Benefits of equity and debt based on market valuation
While making investments, investors’ do keep certain aspects in mind – how to grow the capital and second is how to protect the capital. There are plenty of investment options available in the markets that can cater to an investor’s requirement of capital protection and growth. Each investment option has a different level of risk and return potential.
With the global pandemic and uncertainty around, markets have been quite volatile. For new/few investors, this may create stress and confusion. Asset allocation helps to a certain extent to remain at peace during volatility. But the main question arises – which asset to invest? Debt or Equity? How to decide?
Equity as an asset class is associated with high volatility and this is the key reason why most investors tend to stay away from equities or under allocate to equities, despite the strong long term return potential of this asset class. Such cautious investors fearful of high volatility could consider investing in funds which dynamically manage equity allocation based on valuation level – i.e. increase equity exposure when markets are cheap and reduce equity exposure when markets are expensive.
Historical data suggests that such a strategy helps in taming the volatility and yet help investors participate in the long term growth potential of equities. Dynamic asset allocation funds, also known as balanced advantage fund, are actively managed and invest in a mix of debt and equity depending on market movements. They increase/decrease their allocation to equities and debt depending on their view of the stock markets. It does not aim to outperform pure equity strategies.
How Dynamic Asset Allocation Funds work?
These funds essentially work on the investing strategy that allows it to adjust the mix of equity and debt component depending on the view of stock market and prevailing economic conditions to help mitigate risk.
The portfolio model is derived from various fundamental and technical indicators which allows the fund managers to increase or decrease allocation to equity. So ideally when valuations are low, fund houses increase equity in the portfolio, and vice versa. Calculation methodology could vary from fund house to fund house.
Among the metrics that maybe considered for deciding the debt-equity mix at any point of time could be the interest rate cycle, equity valuations, medium to long term outlook of the asset class, etc.
Why invest in dynamic asset allocation funds?
- These funds help investors participate in the long term growth potential of equities but with a much lower volatility
- They help in systematically managing equity and debt allocation based on valuations and keep emotions away from asset allocation decisions
- History suggests that sharp corrections in the market typically occur when equity valuations are expensive. Due to the fund’s strategy of maintaining low equity allocation at higher valuation levels, it could help reduce downside significantly during such market corrections
- Potential to substantially improve risk-adjusted return for medium to long term investors
- These funds provide a tax-efficient and cost efficient dynamic asset allocation solution – taxation similar to equity oriented schemes
Who are these funds suitable for?
- Cautious investors with relatively low risk appetite, looking to benefit from the long term potential of equities
- Investors sitting on sidelines, waiting for appropriate market valuation level to make an investment in equities
- Investors planning for their long term financial goals such as retirement could look to invest through SIP or lump sum route
Investment decisions often involve finding the right balance between various asset classes through unpredictable market conditions. And dynamic asset allocation does that – it provides a mechanism that intends to combine the unique benefits of equity and debt based on market valuation. This strategy is ideal for investors seeking stable risk-adjusted returns with lower drawdown over long-term investment horizons.
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