You know there are balanced funds, which invest mostly in equity and some in debt. You know there are MIPs, which invest mostly in debt and some in equity. You know that these funds play around with the equity-debt ratio depending on the market. So what, then, are asset allocation funds?
What it is
To begin with, an asset allocation fund need not restrict itself to only equity and debt. It can combine equity, debt and sometimes gold in varying proportions or sometimes add arbitrage as an additional strategy to this asset allocation combination.
Next, there are two groups of asset allocation funds. One group dynamically changes the allocations to each asset class depending on several indicators. The second group is like a regular balanced fund or MIP with set ranges for each asset class.
Funds in the first group are dynamic asset allocation funds. These funds are extremely flexible in how much of the portfolio they allocate to each asset class. Balanced and debt-oriented hybrid funds have strictly defined allocations within which they operate. An MIP, for instance, will never move beyond 30% in equity no matter how attractive stocks look, nor will it completely divest itself of equity.
Truly dynamic asset allocation funds are not restrictive. They can go all into debt or all into equity if the situation so demands it. They use a set of parameters to decide the asset-wise breakup of the portfolio. This break up will change dynamically depending on the performance and prospects of each asset class. If, for example, equities have run beyond what the fundamentals support and are overvalued, the fund can shift significantly away from equity and move into debt. A balanced fund can at best reduce equity to 65%.
Take Franklin India Dynamic PE Ratio Fund-of-funds for example. This fund uses the Nifty PE and defines six PE bands with a corresponding equity-debt breakup. If the PE is above 28 times, the fund can pull equity to nil and invest entirely in debt. If the Nifty PE is between 20-24 times, equity can be 30-50% of the portfolio. A PE below 12 times can see the portfolio entirely in equity.
In another example, DSP BR Dynamic Asset Allocation fund uses the ratio between the 10-year G-Sec yield and the earnings yield of the Nifty index to determine its asset allocation. For this fund, both debt and equity can be 10-90% of the portfolio. SBI Dynamic Asset Allocation fund also has 0-100% in debt and equity, and uses momentum indicators such as moving averages for the Sensex and the G-Sec yield to decide on allocations. UTI Wealth Builder combines equity, arbitrage, debt, and gold with allocations based on a model that considers several factors such as valuations, momentum, and earnings sentiment.
The second group of funds are plain hybrid funds, except that they can involve any combination of assets. These funds are not dynamic and have a pre-defined range for each asset class, just as it is in a balanced fund or an MIP. Most asset allocation funds are built in such a manner.
Axis Triple Advantage, for example, has equity, debt, and gold, of which the first two are 30-40% of the portfolio and gold is 20-30%. Then there is Kotak Multi Asset Allocation and Invesco India MIP Plus, which are predominantly debt-held with some exposure to both gold (its a 10% minimum in the Invesco fund) and equity. Canara Robeco InDiGo has 65-90% in debt and the rest in gold.
The difference between the two groups is that in a dynamic asset allocated fund, you aren’t really certain whether it is equity-oriented or debt. In the others, you are certain of the orientation of the fund and the approximate return expectation over the long term. More, in dynamic funds, the tax implication for you depends on the fund’s average equity holding in the twelve months before the date of your sale. Some funds, such as UTI Wealth Builder work around this by using arbitrage to maintain an equity exposure above the 65% threshold.
Suitability
Asset allocation funds will deliver only if held over the long term, because the effect of juggling asset classes will show only over market cycles. They also suit only conservative investors, since the changing allocations when returns have rallied help book out at highs and keep volatility down. If you already own funds across asset classes, including these in your portfolio may not have a significant impact.
Note that where funds have equity, the shifting of assets means that returns will not match equity or even balanced funds in the long-term. Where funds combine debt and gold, an underperformance of the latter can pull returns below pure debt funds as well.
