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Everything You Need To Know About Dynamic Asset Allocation

A better understanding about valuation dynamics and positioning the investment portfolios accordingly can result in better outcomes

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Markets are all about valuations. A better understanding about valuation dynamics and positioning the investment portfolios accordingly can result in better outcomes. Different asset classes at various points of time exhibit distinct valuations. It is generally observed that all asset classes do not perform in tandem given their different market cycles. Therefore, one needs to have exposure to various asset classes to ensure the portfolio is well balanced. This is possible when one decides to adhere to asset allocation.

By following asset allocation, one can ensure that the wealth creation journey is not undermined by the behaviour of any one particular asset class. Hence, asset allocation emerges as an essential strategy and plays a key part when it comes to managing an investment portfolio. Since risk management needs to be one of the top priorities, asset allocation ensures concentration risk is at bay.

There are two types of allocation an investor can consider. One, static asset allocation. Here, once the proportion to various asset classes are determined, the same is maintained throughout the year. The other option is dynamic asset allocation. Here, basis the changing market conditions and relative attractiveness of asset classes, the portfolio is rebalanced dynamically.

How does Dynamic Asset Allocation work?
It works on the basic principle of selling when an asset class valuation is high and buying when the valuations are attractive. As a result, the portfolio is primed to make the most out of the opportunities present across various classes at point in time. In fact, dynamic asset allocation responds to the current risks and expected downturns proactively thereby yielding desired returns and better downside protection. Today, within the hybrid fund offerings, there is a dynamic asset allocation category for investors to consider investing. This category is also known the Balanced Advantage category.

Funds which follow Dynamic Asset Allocation
The category of Balanced Advantage Fund (BAF) comes with dynamic asset allocation strategy. This helps keep investors at ease with market fluctuations. They allocate predominantly in two asset classes — equity and debt. With the leeway to re-balance the portfolio on a daily basis, these schemes sell equity when valuations are high and move money to debt and vice versa. Such an effective investment strategy with the least turnaround time helps investors navigate market volatility easily. It needs to be highlighted that such schemes can take equity exposure to as high as 70-80% and can truncate it to as low as 20-30% as and when required.

Schemes with dynamic asset allocations are effective solutions for investors who wish to take exposure to equity but is averse to the volatility that comes along with it. Also, because of the product structure, even during phases when equity market is moving sideways, these funds are able to generate reasonable returns for investors.

Benefits of Dynamic Asset Allocation Fund 

1) Quick to Respond to Market Conditions: The fund manager here can raise or cut allocation to a particular asset class dramatically within a short period of time. For example: During the sharp correction seen during the pandemic times, fund managers across BAF schemes increased their equity allocation and cut their exposure to debt. Thereafter when the market rallied, they booked profits in equity and increased allocation to debt.

2) Effective Volatility Management with Stable Growth: Such schemes use market volatility as a growth tool to create wealth by buying low and selling high. With the ability to reduce downside risk, returns tend to relatively more stable than a pure equity fund.

3) An Option for Conservative Investors: Often investors keep away from equity investing due to the fear of market volatility. Given the relatively lower exposure to equities during elevated valuations, the risks pertaining to equity and its impact on the portfolio in case of a market corrections stands negated to a great extent. So, conservative investors can consider this offering or investors can treat this fund as a stepping stone into the world of equity investing.

At a time when equity valuations are no longer cheap, a dynamic asset allocation scheme should be the preferred choice for lump sum investment given their ability to contain downside risk and generate reasonable return over a full market cycle.

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