How Does Dynamic Asset Allocation Work?

Asset allocation is an essential part of managing an investment portfolio. Not only does it help an investor get the benefits of more than one asset class, it ensures concentration risk is at bay. This eventually aids in navigating different market conditions with relative ease while fulfilling financial goals. When strategy of asset allocation is implemented quite frequently to keep with the changing market condition, it is known as Dynamic Asset Allocation. 

Dynamically managing asset allocation adjusts the mix of asset classes to suit the given market scenario. This typically involves reducing exposure in asset classes which could be overvalued and increasing allocation in an asset category which is either undervalued or has the potential to perform better going forward. Essentially, this strategy which is quite an active part of fund management, is to respond to the changing market conditions on an on-going basis.

Within the hybrid fund category, there is a category by the name dynamic asset allocation (DAAF) or balanced advantage fund. The objective of the fund in this category is to dynamically manage two asset classes namely equity and debt. For the rebalancing purpose, fund managers here will consider parameters like PE, PB etc. and will allocate between the asset classes. In a volatile market, the fund managers tend to rebalance the portfolio on a daily basis if required. As a result, the investment experience tends to be very despite market volatility.

Advantages of DAAF

a) Dynamic Allocation: DAAFs have the flexibility to invest into equity and debt and do not have percentage allocation restriction to any asset class unlike other hybrid funds. So, such funds can drastically cut or raise their exposure to equity/debt at any given point in time. 

b) Endeavours Stability: With an ability to reduce the downside potential in an investment, especially during volatile time, the returns generated by such funds tend to be much more stable when compared to an equity fund. Historical data shows that even when benchmark indices generated negligible or flat returns in a year, dynamic asset allocation strategy tends to outperform by a wide margin.

c) Deals with Market Volatility: While buy low and sell high tends to be the motto of every equity investor, implementing that remains a challenge. This is because investors tend to be nervous when markets turn volatile. By investing in DAAF, an investor gets to make the most out of volatile times thereby creating wealth over long term. DAAF scheme effectively manages volatility by buying stocks when they are available at relatively cheaper valuation and sells them at higher valuation as the market rises. 

d) Valuation Strategy: When it comes to deciding on the valuation parameter, most of the fund manager uses a combination of parameters such as price-to-earnings, price-to-book and several others to reach a decision. 

e) Diversification: The portfolio here has the flexibility to invest across market capitalisation – large, mid and small. As a result, the presence of largecap provides the portfolio the much needed stability and liquidity while mid and Smallcap names bring in tremendous growth potential. 
Importance of DAAF in Investors' Portfolio

Stability of an investment portfolio is of paramount importance. Though investments need to be goal-based, there are times when the need for money comes unannounced. Irrespective of the market conditions, investors need to redeem to fulfil requirements. Touching investments (especially equities) which have seen an erosion in value is a double whammy for investors. It is here that DAAF come to the rescue. Further, since this category of funds offer a better return over long term which are in cases at par with equity or is atleast better than a debt fund, investors can bank of this category funds for meeting their needs without disturbing the wealth creation journey of equity investments. 

Also, for those investors who are unnerved by market volatility, DAAF can be a solution as this type of fund is equipped to benefit out of volatile times. At a time when equity valuation is not cheap, a dynamic asset allocation scheme can be a part of any investor’s portfolio to help make gains from equity while enjoy the downside protection offered by debt.