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Many Roads to Asset Allocation

Asset allocation funds are passively managed funds that help investors automatically buy low and sell high

As an individual investor, it is often difficult not to get carried away by our emotions when deciding between different asset classes. Now that the stock market is up, the temptation is high to shift all one has, into equities. A year ago, investors were betting everything they had on bonds and debt funds.

Asset allocation funds are passively managed funds that solve this problem by taking the emotions out of choosing between assets. They simply follow a formula-based process to determine the fund's bets on equity, debt and money market instruments. This helps the fund to automatically “buy low and sell high.”

If this appears to be quite a neat solution, such asset allocation funds have delivered widely differing returns to investors in recent times. The process that a fund uses to decide on asset allocation and the leeway they have to invest in equities, makes all the difference.

Today there are six asset allocation funds which follow different models to arrive at their equity and debt exposures. While Principal Smart Equity gave a return of 18.86 per cent in the past three months while at the other extreme DSPBR Dynamic Asset Allocation fund generated only 4.42 per cent.

This is because the funds followed very different allocation strategies. While Principal Smart Equity saw its equity allocation hover between 80 and 99 per cent since last September, DSPBR Dynamic Asset Allocation Fund consistently maintained a high bond weight as per its objectives, with equity allocation at just over 10 per cent. Other funds like FT India Dynamic PE ratio and ING Asset Allocator Multi-Manager FoF also posted returns of 11.9 and 14.6 per cent respectively due to their higher equity exposure.

Different models
The wide divergence between the models that these funds follow have influenced their returns.

The FT India Dynamic PE Ratio fund of funds, for instance, uses the PE ratio of the Nifty at each month end to decide on its equity exposure. At a PE of upto 12 times, its equity allocation will be 90-100 per cent, at 12-16 it will fall to 70-90 per cent and so on. With the Nifty PE rising from September, the fund's equity weight has fallen from 75 to about 60 per cent.

The DSPBR Dynamic Asset Allocation fund in contrast compares the debt market yield to equity market yield to arrive at asset allocation. In recent times, the 10 year G-sec yield which the fund tracks, has remained fairly high on RBI's tight money policies. The equity yield on the other hand, hasn't picked up because corporate earnings remain quite sluggish. Thus the scheme's model has resulted in low equity weights of just 10 per cent plus, muting its participation in the rally.

The ING Asset Allocator Multi-Manager also uses a variation of the above model, but invests only in third-party mutual funds. As this fund does use subjective inputs as well as historical trends to map the debt-equity equation, it has ended up with a 60-65 per cent equity allocation in the last eight months, thus benefitting from the equity rally.

As to Principal Smart Equity Fund, the top performer in this short period, the scheme again uses PE bands just like the FT India Dynamic PE Ratio fund. But the scheme's model is far less conservative than Franklin Templeton's, with the lowest PE band starting at 16 times for the Nifty. Given that this fund's allocation allows it to invest 80-100 per cent in stocks as long as the Nifty is below 18, the fund has managed to make the most of this quick rally.

Again a Nifty PE based fund, the BOI AXA Equity Debt Rebalancer also suffered from aluation bands that were too wide. While the minimum Nifty PE that this fund uses to allocate assets is 8 times, the maximum is 26 times. In the short period since its launch, it has invested less than half of its portfolio in stocks.

Finally, there is the middle-of-the-road Pramerica Dynamic Asset Allocation Fund, which bases its allocation not on one parameter but on a whole matrix developed in-house. The model takes three broad parameters which drive asset prices, using historical data - Fundamental, liquidity and volatility. This model has ended up with a 48 to 61 per cent equity allocation for the fund in the last eight months.