Asset Allocation Fund

An asset allocation fund is a diversified portfolio that invests across different asset classes. These allocation funds have a set percentage of investment in other assets or variables among asset classes that are modified owing to market conditions. It gives investors a diversified portfolio that diversifies risks and gives the best possible returns from different asset classes.

Depending on the investment mandate of the investor, these funds invest in different asset classes like stocks, bonds, commodities, cash, equity funds, and real estate. Fund managers manage these investments and make necessary changes based on the movements in the market and the performance of the asset class.

•  Asset allocation funds are investment instruments that enable investors to invest in equity, debt, and other asset classes.
• A portfolio manager manages these funds and considers the investor's risk tolerance and investment period.
• These funds hedge the risks of investments and provide the investor with a diversified portfolio.
• Portfolio managers actively rebalanced some of the funds according to the market movements. As a result, investors can choose the type of allocation funds according to their financial objectives.

Asset allocation funds are investments that let the investor a mix of equity and securities that provide fixed income that helps them achieve growth in terms of capital appreciation, diversification, income, and allocation based on the retirement dates of the investor.

Most funds of this nature have a fixed allocation rate for different assets that generate income or equity. However, they can deviate from the fixed rate depending on the market movement and asset class performance. Still, they are rebalanced to monthly or quarterly fixed allocation rates, depending on the fund's mandate.

Asset allocation gives the investor a portfolio that matches their risk appetite, investment period, and retirement goals. Since every investor’s nature of investing and investment goals differ, it is a reliable medium through which each investor can invest according to their needs.

Moreover, investors may park their investments in different funds for different objectives. For example, if an individual is saving for an international vacation, they might prefer investing in a mix of short-term bonds, certificates of deposit (CDs), and cash.

However, suppose the investor is looking at a long-term horizon. In that case, they might invest in stocks, bonds, and real estate to be unperturbed by the short-term volatility, with the percentage of allocation depending on their tolerance for risk.

Another factor that investors might consider is their current age. With more time behind them, young investors can invest in comparatively risky assets. As the primary goal for most young investors is to grow their investments and multiply their net worth, they can choose to take more risks than someone past their youth.

However, as they age, the portfolio must move more towards more conservative allocations, as their goal is probably to protect the corpus they have developed over the years. Hence, the goal is to harvest regular returns rather than multiply the investments rapidly.

Financial professionals cite that investment allocation is one of the most critical steps in a portfolio’s growth.

Depending on the investor’s risk appetite and investment period, they can choose various strategies for asset allocation. A few of the most followed types of allocations are as discussed below:

#1 - Strategic Asset Allocation

This strategy follows a combination of asset classes based on their expected returns for each asset. Then, depending on the risk appetite and investment period, the investor can choose to rebalance their portfolio according to the movement in the market and the performance of a particular asset class.

For example, if stocks have given profits of 12% historically and bonds have performed at 6%, assuming a 50-50 allocation in stocks and bonds, the investor can expect a 6% return annually.

This strategy promotes the classic buy-and-hold approach and diversification to alleviate risks and boost returns.

#2 - Dynamic Asset Allocation

A dynamic asset allocation fund is a strategy where the fund manager constantly adjusts the mix of assets depending on the market’s upward and downward movements. Practicing this approach will enable the manager to sell the assets on a decline and buy those on the rise.

In this strategy, the portfolio manager’s judgment precedes the asset classes' target mix.

#3 - Constant-Weighting Allocation

Under this strategy, the portfolio is continuously rebalanced, owing to the rise and decline of an asset or asset class. For example, if, say asset declines in value, then the manager would purchase it more to average the buying price, and if that asset gives a positive run, the manager will sell it.

Even though there are no definite rules regarding buying and selling to rebalance the portfolio, fund managers usually follow a practice where an asset class is rebalanced when it gives 5% returns or more.

It is the polar opposite of dynamic allocation, where the declining assets are sold instead of purchasing them even further in quantity to average the cost per unit.

#4 - Insured Asset Allocation

According to this strategy, a base portfolio value is created, below which the portfolio must not be allowed to drop. Then, if the portfolio gives positive and satisfactory returns, the fund manager actively manages the portfolio based on their judgment, forecasts, and analytical research.

However, suppose the portfolio drops to or below the base value. In that case, the fund manager invests in risk-free assets like Treasury bills to ensure the portfolio returns to its base value.

If the portfolio ever reaches this point, it is advised to relocate the assets or even completely change the investment strategy.

#5 - Integrated Asset Allocation

Under the integrated approach, the risk tolerance and expectation from the economy account for the allocation mix of the fund. While other strategies do not necessarily take the investor's risk tolerance into detailed account, the integrated approach does.

This approach integrates strategies that allow it to take market expectations and changes. As a result, integrated allocation is considered a broader strategy for the distribution of assets.

However, two strategies that contradict each other’s functionalities, like strategic asset allocation and constant-weighting allocation, for example, cannot be adopted as they will be detrimental to the portfolio's growth.

Let us understand the ebbs and flows of this concept through the examples below:

Example #1

Stuart recently landed a job at a reputed company through his placements at college. His family and friends had advised him to develop the habit of investing as early as possible. By nature, he is not someone who has tolerance for high risk, unlike his friends. Hence, he began looking around for investment options.

He discovered a multi asset allocation fund that invested in various asset classes, providing investors with a highly diversified portfolio.

The fund has given Stuart an average return of 7% for the last four years.

Example #2

The effect of factors external to the stock market or the debt market, like environmental, social, and governance, playing a vital role in the movement of the prices of asset classes is well established.

Global asset allocation fund companies have needed help finding tools efficient enough to hedge the risks of external factors.

To ensure the investments from their clients are safer, the second-largest US pension fund has reduced its allocation in the fixed income section of the fund to 12%.

Asset allocation and balanced funds are investment products that are closely discussed and looked at for investing opportunities. However, despite their similarities, there are stark differences in their formats, a few of which are as discussed below:

Asset Allocation Fund:

• It is an investment product in which the fund manager invests in various asset classes, diversifying the portfolio and hedging risks for the investor.
• The funds are curated, keeping the risk tolerance and the period of investment of the investor.
• Depending on the type of fund, the portfolio is rebalanced and allocated according to the movement in the market.
• No specific ratio is followed regarding exposure to equity or debt instruments.

Balanced Fund:

• Balanced funds are mutual funds of hybrid nature that invest in equity, debt, and other asset classes.
• They usually maintain a 40-60% exposure to equity and the remaining towards debt and other assets.
• The equity allocation exposes the investor to risky stocks, while the debt component balances the risk and provides fixed interest or returns.
• For a long-term investment, balanced funds provide an opportunity for wealth creation while ensuring the risk element does not exceed the tolerance level of the investor.

This has been a guide to what is Asset Allocation Fund. Here, we explain its types, examples, and comparison with the balanced fund. You can learn more about it from the following articles –

• Asset Based Lending
• Asset Allocation
• Sinking Fund