Asset allocation funds were generated from modern portfolio theory. Modern portfolio theory explains that investors can obtain optimal returns by spending in a diversified portfolio of investments involved in an effective frontier. Moreover, modern portfolio theory describes how a portfolio can change its asset mix to tailor to the risk tolerance of the investor.
Introduction to Asset Allocation Funds
It is a fund connecting the bonds and equities and that holds stocks, equity funds, bonds and real estate. The fund reaches the portfolio across more than 1 asset class, depending upon the investment order. There is a fund manager appointed who is tasked with managing track of the investments and doing significant changes establish based on the performance in the market. In the state of mutual funds especially, it is the fund manager who selects the asset allocation decisions. He grows an asset allocation strategy according to the investment objective of the fund.
Everyone wants to earn maximum returns on their investments. So far equities are seen as the highest return generating asset class, though it has the highest level of a risk factor as well. In contrast, the bonds and money-market instruments like fixed deposits ave low risk and offers low-return on investments.
If you want to earn the greatest returns, you must examine allocating all of your money to investments in equity. But that will further show you the risk of losing all your money. Allocating the same investment over different asset classes, though, will receive better returns by reducing the risk factor.
Deciding how much to spend in every asset class to get a risk-reward tradeoff is what is named as asset allocation.
Who invests in asset allocation funds?
- Asset allocation funds are generated for risk-averse investors. Equity is very in the needed asset class to have as it helps strike inflation. But equity can also be volatile, which makes it unsuited for every investor. This is a situation where asset allocation funds come into the frame.
- Diversified asset allocation funds spend a part of their assets in equities and the rest in other assets. This assists them to create good returns while decreasing risks.
- Balanced funds: For example, spend at least 65% in equity. Monthly Income Plans (MIP) spend 15% of its assets in equity. This is whereby several asset allocation funds can assist to get greater returns without holding up too many risks.
How Asset Allocation Funds Works
Mutual fund advisors usually recommend that to decrease the level of volatility of portfolios, investors need to diversify their investment into different asset classes. Such basic reasoning is what executes asset allocation funds general in portfolio management due to various asset classes will always give several returns. Thus, investors will, however, get protection to guard against the decline of their investments.
Top-performing Asset Allocation Funds
- HDFC Balanced Advantage Fund
- ICICI Prudential Balanced Advantage Fund
- Reliance Balanced Advantage Fund
- Aditya Birla Sun Life Balanced Advantage Fund
- L&T Dynamic Equity Fund
- Principal Balanced Advantage Fund
- Invesco India Dynamic Equity Fund
- Edelweiss Balanced Advantage Fund
Types of Asset Allocation Funds
Asset allocation funds give an easy application of modern portfolio theory with diversifying allocations and combinations of assets for investors.
- One of the most popular types of asset allocation funds is a balanced fund. A balanced fund indicates a balanced allocation of equities and fixed income i.e a 60% stocks and 40% bonds. Investors will find various funds using the 60/40 mix as it has grown a successful graded strategy for investors seeking broad market diversification.
- Static asset allocation funds have a pre-decided portion of funds allocated to different asset classes.
- Asset allocation funds also give differing levels of diversification based on risk tolerance. Investors seeking extra investing classes beyond just 60/40 will get various options, including conservative allocation funds, moderate allocation funds and aggressive allocation funds.
- Life-cycle or target-date funds are those funds which are usually required in retirement planning. It is viewed as a kind of asset allocation fund. These funds are handled with a targeted mix of asset classes that begin with a higher risk-return position. And constantly becomes less unsafe or risky as the fund nears its targeted utilization date.
- Some funds may prefer to invest in a variety of exchange-traded funds to factor many market exposures. Other funds may take a more dynamic approach by applying fundamental examination to choose top-performing securities in all asset class.
- The Dynamic Asset Allocation Funds keep growing and adjusting the balance of assets in their portfolio according to the market variations. When one particular asset class is supposed to do well, the fund raises allocation to that asset and vice versa.
Overall, most funds will actively control and allocate or rebalance securities in answer to emerging market conditions and economic circumstances.
- Goal simplification
If you are preparing for comfortable retirement after 10 years you require to allocate your assets according to the duration of your goals. It is recommended to allocate your assets in minor risk investments for the short term, while in the long run, invest according to your risk appetite. Check whether the asset allocation funds is corresponding to your goals.
- Risk and returns balance
Asset Allocation funds assist in balancing your risk and returns. Higher risk investments usually have value for higher returns. Have a better knowledge of your risk appetite and risk aversion. Asset allocation supports invest according to your risk aversion. Check viscometer in scheme associated documents of the mutual fund schemes before investing.
- Percentage of allocation
Mutual fund distributors, agents or advisors will direct mutual fund schemes according to your demands which usually depends upon your economic goals. Check the asset allocation funds in scheme details before investing. Asset allocations funds will assure your money is diversified in a mix of investment according to investors preferences.
