At a time when valuations have gone up and markets are going through lower levels of intermittent volatility, mutual fund houses are reducing equity allocation to dynamic asset allocation funds, which are an all-season hybrid fund. In these funds, the equity allocation is in the 30-70% range depending on the market conditions and the fund managers shuffle the allocation between equity and debt based on their views on the stock market, interest rate and other relevant parameters.

These funds are good for investors who want to take limited risk, generate overall returns between equity and debt and even take advantage of the volatility in the markets. As dynamic asset allocation funds are flexible, most of the time the portfolio will be aligned for investment and one can consider adding to it gradually, especially in the present times.

Optimise risk
The objective of dynamic asset allocation funds is to optimise risk across market cycles. Nirav Karkera, head of Research, Fisdom, says relative and absolute valuation frameworks are typically central to most dynamic asset allocation funds’ overall selection and allocation methodologies. “The category is among the very few that easily qualify as an all-season product with the current environment also being accretive to strong risk-adjusted performance. Investors can indeed seek to allocate to these funds,” he says. Given that risk optimisation and consistency are central to most dynamic asset allocation funds, promising funds in the category are best suited to retail investors seeking optimal returns while going through lower levels of intermittent volatility, he adds.

Paring equity allocation
Fund managers are booking profits from dynamic asset allocation funds as valuations have risen after the stock market indices have hit record highs. Investors gain from both rising and falling markets by investing in these funds as the equity allocation is reduced when market valuations are high and increased when the valuations are low.

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Indian equities have performed well over the last 6-12 months and scaled new highs despite global headwinds. Dhaval Kapadia, director, Investment Advisory, Morningstar Investment Adviser (India), says India equity valuations, on an absolute basis, are above their long-term averages and also look expensive on a relative basis versus emerging markets particularly China and developed markets which have underperformed over the last one year. “Probably due to the strong performance and valuations, fund managers may be reducing allocation to equity in dynamic asset allocation funds, given that these funds aim to actively manage the asset allocation across equity and debt,” he says.

Harshad Chetanwala, co-founder, MyWealthGrowth.com, says one of the biggest advantages of these funds is that the fund manager can build and update the portfolio based on market conditions. “They can increase or decrease the allocation in equity or debt depending on the views of the fund house. Such a strategy works for investors who want to take a limited risk and prefer this flexible approach offered by these funds,” he says.

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Similarly, Santosh Singh, fund manager, Motilal Oswal Financial Services, says dynamic asset allocation funds take advantage of the volatility in the markets.

“Given that earnings have grown and the market has remained range bound, our equity allocation in Motilal Oswal Dynamic Fund has remained between 50%-60% in the last six months,” he says. In fact, Motilal Oswal Dynamic Fund equity allocation is based on the fund house’s proprietary index called MOVI.

What to look out for
Like with all funds, it is critical to evaluate the fund management framework, portfolio construct and how the portfolio constituents were actively managed across cycles. Karkera says one way to form a perspective on expected style is by analysing the portfolio and performance of pure play equity, fixed income, and arbitrage funds managed by the same fund manager or fund house.

Investors who have mid-duration goals of three to five years can consider dynamic asset allocation funds. Chetanwala says those who do not have the risk appetite to invest entirely in equities and prefer to have some element of debt alongside can also consider these funds. “These funds can work for retired investors who want to withdraw for their monthly expenses after a couple of years,” he says.

DYNAMIC BETS
Fund managers are booking profits from these funds as valuations have risen after market indices hit record highs
Investors who have mid-duration goals like three to five years can consider dynamic asset allocation funds
It is an all-season product with the current environment also being accretive to strong risk-adjusted performance