- Notice Cum Addendum For The Merger Of Navi Conservative Hybrid Fund Into Navi Aggressive Hybrid Fund & Navi Overnight Fund Into Navi Liquid Fund
- Suspension of Subscriptions in Select Nippon India Mutual Fund Schemes
Should you wait for a market correction?- Resumption of Subscription in NIMF Schemes Investing in Overseas Securities
Wealth Conversations – October 2024
Is ICICI balanced advantage fund an asset allocation fund?
No Vijay, it is a balanced fund with an option to hold derivatives.
Are Asset Allocation Funds good in this market condition (Sensex 32000). Will it be good strategy to park lumpsum money in these funds for 1 year and then start SIP to Long Term Equity Diversified Plans or pure Balanced Plans? This is because liquid plans have harsh tax treatment now for individual falling in 30% tax bracket.
Hello Anup,
No, asset allocation funds do not suit what you’re looking for. Their nature requires a longer holding period than a year or two years. You may have situations where they deliver losses, in such shorter periods. If the fund manager views equity as the place to be – and remember, they take a long-term view – and the portfolio is aligned more towards equity and markets fall after a year, you would be booking losses if you start a transfer then. You can’t set off long-term equity losses either :-). Or you may be forced to continue holding the fund. For another thing, if you don’t want to invest a lump-sum today in equity because markets are expensive, an asset allocation fund does not really answer that timing problem, since several are oriented towards equities anyway. The point in asset allocation funds is that you do not have to do the allocating according to market cycles on your own. It is not to time your own entry/exit based on market cycles or be a temporary parking ground for your money.
You don’t need to wait for one year to start investing in equity, simply for the sake of saving on tax. If there’s a correction before that time, you would miss that opportunity. If you have a lumpsum to invest now, simply put it into a liquid fund and run an STP for 8-12 months into eqiuty or balanced funds. No other category is as suited for a systematic transfer into equity than liquid since they are safe and don’t deliver losses even on a 1-day basis. You can go for dividend reinvestment option in your liquid fund, if you’re in the 30% bracket. The tax treatment is better. Look at the purpose for which you’re investing, and take the option that is most suited and prudent. Taxation should not be the overriding factor at all times.
Thanks,
Bhavana
Is ICICI balanced advantage fund an asset allocation fund?
No Vijay, it is a balanced fund with an option to hold derivatives.
Are Asset Allocation Funds good in this market condition (Sensex 32000). Will it be good strategy to park lumpsum money in these funds for 1 year and then start SIP to Long Term Equity Diversified Plans or pure Balanced Plans? This is because liquid plans have harsh tax treatment now for individual falling in 30% tax bracket.
Hello Anup,
No, asset allocation funds do not suit what you’re looking for. Their nature requires a longer holding period than a year or two years. You may have situations where they deliver losses, in such shorter periods. If the fund manager views equity as the place to be – and remember, they take a long-term view – and the portfolio is aligned more towards equity and markets fall after a year, you would be booking losses if you start a transfer then. You can’t set off long-term equity losses either :-). Or you may be forced to continue holding the fund. For another thing, if you don’t want to invest a lump-sum today in equity because markets are expensive, an asset allocation fund does not really answer that timing problem, since several are oriented towards equities anyway. The point in asset allocation funds is that you do not have to do the allocating according to market cycles on your own. It is not to time your own entry/exit based on market cycles or be a temporary parking ground for your money.
You don’t need to wait for one year to start investing in equity, simply for the sake of saving on tax. If there’s a correction before that time, you would miss that opportunity. If you have a lumpsum to invest now, simply put it into a liquid fund and run an STP for 8-12 months into eqiuty or balanced funds. No other category is as suited for a systematic transfer into equity than liquid since they are safe and don’t deliver losses even on a 1-day basis. You can go for dividend reinvestment option in your liquid fund, if you’re in the 30% bracket. The tax treatment is better. Look at the purpose for which you’re investing, and take the option that is most suited and prudent. Taxation should not be the overriding factor at all times.
Thanks,
Bhavana