How does dynamic asset allocation work?
Asset allocation is an essential part of managing an investment portfolio. Not only does this help an investor leverage more than one asset class, but it ensures that concentration risk is at bay. This ultimately helps navigate different market conditions with relative ease while achieving financial goals. When the asset allocation strategy is implemented frequently enough to keep pace with changing market conditions, it is known as dynamic asset allocation.
Dynamic asset allocation management adjusts the composition of asset classes according to the given market scenario. This typically involves reducing exposure to asset classes that may be overvalued and increasing allocation to an asset class that is undervalued or has the potential to perform better in the future. Essentially, this strategy, which is an integral part of fund management, consists of constantly reacting to changing market conditions.
Within the category of hybrid funds, there is a category called Dynamic Asset Allocation (DAAF) or Balanced Advantage Funds. The fund’s objective in this category is to dynamically manage two asset classes, namely equities and debt. For rebalancing purposes, fund managers here will consider parameters such as PE, PB, etc. and allocate between asset classes. In a volatile market, fund managers tend to rebalance the portfolio daily if necessary. As a result, the investment experience tends to be high despite market volatility.
Benefits of DAAF
a) Dynamic allocation: DAAFs have the flexibility to invest in equities and debt securities and have no percentage allocation restriction to an asset class, unlike other hybrid funds. Thus, these funds can significantly reduce or increase their equity/debt exposure at any time.
b) Striving for stability: With an ability to reduce the downside potential of an investment, particularly in times of volatility, the returns generated by these funds tend to be much more stable compared to an equity fund. Historical data shows that even when benchmarks have generated negligible or flat returns over the course of a year, the dynamic asset allocation strategy tends to significantly outperform.
c) Transactions with market volatility: While buy low and sell high tends to be the motto of any equity investor, implementing it remains a challenge. Indeed, investors tend to get nervous when markets become volatile. By investing in DAAF, an investor makes the most of periods of volatility, creating long-term wealth. The DAAF regime effectively manages volatility by buying stocks when they are available at a relatively cheaper valuation and selling them at a higher valuation as the market rises.
d) Evaluation strategy: When it comes to deciding on the valuation metric, most fund managers use a combination of metrics such as price-to-earnings ratio, price-to-book ratio, and several others to make a decision.
e) Diversify: The portfolio here has the flexibility to invest in all market caps – large, mid and small. As a result, the presence of large caps provides the portfolio with much-needed stability and liquidity, while mid- and small-cap companies offer enormous growth potential.
Importance of DAAF in the portfolio of investors
The stability of an investment portfolio is of paramount importance. Although investments should be goal-based, there are times when the need for money comes unexpectedly. Regardless of market conditions, investors must redeem to meet requirements. Hitting investments (especially stocks) that have seen their value erode is a double whammy for investors. This is where DAAF comes to the rescue. In addition, since this category of funds offers a better long-term return which is in cases equal to equity or is at least better than a debt fund, investors can bank funds of this category for meet their needs without disrupting the equity wealth creation journey. investments.
Additionally, for investors who are confused by market volatility, DAAF can be a solution as this type of fund is equipped to take advantage of periods of volatility. At a time when stock valuations don’t come cheap, a dynamic asset allocation system can be part of any investor’s portfolio to help capture gains from stocks while taking advantage of the downside protection offered. by debt.