Asset Allocation schemes - managed risk, enhanced returns

Some mutual fund houses have launched schemes known as the “asset allocation schemes”. What are these schemes? How do they operate? Should one consider investing in such schemes? 

Read my article in Mid-day Gujarati edition today on the subject of asset allocation ...

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The English translation of the same is as under:

Some mutual fund houses have launched schemes known as the “asset allocation schemes”. What are these schemes? How do they operate? Should one consider investing in such schemes?

Before answering the above questions, it is important to understand what asset allocation means. It is a process to allocate one’s investments across various asset categories. The reasons behind asset allocation, the reasons why and how much money is allocated to different asset categories could be either unique to the investor or sometimes based on the fund manager’s view on the opportunities in different asset categories.

Since mutual fund companies cannot customize the schemes for individual investors, the logic of investing the fund’s investments across asset categories cannot be done in line with the investors’ needs. Hence, the objective of the asset allocation schemes launched by mutual fund companies would be to generate better risk-adjusted returns. Some people call these schemes offer peace of mind to investors, as the returns are decent, but the price fluctuations are moderate.

For this purpose, money in the scheme is invested across more than one asset classes. Since the market prices of different assets move differently, the scheme’s NAV exhibits moderate movement only.

Let us assume that a scheme has invested in both equity and debt. As we all understand, market prices of equity and debt do not move together. At some time, when the equity prices could be down, debt might have gone up. This is when the down movement of equity would be compensated partly by the up movement of debt prices.

The reverse may also happen when the debt prices do not move much or move in negative direction, equity might be up.

Thus, the opposite movements tend to cancel each other out partly, which lowers the fluctuation in the NAV of the scheme.

The asset allocation schemes may allocate money across more asset categories. in the Indian mutual fund industry, we have schemes that invest in various combinations of equity, debt and gold.

In certain cases, the schemes define the allocation across the asset categories and keep the same fixed. So, a scheme may invest 60% in equity and 40% in debt. At a pre-defined frequency the allocation would be checked and if required, would be restored to the 60-40 ratio.

Some schemes may give some flexibility to the fund manager to alter the allocation marginally, based on his or her market view. Such schemes depend on the portfolio manager’s abilities to improve the scheme’s performance.

There are some schemes that allow changes to the set percentage allocation based on certain valuation parameters. We will talk about such schemes in our next article.

Till then, keep an eye on the asset allocation schemes. In fact, two categories of funds that we have already covered earlier are Balanced Funds and MIP (or Monthly Income Plans). These are also known as hybrid schemes.

One must be careful to check whether the allocation between equity and debt is fixed at a certain ratio or the fund manager has a leeway to change it as per the outlook. For this purpose, one needs to check the following:

1.     The Scheme Information Document (popularly known as the SID) contains the details of asset allocation allowed. Read the table as well as the text below it., and

2.     The fact sheet contains the details of actual investments made by the scheme. Even when the fund manager has the flexibility to change the asset allocation, more often, the same is not used and the allocation is kept fixed.

If the allocation is kept at a near-constant ratio, one is not so much dependent on the fund manager’s outlook on the different asset categories. However, when the fund manager keeps changing the allocation between equity and debt, it requires skills. These skills can add to the returns, but at the same time are subject to the risk of the fund manager’s judgment being wrong.

Happy investing to you all.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.