Dynamic Asset Allocation Funds: Your ally in a volatile market

Dynamic Asset Allocation Fund is a type of hybrid mutual fund which invests in both equities as well debt instruments. The equity allocation is generally between 65% to 100% whereas the debt exposure can be between 0 to 35%. The USP of this category is that they do not always keep pure equity exposure.

“The funds invest predominantly in equities and use derivatives to hedge the downside risk of the portfolio. So, by this way, its net equity exposure remains generally between 20-80%,” explained Juzer Gabajiwala, Director, Ventura Securities.

This type of scheme aims to increase equity exposure when valuations are attractive and reduces equity exposure when valuations are expensive. As of May 31, this category has 23 schemes with Asset Under Management of Rs. 1.1 lakh crore.

“These funds invest in both equity and debt and dynamically adjust the exposure between the two depending on market conditions and attempt to provide returns closer to equities but with much lower volatility,” says Arun Kumar, Head of Research, FundsIndia.

How does this fund work?

Dynamic Asset Allocation Fund managers manage their asset allocation, based on various models. Market experts explain that some fund houses use price-to-earnings-based models and some have their own in-house built models.

Using these models, the fund tries to adopt a strategic allocation by increasing or decreasing its proportion towards equity or debt as per the prevailing market conditions. This dynamic allocation helps to minimise risks.

“When the market is in a bull phase the equity valuations tend to go high, so the net equity component will be reduced, and when there is a bear phase in the market the valuations tend to be low so that the fund will increase its equity allocation. The fund manager carefully monitors the investments and adjusts the equity or debt exposure based on market research and analysis on a frequent basis,” says Gabajiwala.

Who can choose this fund?

This is a decent fund for a risk-averse investor who wants to maximise their returns without taking much risk. The dynamic allocation approach smoothens the ride in the volatile equity market, thus enhancing the risk-adjusted returns of the investors.

These funds tend to fall less than pure equity funds when the stock market declines because of their debt & arbitrage exposure. So, along with capital appreciation, it also tries to take care of the capital protection of the investor.

“Dynamic Asset Allocation funds in the category are more suitable for conservative investors. Also, since this is an equity-oriented hybrid fund, the taxation is similar to that of equity. Short term is considered as less than 1 year and more than that it is long term. But, do not misinterpret it with the holding period as the investors need to make sure that the investment duration is approximately three years,” says Gabajiwala.

“This is an ideal product for investors with a moderate risk appetite and a 5+ year time horizon and has the potential to provide returns closer to equities with much lower volatility over a market cycle” concurs Kumar. As per the value research data, the Dynamic Asset Allocation has given annualised returns of 29.92%,8.87%, and 9.26% over 1, 2 and 3 years.