What are asset allocation funds

Asset management companies in India can now offer lifecycle funds, a category of funds introduced by SEBI this year. Such funds can hold equity, bonds and commodities. Hybrid funds typically carry equity and bonds.

For our discussion, we refer to all multi-asset-class funds as asset allocation funds. In this article, we discuss the characteristics of such funds and what you should be mindful of before investing in such funds. Asset allocation funds typically have an asset allocation range. Suppose a fund invests in equity and bonds and has an asset allocation range of 65-75% in equity and 25-35% in bonds. This allows fund managers to tactically move between 65% minimum allocation to equity to a maximum allocation of 75%.

Now, asset allocation, the proportion of how much you should invest in various asset classes to create a portfolio, is the first step in your investment process. Importantly, your asset allocation is a function of how important your life goal is. Your children’s education portfolio, for instance, may require a conservative allocation (more bonds, less equity) than, say, your retirement portfolio.

By investing in asset allocation funds, you are giving-up the first step in your investment process. This is because fund managers will manage the asset allocation based on the fund’s mandate and their view of the asset markets, not based on your life goals. This is not to say that asset allocation funds do not serve a purpose. It is useful if you believe that determining asset allocation for each of your goal is a tedious process. Technically, outsourcing your asset allocation would mean hiring an investment advisor to custom-tailor portfolios to meet your life goals. Asset allocation funds cannot fulfill such objectives.

Asset allocation funds carry some benefits. For one, such funds are tax efficient compared to you separately managing an equity and a bond portfolio for each goal. This is because fund managers moving money between stocks and bonds within the fund will not be taxable for you, unless you sell your units in the fund. For another, you get the benefit of professional expertise. Fund managers are better equipped than us to understand how to tactically move between equity and bonds. But if you prefer bank deposits for your bond allocation, asset allocation funds may not be an optimal fit for your goal-based investment.

(The author offers training programmes for individuals to manage their personal investments)