Understanding dynamic asset allocation funds

Explore key features, benefits, and strategies of dynamic asset allocation funds.
Dynamic asset allocation funds
4 mins
17 Feb 2024

If you are looking for a mutual fund that can adjust its portfolio according to the market conditions and offer you optimal returns with minimal risk, you may want to consider dynamic asset allocation funds. These funds are a type of hybrid funds that invest in a mix of equity and debt instruments and dynamically change their allocation based on predefined market indicators. In this article, we will explain what dynamic asset allocation funds are, how to invest in them, their benefits and drawbacks, and who should invest in them.

What are dynamic asset allocation funds?

Dynamic asset allocation funds are mutual funds that do not have any fixed allocation to equity or debt. Instead, they follow a rule-based model that determines the allocation based on the market valuation, sentiment, and momentum. For example, some funds use the price-to-earnings (PE) ratio of the Nifty 500 index as a market indicator. If the PE ratio is high, indicating that the market is overvalued, the fund will reduce its equity exposure and increase its debt exposure. Conversely, if the PE ratio is low, indicating that the market is undervalued, the fund will increase its equity exposure and reduce its debt exposure. This way, the fund can capture the upside potential of the equity market when it is rising and protect the downside risk when it is falling.

How to invest in dynamic asset allocation funds

Investing in dynamic asset allocation funds is quite easy. You can follow these simple steps to complete your investment:

  • Step 1: Click on INVEST NOW. You will be redirected to the mutual funds listing page.
  • Step 2: Filter by scheme type, risk appetite, returns, etc. or choose from the top performing funds list.
  • Step 3: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating.
  • Step 4: Get started by entering your mobile number and sign in using the OTP.
  • Step 5: Verify your details using your PAN, date of birth. If your KYC is not complete, then you will have to upload your address proof and record a video.
  • Step 6: Enter your bank account details.
  • Step 7: Upload your signature and provide some additional details to continue.
  • Step 8: Choose and select the mutual fund that you want to invest in.
  • Step 9: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’
  • Step 10: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS.
  • Step 11: Once your payment is done, the investment will be complete.

Your investment will start reflecting in your portfolio within 2-3 working days.

Purpose of dynamic asset allocation funds

The main purpose of dynamic asset allocation funds is to provide long-term capital appreciation with relatively lower volatility through a dynamically balanced portfolio of equity and debt funds. These funds aim to optimise the risk-return trade-off by adjusting the asset allocation according to the market conditions. These funds are suitable for investors who want to benefit from the growth potential of equities without taking too much risk.

Major advantages of dynamic asset allocation funds

Some of the major advantages of dynamic asset allocation funds are:

  • Diversification: These funds offer diversification across different asset classes, sectors, and market segments, which can reduce the overall portfolio risk and enhance the return potential.
  • Professional management: These funds are managed by experienced fund managers who use sophisticated models and algorithms to decide the optimal asset allocation based on the market indicators. This saves the investors from the hassle of timing the market and monitoring the portfolio performance.
  • Tax efficiency: These funds are usually tax-efficient as they maintain a gross equity exposure of more than 65%, which makes them eligible for equity taxation. This means that the long-term capital gains (LTCG) are taxed at 10% above Rs. 1 lakh in a financial year, and the short-term capital gains (STCG) are taxed at 15%.

Who should invest in a dynamic asset allocation fund?

Dynamic asset allocation funds are ideal for investors who:

  • Have a high risk appetite and a long-term investment horizon
  • Want to diversify their portfolio across different asset classes
  • Want to benefit from the growth potential of equities without taking too much risk
  • Do not have the time or expertise to manage their portfolio actively
  • Want to enjoy the tax benefits of equity taxation

As mentioned earlier, dynamic asset allocation funds are usually taxed as equity funds, as they maintain a gross equity exposure of more than 65%. However, if the fund’s equity exposure falls below 65%, then the fund will be taxed as a debt fund. In that case, the LTCG will be taxed at 20% with indexation benefit if the holding period is more than three years, and the STCG will be added to the investor’s income and taxed at the applicable slab rate if the holding period is less than three years. The dividends will be taxed at the investor’s income tax slab rate in both cases.

Things to consider before investing in dynamic asset allocation funds

Before investing in dynamic asset allocation funds, you should consider the following factors:

  • Fund performance: You should compare the past performance of different dynamic asset allocation funds and choose the one that has delivered consistent and stable returns over different market cycles. You should also check the fund’s risk-adjusted return measures, such as Sharpe ratio, Sortino ratio, and alpha, to evaluate the fund’s performance relative to its risk and benchmark.

  • Fund strategy: You should understand the fund’s strategy and the market indicators that it uses to decide the asset allocation. You should also check the fund’s portfolio composition and turnover ratio to assess the fund’s quality and stability.

  • Fund expenses: You should check the fund’s expense ratio, exit load, and other charges that may affect your net returns. You should opt for a fund that has a low expense ratio and no exit load.

  • Fund suitability: You should assess your risk profile, investment objective, and time horizon before investing in a dynamic asset allocation fund. You should also consult your financial advisor if you have any doubts or queries regarding the fund’s suitability for your portfolio.

Conclusion

If you have a long-term investment horizon and want to benefit from the growth potential of equities while attempting to limit the downside by dynamically managing the portfolio through investment in equity and debt, dynamic asset allocation funds may be right for you. However, before investing in these funds, you should consider their performance, strategy, expenses, and suitability for your portfolio.

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Frequently asked questions

How long should I stay invested in dynamic asset allocation mutual funds?

There is no definitive answer to how long you should stay invested in dynamic asset allocation mutual funds, as it depends on your financial goals, risk appetite, and market conditions. However, some general guidelines are:

  • Dynamic asset allocation mutual funds work well for long-term investors who want to benefit from the growth potential of equity and also have the stability of debt. Therefore, you should have a time horizon of at least 3 to 5 years to stay invested in these funds.
  • You should also monitor the performance of your funds regularly and compare them with their benchmark and category peers. Review your portfolio allocation and rebalance it if needed to maintain your desired risk-return profile.
Where do dynamic asset allocation mutual funds invest?

Dynamic asset allocation mutual funds invest in a mix of equity and debt instruments, and adjust their portfolio allocation based on market conditions and other indicators. They aim to provide optimal returns with minimal risk by taking advantage of market fluctuations. They can also invest in other asset classes like real estate, currencies, and so on.

What kind of returns can I earn from dynamic asset allocation?

The returns from dynamic asset allocation funds depend on the performance of the underlying assets and the fund manager’s ability to adjust the portfolio allocation according to the market. There is no fixed or guaranteed return from these funds, as they are subject to market risks.