‘Change is the only constant!’ is an often heard phrase. While this is applicable in life, it is also applicable in investing. It is the change in prices that either results in profit or loss. Depending on the market expectations (backed by research and analysis) investors either buy or exit any investment. This means depending on the expected move someone would either go long or short in the markets. Further, the decisions about whether to opt for debt related investment or equity is also decided based on such research. Most of the time such research pay’s off and investors get a good clarity on what is expected from markets.
However, there are times when the markets are uncertain and hence taking a call becomes quite difficult. If we take a look at the current scenario in Indian equity markets, there is a lot of uncertainty. While the markets recaptured the new highs (after hitting a low in March 2020), there are concerns about the sustainability of valuations. Even the re-occurrence of Covid-19 issue is adding to the worries.
Whether the earnings growth would happen or the second wave of Covid-19 will result in earning downgrades needs to be seen. On one hand, there are concerns there are few positives as well. Like the liquidity provided by the global central banks and sustained support in terms of economic packages – there is a lot of positivity as well. A lot has been discussed about the rising yields. In such uncertain times – Dynamic asset allocation comes in very handy. Let us understand the dynamic asset allocation (also known as balanced advantage funds).
What is dynamic asset allocation?
As the name suggests, the dynamic asset allocation funds (falling under the hybrid fund type), are invested and spread across various sectors including equity funds, real estate, stocks and bonds. Depending on the market scenario, the shift to different asset classes is managed by the fund managers. A dynamic asset allocation perspective means that whenever a competing investment vehicle is malfunctioning, the liquidity poured in is often shifted to another vessel which is performing better.
For instance, in case the market slows down in times of a recession or a bear economy, a dynamic asset allocation fund is the one recourse meant for all consumers regardless of their risk threshold. Each of these funds is managed by a professional manager who takes care to ensure that the quality of investments is not lowered even during the uncertain times.
It is a known fact that in the long run (despite all volatility) equity investment offers the highest returns on a comparative basis. But one must not forget that the associated risks are also relatively high too. At least in the medium the volatility leads to higher risk.
Dynamic allocation is taking an investment call based on the current scenario in a different asset class and trying to maximise the returns even in uncertain scenarios. While carrying out dynamic asset allocation may sound simple, it requires a watchful eye on the markets, and creating and testing various investment strategies.
How does a dynamic asset allocation fund work?
These funds automatically adjust the level of equity in line with the markets – as the Sensex levels go up, their allocation to equity comes down; and as the market gets cheaper, they increase their equity allocation. The category of fund is not without risk, since it will always have some equity allocation. Considering the fact that markets may remain volatile for medium term, and opportunities to invest may exist during that time as well, this is a good category to invest in.
While we have mentioned that in uncertain times the dynamic asset allocation funds are helpful, there are certain factors that make it work properly. Primarily, the working of the dynamic asset allocation fund directly depends on the fund manager’s ability to match the right decision of asset allocation. With the market low or high, equity exposure of the fund is decided. For instance, if the economy is not doing well, then the investment manager using this strategy would reduce his equity exposure and would prefer more investments in interest-bearing securities or even sit on cash till the economy’s situation changes and vice-versa. With strong research capabilities, experience of economic peaks and troughs and most importantly ability to peak a theme ahead of the curve, makes the task easier for such fund managers.
A dynamic asset allocation fund is one of the best and most suited investment options in an uncertain market. Unlike the static allocation funds, the dynamic funding mechanism is a better option because the investments are widely spread out and diversification happens. The inherent dynamic nature of funds is a basic advantage. The diversification mechanism helps to beat the market slumps at least in medium to long term. It is also a valuable asset to those who have limited funds to invest in multiple sectors.
Important characteristics of dynamic allocation funds
With exposure to all asset classes representing the economy, dynamic allocation funds are considered an ideal vessel to become direct beneficiaries to the growth Indian economy.
With dynamic asset classes having exposure to real estate – consistent returns would be visible.
On the taxation front as well benefits are there. Since the investments are spread across several sectors, there is a chance of availing tax exemptions as and where applicable.
Returns on such kinds of funds are considered more dependable.
The biggest advantage of dynamic asset allocation funds is that they are usually structured to be taxed as equity funds for investors. Usually the idea is, if in case the fund eventually lowers its equity exposure, it ensures that equity plus the arbitrage component of the scheme is at least 65 per cent of the corpus, which helps it to qualify for equity taxation. Further, the dividends from such funds and gains after one year are completely tax-free. Even short-term gains are taxed at 15 per cent, which is lower than the rate applicable on pure debt funds or bank deposits.
With equity at the centre of the investment theme, the dynamic asset allocation funds are best suited for the long- term investors. Especially those having a low-risk appetite but are keen to take a bit of risk to enjoy the returns from an equity-debt mix of assets in their portfolio.