- Period of investment
Long term investments gain compounding returns which assist you to obtain bigger financial goals. Have a sound knowledge of how much time you want to stay invested. Asset allocation funds assist you to play securely while you invest to get returns over the period.
- Picking up quality stocks
In the case of Asset Allocation funds, your experienced fund manager does this job for you. Check investors portfolio and past returns performance of the fund. If your fund invests in quality stocks with a greater potential return for the long term, small-time market shifts are going to be inappropriate.
Investors should refer to asset allocation funds due to the following reasons:
Investors who need to reduce their risk for a given duration can invest in various classes of assets and expand their portfolio. These funds are made up of stocks and bonds from various sectors, many regions and several styles. All commonly in a single fund, serving to reduce risk but not remove it.
- Handle over volatility
If an asset class works well in 1 year, there is no assurance that it will perform uniformly well in the next year as well. The asset class can underperform also. By investing in a diversified portfolio, your investments will not get hit exceedingly by 1 asset class.
- More genuine returns
In asset allocation funds, the investor’s portfolio is opened to various asset classes and hence, it performs to intensify returns.
Taxation for asset allocation funds
Asset allocation funds are controlled to taxation as debt funds as many of these funds are Fund of Funds. As per the investor’s tax slab, the short-term gains from debt funds are combined into the income and taxed equally. There is a 20 % taxation setting the buying price for inflation with indexation. For long-term gains of 3 years and over. This reduces the tax burden because of decreased capital gains.
Factors affecting asset allocation decisions
When making investment decisions look for the asset allocation dependence on various factors like personal goals, level of risk tolerance, and investment horizon. Also, the age of the investor, their risk profile, financial goals, net worth and the prevailing market conditions are important to consider.
- Goals factors
Goals factors are individual goals to reach a given level of return or saving for a particular purpose or want. Hence, different goals change how a person invest and risk.
- Risk tolerance
Risk tolerance relates to how much an investor is ready and capable to lose a given amount of the initial investment in the prospect of receiving a greater return in the future.
- Time horizon
Time horizon factor depends on the duration an investor keeps investing. Most of the time, it depends on the purpose of the investment. So, different time horizons involve diverse risk tolerance.
Additionally, asset allocation also changes depending on the investment risk profile of the mutual fund scheme. Fixed asset allocation plan, also known as tactical asset allocation. They are those mutual funds to invest money in different asset classes based on a particular quantitative model. This model does not help those investors who have changing investment requirements. There is some other asset allocation determining models that are based on the Nifty 50’s price-to-earnings ratio that increase their debt allocation and avoid the pricey market.
Taxes thus perform a crucial role in the development of a portfolio as both equity and debt have distinctive tax formations.
Asset Allocation and the difficulties in its execution
- The tax structure for various asset classes like equity and debt varies. Even in debt, there is a distinct tax structure for bonds, fixed deposits, and debt mutual funds. Thus, building a portfolio and balancing the taxation aspect becomes a dare.
- Many asset classes begin at a high cost. The fixed price along with a performance incentive in the case of real estate funds or private equity is comparatively greater to simple mutual fund schemes.
- Observing of illiquid securities in your portfolio constantly can be a difficulty.
- When creating a diversified portfolio in an asset class, the least investment needed for security may sometimes very high.
Balanced or Dynamic asset allocation fund: Which is better?
To start with, Investor must know that balanced funds and Dynamic funds differ in their approach to distort proportions. While balanced funds have a steady exposure to equity and debt a least of 65% and a peak of 80% allocation to equity. Dynamic funds are much more manageable. They can spend among 0 and 100% in both equity or debt.
Just put, a DAA fund can match a 100% equity fund if equity is supposed to do great. In dynamic funds, these decisions are not based on the fund manager’s evaluation, but a technical formula. Hence, this strategy begins to discipline in the form the portfolio is maintained by the fund manager.
An investor can opt for this fund if they want to assure that it buys equity at lower levels and books benefit at higher prices, no matter what the market conditions or fund manager’s view is. Also, an investor must be informed of the fact that this kind of aggressive rebalancing sometimes serves as a block for returns.
Dynamic asset allocation funds are expected to underperform while a bull point in the market. As the equity market grows, these funds might maintain profits and spend more in debt, losing out on a continued equity market rally. These funds would be perfect for when an investor is nearing their purpose as they will defend their gains in the equity market and hold the volatility low.
An asset allocation fund is a fund that gives investors a diversified portfolio of investments over different asset classes. The asset allocation of the fund can be set or changeable among a mix of asset classes, indicating that it may be held to fixed portions of asset classes or authorised to go over on some depending on market circumstances.
Popular asset categories for asset allocation funds hold stocks, bonds and cash equivalents that may also be reached out geographically for additional diversification. So do invest in asset allocation funds.
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