Last time we discussed the basics of asset allocation with a view to be able to take a better decision while selecting an appropriate mutual fund scheme. While each scheme comes with its own asset allocation, we need to dig deeper to understand the various differences that arise across schemes due to this…

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Asset allocation

Last time we discussed the basics of asset allocation with a view to be able to take a better decision while selecting an appropriate mutual fund scheme. While each scheme comes with its own asset allocation, we need to dig deeper to understand the various differences that arise across schemes due to this. We also discussed various categories of schemes that invest in certain asset category – we may call it allocation in a single asset category. At the same time, there are mutual fund schemes that invest in more than one asset classes. Such schemes are popularly called “hybrid schemes”.

We have already discussed different varieties of hybrid mutual fund schemes in our earlier articles. Let us look at some categories with the perspective of the asset allocation.

There are schemes like balanced hybrid fund, or conservative hybrid fund and there are balanced advantage fund or dynamic asset allocation fund. How do these schemes differ from one another? In order to understand this, we need to take a look at two broad approaches to asset allocation, viz. strategic asset allocation and tactical asset allocation.

Strategic asset allocation v/s tactical asset allocation

As we have seen last time, asset allocation means allocating assets across asset categories. In case of hybrid funds, it is important how the assets are allocated – whether a fixed allocation is maintained, or is it changed based on certain factors.

When the asset allocation is maintained in line with some strategy, e.g. a conservative hybrid scheme would allocate more money towards conservative fixed income asset category, while allocating a small portion of the portfolio in the risky equity. This allocation is maintained through the life of the scheme, with very marginal changes. Such an approach is in line with a certain strategy. Hence, it may be termed as “strategic asset allocation”.

On the other hand, one scheme may be managed by dynamically altering the asset allocation. Since such an approach involves tactical moves in and out of an asset category, it is termed as “tactical asset allocation”. Typical example of this includes the various balanced advantage funds that move asset allocation between equity and fixed income securities. The change in asset allocation is done in such schemes in line with either a formula or the fund manager’s views on various assets. Some of the schemes may also be termed as “dynamic asset allocation” funds, as the asset allocation is changed dynamically between assets.

What could be a formula for changing the allocation?

Many schemes alter allocation between equity and fixed income securities based on some valuation parameters like PE ratio or PBV ratio of a popular index. On the other hand, someone may adopt a slightly complex methodology involving more than one variables.

Some schemes also change the asset allocation tactically based on the views of the fund management team.

An important point must be noted here. Tactical asset allocation generally revolves around strategic asset allocation (though not necessarily). This means that the scheme starts with a broad strategy, and the allocation may be tactically altered. However, the fund manager may not attempt to completely get in or out of an asset category.

Asset allocation offers multiple advantages.