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Asset Allocation Funds – Types, Features, Risk & Taxation

  • Nirav Karkera
  • Jan 12 2022
  • 5 minutes
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What are Asset allocation funds?

Asset allocation funds are mutual funds that invest in different types of asset classes. These assets can be a mix of equity, debt, or other assets and securities like gold, commodities, other metals, etc. Asset allocation funds are classified under the hybrid mutual fund’s category. These funds are relatively less risky than equity mutual funds on account of higher diversification.

What are the types of asset allocation funds?

There are many types of asset allocation funds that investors can access to add to their portfolios. Some of the common types of asset allocation funds and their details are mentioned below.

Dynamic asset allocation funds

As mentioned above, dynamic asset allocation funds belong to the hybrid funds category. The asset class of these funds includes debt and equity but also real estate, derivatives, bonds, etc. Such a  diversified portfolio helps in generating risk-adjusted returns. The fund managers do not have any mandatory conditions to adhere to with respect to the underlying asset classes and can adjust their exposure based on the current market trends. This rebalancing of the fund is done based on in-house models that ensure that the fund manager bias does not affect the performance of the fund.

Static asset allocation funds

Static asset allocation funds are hybrid funds that have a fixed allocation of specific asset classes. Unlike dynamic asset allocation funds, fund managers do not have the liberty to change the percentage of the assets allocated. The fund manager can therefore not alter the basic composition of the fund as per the prevalent market trends.

What are the features of asset allocation funds?

Asset allocation funds have the features of multiple asset categories. Some of the key features and benefits of asset allocation funds are mentioned below.

Diversification

Diversification is one of the prime features of asset allocation funds. These funds invest across a huge variety of assets hence the inherent benefit of diversification in mutual funds is quite enhanced in asset allocation funds. 

Lower risks

The risk in asset allocation funds is also lower as compared to equity-oriented funds. The enhanced benefit of diversification further reduces the overall risks of the fund.

Balanced returns

The returns of asset allocation funds are higher as compared to plain vanilla debt funds on account of diverse asset classes. The overall returns of the fund are further increased due to the expertise of experienced fund managers. 

Exposure to different asset classes and sectors 

Asset allocation funds invest in multiple assets which gives the investor maximum exposure to different asset classes at a structured cost. 

Who are the target investors for asset allocation funds?

Asset allocation funds are hybrid funds. Hence, these funds have the dual advantage of equity funds and debt funds. The risk perception of these funds is lower than equity-oriented funds but the returns are higher than regular debt-oriented funds. Hence these funds are ideal for investors that have a low-risk appetite and have a long-term investment horizon. 

How are asset allocation funds taxed?

The taxation of asset allocation funds is based on the form of the dominant asset class of the fund. The broad categories of these funds are either equity-oriented or debt-oriented. Hence the taxation of these funds can be explained as under. 

Type of funds Short term gains Tax rate Long term gains Tax rate
Hybrid equity-oriented mutual funds Less than 12 months 15% (plus cess and surcharge) 12 months and more Exempt up to Rs.1,00,000Above Rs.1,00,000 taxed at 10% (plus cess and surcharge)
Hybrid debt-oriented mutual funds Less than 36 months Slab rate of investor 36 months and more 20% (plus cess and surcharge)

What are the risks of asset allocation funds?

The prime risks of asset allocation funds are highlighted below.

Complex tax structure 

One of the biggest limitations of asset allocation funds is the complex tax structure of the fund. Owing to different assets in the fund and their changing composition it is difficult to manage the taxation of the fund.

High cost of investment

The cost of investment in asset allocation funds is quite high. These funds invest in different types of assets and securities some of which have a higher cost of investment. 

Review of the fund performance 

Constant review of the fund performance and adjustment of the assets of the fund based on the market conditions is a huge task. This requires expert fund managers and the absence of good quality fund managers can hamper the fund performance. 

Conclusion

Asset allocation funds are dynamic funds that provide benefits of investment across multiple assets and sectors. These funds can be an excellent addition to the portfolio of especially risk-averse investors so they can get potentially better returns at balanced risks.

FAQs

Are dynamic asset allocation funds active or passive funds?

These funds are actively managed funds where the expertise of the fund managers plays a key role in the fund performance.

What is the basic difference between static funds and dynamic asset allocation funds?

Static funds have a fixed percentage or proportion of assets to be maintained whereas the proportion of assets in dynamic asset allocation funds is not constant.

Do investors need to open a Demat account to invest in asset allocation funds?

Asset allocation funds can be invested through registered brokers or AMC directly like any other fund. Hence Demat account is not necessary.

Can investment in asset allocation funds be done through SIPs?

Yes. The option to invest in asset allocation funds through SIPs is available to investors like any other mutual fund.

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