What is Dynamic Asset Allocation Fund – Meaning, Taxation, and Returns
Asset allocation is at the core of any investment portfolio
Different asset classes perform differently every year. As investors, we don't know which asset class will do well next year. Hence, it makes sense to invest in a mutual fund that will give you exposure to multiple asset classes. Also, if the fund manager can increase/decrease the allocation to each asset class based on some predefined criteria, that will be another benefit. Dynamic asset allocation funds provide you the dual benefits of exposure to multiple asset classes in a single scheme and dynamic management of each asset class. This article will focus on what is dynamic asset allocation fund - Meaning, taxation, and returns.
What are dynamic asset allocation funds?
A dynamic asset allocation fund is an open-ended mutual fund scheme that invests in multiple asset classes, primarily equity and debt, and manages their proportion dynamically. Apart from debt and equity, the fund may also invest in gold and real estate. A dynamic asset allocation fund is also known as a balanced advantage fund.
Most dynamic asset allocation funds keep the equity investment at higher than 65% so that they are taxed as equity funds. Dynamic asset allocation funds are categorised under the broader category of hybrid funds. Now that we understand what is dynamic asset allocation fund, let us understand who should invest in it.
Who should invest in dynamic asset allocation funds?
An investor who wants to spread their asset allocation across multiple asset classes such as equity and debt may invest in a dynamic asset allocation fund. Equity has the potential to earn inflation-beating high returns and create wealth for investors. At the same time, debt can provide stability to the portfolio when the equity markets are falling. Also, investors who don't wish to manage the asset allocation on their own and instead want the fund manager to do it on their behalf may invest in a dynamic asset allocation fund.
Importance of dynamic asset allocation
In a dynamic asset allocation fund, the fund manager dynamically manages the equity and debt component based on some in-house criteria. The criteria may be the price to earnings (P/E) ratio or price to book ratio (P/B) ratio, or some other criteria.
For example, let us assume that the fund manager manages the equity and debt components based on the P/E ratio. In such a scenario, if the P/E ratio goes higher than a certain point, the fund manager will sell equities and invest the sale proceeds in debt. So, the equity component will go down, and the debt component will go up.
Similarly, the P/E ratio will go down when the market has fallen. In such a scenario, when the P/E ratio falls below a certain point, the fund manager will sell debt and invest the sale proceeds in equities. So, the debt component will go down, and the equity component will go up.
Challenges with dynamic asset allocation
The above section saw how the fund manager manages the equity and debt portion dynamically based on some in-house criteria. One of the major challenges in dynamic asset allocation is that the equity market continues to go in the opposite direction even after the fund manager has changed the equity allocation.
For example, let us assume that the fund manager manages the dynamic asset allocation based on the P/E ratio. The P/E ratio has gone above a certain level, and hence the fund manager has sold equities and invested the sale proceeds in debt. However, the equities continue to head higher even after the fund manager has reduced allocation to equities. In such a scenario, the fund's returns will underperform the benchmark.
Similarly, the P/E ratio may have fallen below a certain level when the equity market is falling. In this case, the fund manager will sell debt and invest the sale proceeds in equity. However, equities may continue to head lower even after the fund manager has increased allocation to equities. In such a scenario, the fund's returns will underperform the benchmark.
Performance of dynamic asset allocation funds in India
Let us look at the performance of some dynamic asset allocation funds in India.
|Scheme name||AUM (Rs. crores)||1-year||3-years||5-years|
|HDFC Balanced Advantage Fund||43,950||12.65%||11.80%||11.93%|
|Edelweiss Balanced Advantage Fund||8,007||6.46%||14.05%||11.93%|
|ICICI Prudential Balanced Advantage Fund||39,760||7.98%||11.38%||10.66%|
|Nippon India Balanced Advantage Fund||6,017||5.51%||9.92%||9.18%|
|IDFC Balanced Advantage Fund||3,012||2.46%||9.24%||9.07%|
Note: The returns are as of 30th May 2022. The returns are for direct plans with growth option. The one-year returns are absolute. The three and five-year returns are CAGR. The funds have been ranked based on five-year performance.
How to invest in dynamic asset allocation funds?
You can invest in a dynamic asset allocation fund directly through the AMC website, an online portal such as Glide Invest, or a mutual fund distributor. You can start by investing a lumpsum amount or a systematic investment plan. It is advisable to start a systematic investment plan (SIP).