre-emptively when cycle is heated up and going strong and add to equity when it looks like a spent force and weak. This is implementing a framework that consists of 5 levels of equity exposure bands based on Adj. trailing P/E of BSE100 index*. We use ranges (or bands) instead of a precise number to retain flexibility and avoid unnecessary model fitting. The equity exposure is calibrated by using a combination of direct equities, stock arbitrage and portfolio hedge (shorting Nifty futures against a part of the portfolio). We avoid frequent or fixed time interval-based rebalancing in order to let the valuation cycle to play out. It has been tested thoroughly using historical data and has stood good on prospective basis for over 5 years now. We believe that the disciplined approach to investing & cutting risk objectively and continuously fine tuning our model has helped delivering on the investor expectation as well as on relative basis thus far.

*  Adj trailing P/E is calculated by eliminating loss making companies from earnings computation and aggregating previous 4 quarters earnings.

How frequently do you review your model? Will you consider revising the model to select asset allocation considering the dynamic nature of markets?

 Ayn Rand wrote in one of her books, "Contradictions do not exist. Whenever you think that you are facing a contradiction, check your premises. You will find that one of them is wrong." We follow a similar principle. Whenever a divergence is spotted between actual model outcome and a reasonably expected result, it calls for digging deeper and reassessing our hypothesis. Another reason to review the model is when we have newer ideas or alternative hypotheses to test. This process goes on and we keep on testing multiple variations throughout the year. However, only a few small changes have finally been adopted over the years. The best way to describe our system is that there is a static model, encased in a dynamic process.

As on January 31, 2021, the fund has cash holdings of 27%. What is the key reason for this?

This number is often misunderstood due to the way accounting works for arbitrage and hedging positions. A breakup of our investment looks as follows:

Cash, Liquid & Equivalents consists of 9.6% investment in liquid fund which is pledged as margin for F&O positions. So, the cash position is not very large and provides us with dry powder in case we spot some opportunities.

What is the fund management philosophy to select securities to manage equity and debt component in the fund?

The philosophy is simply to buy stocks at prices that are less than what we believe the company should be worth. It includes growth companies quoting at reasonable prices, cyclical businesses when the going is tough for them, stable and mature businesses that might trade at steep discount to fair value etc. We apply filters of governance quality and business sustainability to weed out potential terminal value shocks.

The debt component is meant for managing liquidity & bringing stability to the fund relative to equity. It is expected to generate reasonable degree of yield without taking significant duration / credit risk. Average maturity is typically less than 2 years

Why should distributors recommend Aditya Birla Sun Life Balanced Advantage Fund?

This is a product that helps investor deal with volatility in their portfolio. This could be useful for two major needs of investors 1) For investors who are not comfortable with pure equity volatility and;2)  people who have an investment horizon ( say around ~3 yrs), which is shorter than the ideal duration for pure equity, could make use of a fund like this where equity allocation is managed within the fund and volatility is considerably lower.

Many MFDs believe that asset allocation is the prerogative of advisors. Your comments

This fund helps implement a solution with reduced friction of transaction and tax related costs that impede the compounding process. So, this is an additional tool in the advisors’ toolkit. And, while it does help in managing equity allocation over the market cycle, there are other assets where investors need advisors help. To the extent we can help the advisors implement client portfolios in a convenient and a friction free manner, such products would continue to find good use.