Dynamic asset allocation funds, a category of mutual fund schemes known well abroad, has caught the fancy of most Indian fund houses only recently. The past few years have seen the launch of such funds like DSP BlackRock Mutual Fund, SBI Mutual Fund, Pramerica Mutual Fund, BOI AXA Mutual Fund, Birla Sun Life Mutual Fund and HDFC Mutual Fund. Franklin Templeton Mutual Fund has been running its dynamic price-to-earnings ratio fund for the past 12 years.
The category is broadly based on the premise that over a period of time, the relative attractiveness of the debt and equity markets vary and investors must rebalance their portfolios accordingly. To avoid the hassle of doing this by withdrawing capital from a scheme investing in a certain asset class and putting it in another that invests in a complementary asset class, they can simply invest in a scheme that seamlessly makes the switch as and when required. A dynamic asset allocation scheme can be the enabling device that does this. While the parameters used to determine the timing and direction of the switches differ from fund house to fund house, by and large most use some kind of valuation metric.
“For instance, in the case of equity, a fund house may have, simplistically put, price valuations or price-to-book valuations and have filters on when you reach the optimal level of those valuations. If you cross that level of valuation, they believe that the asset has become overvalued and they prune the level of equity accordingly,” said Vidya Bala, head of mutual fund research at FundsIndia.com, an online investment platform. “Similarly, when the asset falls below a certain valuation, it becomes cheap and, therefore, they try to increase allocation to that asset. This is broadly how the fund is managed, mostly in the equity component, and accordingly the debt and gold components [if the fund mandates investing in gold] are tweaked.”
Some of these schemes have a fund-of-funds structure—investing in other mutual fund schemes rather than in stocks or bonds.
One of the advantages of investing in a dynamic asset allocation scheme is that it cuts down on risk by enabling the fund managers to switch from high-risk equities to low-risk debt when the share market goes through a rough patch.
“To me, it is really about the risk. What we believe is that there is a decent chunk of investors who want to take some risk as they are not satisfied with FD [fixed deposit] returns. But they do not want any major risk and that is the category that our dynamic asset allocation fund targets,” said Dinesh Balachandran, who is part of the team managing SBI Dynamic Asset Allocation Fund.
In times of volatility, dynamic asset allocation products are especially effective. “Once an investor stays invested through one or two business cycles [typically seven to ten years long], a product like this provides shock-absorbing capacity when the market is in turmoil. Even today, the equity allocation is not very high because according to the model, the fixed income markets appear relatively more attractive,” said Pankaj Sharma, executive vice-president and head of business development and risk management at DSP BlackRock Mutual Fund.
Sharma said the product's low-risk credentials are enhanced by its use of historical trends for changes in asset allocation rather than expectation-based forecasts. “It is a complete disintermediation product, which is especially useful to a small retail investor who does not know which fund to invest in, when to invest, how much to invest, when he should redeem his investment or reallocate capital from one fund to the other. It will work for those who have a long-term investment horizon, which spans over a business cycle,” he said.
The confidence fund houses seem to have in the product are, however, not reflected in the views of analysts, some of whom have a problem with the way historical trends are being used to rebalance asset allocation by schemes.
“Just back-testing some key metrics, such as the Sensex, and extrapolating future trends from them does not necessarily work. Whatever fundamental rules they [fund managers] have developed and applied to their funds are based on the assumption that you can make major extrapolations from the past. I don't agree with that,” said Prem Khatri, founder and chief executive officer of Cafemutual, a web-based platform that offers news, analysis and related content on the mutual fund industry.
Both Khatri and Bala of FundsIndia.com are unimpressed with the returns delivered by dynamic asset allocation funds. Bala said that if they have a fund-of-funds structure, they are seen as debt-oriented funds for tax purposes, which means they do not enjoy tax exemptions beyond a year. “An investor is better off holding a basket of funds across equity, debt or gold,” said Bala. “Based on your own requirement, you can customise your portfolio. Holding funds across assets also enables you to invest in funds of different fund houses.”