When making investment decisions most individuals have two overarching goals. One is to protect their capital and the other is to grow their capital. There are plenty of investment options available in the Indian markets that can cater to an investors requirement of capital protection and growth. Each investment option has a different level of risk and return potential. Equities are considered to be a great asset class for generating relatively high returns over the long-term. However, equities are also considered riskier than most other asset classes. So how can risk-averse investors take advantage of the growth potential of equities. The simple answer to this is asset allocation funds.
Asset allocation funds are basically mutual fund schemes that invest in a combination of equities and bonds. They offer investors an opportunity to diversify their investment portfolio by creating an exposure to stocks and bonds. Based on the investment objective of a mutual fund scheme, the assets are allocated by a fund manager who tracks the investments and makes changes in the asset allocation according to the scheme mandate. Asset allocation funds are ideal for conservative investors who have a low tolerance for risk. While they are similar to hybrid funds in terms of asset allocation but differ in terms of how they are managed.
Types of asset allocation funds
Dynamic asset allocation funds – these funds are actively managed where the fund manager adjusts the asset allocation based on market fluctuations. When markets turn expensive, fund managers reduce their exposure to equities and increase their exposure to debt and arbitrage. On the other hand, when market valuations improve, they increase their exposure to equities and reduce their debt exposure.
Static asset allocation funds – these funds allocate to different asset classes based on a pre-determined percentage. Balanced funds are a great example of static asset allocation funds.
Benefits of investing in asset allocation funds
• Diversification – these funds allow investors to diversify their portfolio by creating exposure to both equities and bonds. This way, investors can mitigate the risks that stem from pure equity investing and increases their potential earnings.
• Mitigate volatility – due to an exposure to multiple asset classes, the underperformance of one asset class will not have an inordinately large impact on the overall portfolio returns.
• Potential for higher returns through an exposure to different asset classes.
Asset allocation funds can be a good investment avenue for investors who want to diversify their portfolios and harness the potential gains of equities. They can be a great addition to a portfolio during volatile times.