What every investor should know about multi-asset allocation funds

Mutual funds are versatile investment instruments that cater to a wide variety of investors with varying risk appetites and goals. Multi-asset allocation funds are a popular type of hybrid fund category that invest in a minimum of three different asset classes to offer instant diversification benefits to investors. While these funds offer hedging to your portfolio, you must understand them thoroughly before investing. This article outlines the things you must know before investing in multi-asset allocation funds and adding them to your portfolio.

• Multi-asset allocation funds are hybrid funds that invest at least 10% of their corpus in a minimum of three asset classes.

• Multi-asset allocation funds may not always be optimally diversified and do not serve as substitutes for individual portfolio diversification.

• Taxation on multi-asset allocation funds depends on the asset allocation of the fund and the investor’s holding period.

• Performance and returns depend on the expertise of the fund manager who actively manages the asset allocation for best risk-adjusted returns.

A multi-asset allocation fund is a type of hybrid mutual fund that invests in at least 3 asset classes. These funds aim to offer diversification benefits to the investor by investing in a mix of assets like equity, debt, and gold. The fund manager dynamically allocates investments across asset classes based on the analysis of market conditions.

For instance, if the market looks promising, the fund manager may increase the equity exposure of the fund. However, when markets are slowing down, the manager may increase the gold exposure of the fund since gold tends to perform best when other assets are declining. Since returns are not based on the performance of any single asset class, multi-asset allocation funds offer the potential for better risk-adjusted returns, while the dynamic allocation strategy helps weather volatility.

Here’s a list of things you should know before investing in multi-asset allocation funds:

Multi-asset allocation schemes may not always be diversified

The Securities and Exchange Board of India or SEBI defines multi-asset allocation funds as funds that are required to invest in a minimum of three different asset classes adhering to a basic allocation limit of 10% in each asset class. This means you can gain exposure to three different asset classes with a single investment and gain diversification benefits. However, the 10% minimum limit can also potentially compromise the extent of diversification.

For instance, if the fund manager is not optimistic about the economy and wants to avoid volatile waters in the near future, he may switch to a higher gold-based asset exposure and reduce equity and debt exposure to the minimum 10% limit. As an investor, it is important for you to know the specific exposure proportions of the scheme vis-a-vis different asset classes.

Multi-asset allocation funds are not short-cuts to individual portfolio diversification

Even if you are a new investor, you must be familiar with the gospel of diversification. Experts suggest diversifying your investments across asset classes to minimise risks and strengthen your portfolio. Given the importance of diversification, you may be tempted to invest in multi-asset allocation funds. However, you must understand that portfolio diversification is different from choosing a mutual fund scheme that invests in different asset classes. Multi-asset allocation funds have fund managers who study market trends and change asset allocation to suit the objectives of the scheme and protect the investor’s returns.

While investing in such funds is beneficial to your portfolio, they cannot be a substitute for individual portfolio diversification. Individual portfolio diversification involves investing in funds with underlying assets that have a low correlation with each other. Another thing you must know before investing in multi-asset allocation funds is that these funds do not allow investors to tap into style-based diversification like growth or value, or market cap-based diversification. However, you can achieve such diversification with your own portfolio by picking funds that match your requirements.

Taxation on multi-asset allocation funds depends on their portfolio composition

Taxation is yet another important thing you must know before investing in multi-asset allocation funds. Since there is no mandate that the fund has to invest 65% of its holdings into equity or debt, the taxation aspect varies from one multi-asset allocation scheme to the next. For instance, if the fund holds at least a 65% exposure to equity, it is taxed as an equity fund.

In this case, a STCG tax of 20% is applicable if the units are held for less than 12 months, while an LTCG tax of 12.5% is applicable if the units are held for more than 12 months. According to Union Budget 2024, if the multi-asset allocation fund has an equity exposure of less than 65%, the STCG and LTCG tax rates remain the same, but the holding period changes. STCG is applicable if holdings are sold in less than 24 months, while LTCG will be applicable if units are sold after 24 months.
 

The fund manager plays an important role in the performance of these funds

Multi-asset allocation funds are actively managed funds where the role of the fund manager plays a crucial role in the fund’s performance. This is especially true since these funds do not follow a specific investment style. As mentioned earlier, the returns from a multi-asset allocation fund depends entirely on how the manager evaluates the market conditions, the functionality of asset classes, and makes investment decisions.

For instance, the scheme may decide to invest 40% of its corpus in equity assets, but since there is no predetermined investment style, the fund manager can choose stocks from any market cap or sector. As a diligent investor, you must read scheme information documents carefully and also conduct research on the fund manager before investing in mutual funds.

Adding a multi-asset allocation fund to your investment portfolio may be a prudent choice, provided you read the scheme-related documents carefully. Reviewing the various things you must know before investing in multi-asset allocation funds can help you choose funds that best align with your financial goals, risk tolerance, and investment style.

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