Amid the volatility caused in the market due to the second wave of COVID, dynamic asset allocation funds / balanced benefits funds, which invest in a mixture of debt and stocks, are gaining ground.
From January to March 2021, the dynamic asset allocation / balanced benefit funds received cumulative inflows worth Rs 5,375 crore. As of March 2021, this category received inflows worth Rs 2,711 crore, which was higher than the inflows received by any category of equity fund.
The main advantage of these funds is their ability to dynamically maneuver between stocks / cash / debt, which allows investors not to worry about increasing or decreasing exposure to stocks when valuations go up. These funds are positioned by asset managers as adept at taking tactical calls.
Currently, dynamic asset allocation funds hold an average of 44% cash, indicating that fund managers are waiting for opportunities to enter the market when valuations become attractive. Main Balanced Advantage and BOI Axa Equity Debt Rebalancer currently hold over 60% of the net assets in cash.
The table below shows the current stock allocation, one-year rolling return and the recovery from the crash.
“Balanced Advantage Funds are ideal for most investors. This eliminates the hassle of market timing for investors. The main advantage is that these funds can offer returns close to the equity market over the long term with significantly lower volatility. Currently, the stock markets are trading at a premium to their fair value. However, the market may rise further due to liquidity and therefore being out of the market is not recommended either. These funds provide investors with moderate exposure to equities at this point and when valuations become more attractive the fund manager will automatically increase the equity allocation. Anyone who is not comfortable with current valuations can consider FBAs rather than being out of the market, ”said G Pradeepkumar, CEO of Union Mutual Fund.
Since debt funds are unlikely to generate double-digit returns in the near future, some fund managers recommend that investors look to aggressive asset allocation funds.
“We need to focus on long-term debt funds to asset allocation funds where investors get a mix of stocks and debt. While the debt cycle may have ended on the duration side, stocks have had a good period. Stocks can generate returns although they are a much riskier asset class. On the other hand, debt is a low risk asset class relative to equities, but debt funds could offer sub-optimal returns during this phase. Therefore, we recommend that investors switch to the dynamic asset allocation category, ”said Sankaran Naren, Executive Director and Chief Investment Officer, ICICI Prudential Mutual Fund.
How do they work?
Each fund in this category is free to choose the methodology for deciding when to increase or decrease the allocation to equities. Most often, fund managers use the price / earnings (P / E) ratio, book value, interest rates, and the medium to long term outlook for the economy and markets while taking a call on the exhibition.
SEBI does not mention any lower or upper limit on the amount of exposure that this category may have in debt and equity. Thus, these funds can range from 0 to 100% in debt, equity or cash. But most funds try to maintain an allocation balance between equity, debt and cash. Dynamic asset allocation funds could attract tax from debt funds if equity exposure is below 65%.
How did these funds behave?
The category delivered 29.48% over a period of one year to April 13, 2021.
HDFC Balanced Advantage Fund is the largest fund in this category with assets under management of Rs 39,784 crore as of February 2021. This top performing fund generated 49.05% over a one year period. The worst performing BOI Axa Equity Debt Rebalancer generated 16.45% over the same period. As of February 2021, the fund holds 71% cash. This implies that the returns of each fund within the category could vary depending on exposure to equities / debt / cash and market capitalizations.
“These funds take our stress out of rebalancing equity and debt for cautious investors or for investors with shorter investment terms. We only offer these funds selectively from a few AMCs, as not all DAAF funds exactly follow their mandates. We prefer to offer DAAF as a strategy rather than a tactical allocation, ”says Nisreen Mamaji of Moneyworks Financial Services.
These funds can protect against declines in a bear market, but that would only depend on the fund’s exposure to equities during this phase. In the March 2020 crash, when the S&P BSE 500 TRI fell -32.55% (January – March 2020), the dynamic asset allocation fund category fell by -21% on average. Of course, some funds in the category fell from 27% to 33% during that time.
Thus, these funds carry their own share of risks.
“According to historical data, dynamic asset allocation funds suffered a fairly sharp correction during stock market crashes. For example, in calendar years 2020 and 2008, a few funds experienced a sharp correction of over -30% and -50%, respectively. Investors should understand that even well-managed funds will experience a downside during market corrections. In addition, it is very difficult to follow the debt portfolio of these funds and many managers can venture into low-credit quality instruments which can put the fund at risk, ”warns Rushabh Desai, distributor of funds. Mumbai based mutuals.
Who should control asset allocation?
Rushabh believes that since each investor’s risk profile and time horizon is different, it is advisable to have separate exposure to debt and stocks through different funds. Additionally, investors should take a close look at the portfolios of dynamic / balanced asset allocation funds to see if the funds hold credible debt securities in their debt allocation.
“Investors are advised to separate their equity and debt portfolios to avoid any mishaps encountered by the equity and debt segments, especially at the same time. In times of risk, it is very difficult for investors to immediately withdraw from these funds. Each investor will have a different time horizon and risk profile, which is why the power of asset allocation must rest in the hands of the investor. Looking at the risks, investors shouldn’t put all of their money in a category like this, even though it may be part of the portfolio, ”Rushabh adds.
Investors who are undecided about entering the market or entering the market for the first time and therefore do not know how much to allocate between equity and debt and in which segment (large, medium, small cap ) Market may consider a dynamic asset trust fund. But note that these funds are not completely immune to stock market volatility and therefore investors should have a reasonable time horizon when investing in such funds.