Asset allocation funds can provide cushion in volatile markets

Getting the right asset allocation that works well with the market conditions is a must for creating long-term wealth. However, most often, people ignore the importance of deciding the asset allocation mix. Besides, investors can even get carried away by the frenzy of the moment making wrong asset-allocation decisions.

So what is more likely to go well for investors who do not want to get caught up in the nitty-gritty of asset allocation? Needless to say, a fund that combines both debt and equity into a suitable asset allocation model for investors is asset allocation funds.

These funds seek to offer the benefit of both worlds in a single investment structure as equity has the potential to reasonable long-term returns while debt provides relative stability to the portfolio. They balance the equity and debt portion according to market conditions, thereby aiming to provide you a suitable asset allocation according to market conditions.

Hence, they tend to better risk-adjusted returns than a pure equity fund that is invested only in equities. The debt portion of balanced funds can help iron out the volatility of equity, which can be unnerving if investors are not watchful.

Due to the debt portion, such a fund structure is a relatively conservative product as compared to pure equity funds. However, they are still an effective wealth creation tool. They suit investors who are looking for a lower risk without compromising on the potential for long-term wealth through equities; and the portfolio is constructed keeping in mind the conservative risk profile of investors.

Usually, balanced funds allocate in the ratio of 65% equity and 35% debt, including some cash. Within balanced funds are asset allocation funds or balanced advantage funds which allocate dynamically between equity and debt using valuation yardstick such as price-to-book value. These funds are structured to invest in equities when markets are cheap and book profits when markets are rising, thus minimising risk and aiming to provide good long-term returns: they makes it possible for investors to have an asset allocation plan that is workable and tailor-made for different market conditions.

Another advantage such funds have is taxation like equity funds (due to their 65% exposure to equity). If the holding period is longer than a year, returns are tax-exempt; otherwise, they are subject to short-term capital gains tax. And, for the dividend option, dividends paid and received are tax-free (without any dividend-distribution tax) irrespective of holding period. For funds with an average equity exposure that is lower than 65%, tax treatment is similar to that of debt funds.

It can be a preferred solution for investors looking for price-based and stress-free, dynamic asset allocation fund model that can work – effortlessly. Such products can deliver a superior investment experience to a varied set of investors; be it a retired individual, a school teacher, or a young IT professional; anyone can aim to benefit from it. It works across market cycles while offering the benefits of asset allocation; this product could form part of an investor's core portfolio.

The writer is director, Optima Money Managers