Dynamic asset allocation could cut risks of mutual funds
A dynamic asset allocation approach seeks to lower the downside risk without much impact on upside returns.
Mutual funds and unit-linked insurance plans (Ulips) that invest in shares can give good returns in rising markets. Most people love to see their funds beat benchmarks but become nervous when equity markets fall and they start losing money.
During such times all they wish for is a mechanism to automatically shift from shares to fixed income securities or cash whenever a correction seems imminent.
For such investors, some mutual fund schemes and Ulips do adopt a dynamic asset allocation strategy based on parameters such as the price to earning, or P/E, ratio. When these show an upside potential in equity markets, fund managers invest more money in equities. The opposite happens when a fall is sensed.
Debt fund investments better than fixed deposits
Franklin Templeton Dynamic P/E Fund, Principal Smart Equity Fund, Pramerica Dynamic Equity fund, ICICI Prudential Dynamic Funds and Edelweiss Absolute Return Fund follow this approach. Aviva Life Insurance recently introduced dynamic P/E-based asset allocation in five of its Ulips.
ASSET ALLOCATION
It is assumed that when one asset class is not performing well, there is always another that is, neutralising the downside.Take a hybrid fund in which equity exposure is 65-100% while the debt component is 0-35%. In a traditional approach, the fund will most likely stick to this allocation pattern.
How to choose the best Ulip to invest in
However, in a dynamic approach, the fund manager will invest in the asset class that is giving the best returns. Exposure to different asset classes can range from 0-100%.
"A dynamic asset allocation and active management in underlying funds helps investors get comprehensive exposure to the potential of equity markets with reduced volatility," says Jaya Prakash K, head, products, Franklin Templeton Investments, India.
THE TRIGGERS
The changes in proportion of different assets-equity, debt and cash-in the portfolio depend on the fund manager's call and automatic triggers based on indicators such as index P/E (price to earning) ratio, P/B (price to book value) ratio, liquidity and volatility.
"The mandate of these funds is to make gains with their equity investments while retaining the flexibility of getting out when equity markets are not doing well," says Trideep Choudhary, head, research, products and services, Icra Online.
Index P/E levels are a good indicator of valuation and are used by many asset allocation funds to balance their portfolio.
Franklin Templeton Dynamic P/E Fund, Principal Smart Equity Fund and some Ulips of Aviva Life Insurance use P/E multiples to change allocations.
According to Jyoti Vaswani, CIO and director, fund management, Aviva India, a disciplined asset allocation fund is designed to make the most of changing market conditions. It follows the investment principle of 'buy low and sell high', which may give steady returns with low risk.
However, some funds do not follow a trigger-based asset allocation strategy but use more than one indicator to rebalance their portfolio. For example, ICICI Prudential Dynamic Fund takes into account dividend yields, P/E ratio, P/B ratio and discounted cash flow. Pramerica Dynamic Equity Fund uses fundamental factors such as gross domestic product growth, interest rates, corporate earnings, liquidity and volatility in equity markets.
PROS AND CONS
The main aim of these funds is to limit the downside risk without hitting returns too much. In volatile markets, they can outperform benchmarks and provide a cushion against corrections. Also, the use of automatic triggers limits the risk associated with the fund manager's call on portfolio allocation.
"However, being trigger-based may lead to situations where they do not enjoy full benefits of a bull-run," says Trideep Choudhary of Icra Online.
Since any fund with less than 65% equity allocation is considered a debt fund, in extreme situations where exposure to equity is below this, an investor will have to forgo the tax benefits. Long-term capital gains from equity funds are not taxable. However, gains from debt funds are added to your income and taxed.
Dynamic asset allocation funds are ideal for investors who seek consistent returns with limited risk. They may not always beat the benchmark on the upside but provide cover when the markets are falling.
During such times all they wish for is a mechanism to automatically shift from shares to fixed income securities or cash whenever a correction seems imminent.
For such investors, some mutual fund schemes and Ulips do adopt a dynamic asset allocation strategy based on parameters such as the price to earning, or P/E, ratio. When these show an upside potential in equity markets, fund managers invest more money in equities. The opposite happens when a fall is sensed.
Debt fund investments better than fixed deposits
Franklin Templeton Dynamic P/E Fund, Principal Smart Equity Fund, Pramerica Dynamic Equity fund, ICICI Prudential Dynamic Funds and Edelweiss Absolute Return Fund follow this approach. Aviva Life Insurance recently introduced dynamic P/E-based asset allocation in five of its Ulips.
ASSET ALLOCATION
It is assumed that when one asset class is not performing well, there is always another that is, neutralising the downside.Take a hybrid fund in which equity exposure is 65-100% while the debt component is 0-35%. In a traditional approach, the fund will most likely stick to this allocation pattern.
How to choose the best Ulip to invest in
However, in a dynamic approach, the fund manager will invest in the asset class that is giving the best returns. Exposure to different asset classes can range from 0-100%.
"A dynamic asset allocation and active management in underlying funds helps investors get comprehensive exposure to the potential of equity markets with reduced volatility," says Jaya Prakash K, head, products, Franklin Templeton Investments, India.
THE TRIGGERS
The changes in proportion of different assets-equity, debt and cash-in the portfolio depend on the fund manager's call and automatic triggers based on indicators such as index P/E (price to earning) ratio, P/B (price to book value) ratio, liquidity and volatility.
"The mandate of these funds is to make gains with their equity investments while retaining the flexibility of getting out when equity markets are not doing well," says Trideep Choudhary, head, research, products and services, Icra Online.
Index P/E levels are a good indicator of valuation and are used by many asset allocation funds to balance their portfolio.
Franklin Templeton Dynamic P/E Fund, Principal Smart Equity Fund and some Ulips of Aviva Life Insurance use P/E multiples to change allocations.
According to Jyoti Vaswani, CIO and director, fund management, Aviva India, a disciplined asset allocation fund is designed to make the most of changing market conditions. It follows the investment principle of 'buy low and sell high', which may give steady returns with low risk.
PE BASICS Price to earning (PE) multiple is arrived at by dividing the market price of the stock with the earning per share (EPS). P/E = Stock price/EPS, where EPS = Net profit/total outstanding shares; P/E ratio indicates how much you are paying for a stock for every Re 1 per share earned by the company. If a stock is trading at Rs 20, you are paying Rs 20 for every rupee it earns. |
PROS AND CONS
The main aim of these funds is to limit the downside risk without hitting returns too much. In volatile markets, they can outperform benchmarks and provide a cushion against corrections. Also, the use of automatic triggers limits the risk associated with the fund manager's call on portfolio allocation.
"However, being trigger-based may lead to situations where they do not enjoy full benefits of a bull-run," says Trideep Choudhary of Icra Online.
Since any fund with less than 65% equity allocation is considered a debt fund, in extreme situations where exposure to equity is below this, an investor will have to forgo the tax benefits. Long-term capital gains from equity funds are not taxable. However, gains from debt funds are added to your income and taxed.
Dynamic asset allocation funds are ideal for investors who seek consistent returns with limited risk. They may not always beat the benchmark on the upside but provide cover when the markets are falling.
