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What's the difference between dynamic asset allocation and equity-savings funds?

Ashutosh Gupta talks about different categories of hybrid funds and why Value Research does not recommend dynamic asset allocation funds

What's the difference between dynamic asset allocation and equity-savings funds? Why don't you recommend a dynamic asset allocation fund?
- Pratap Jaisinghani

Let me talk about both these categories of funds. Talking first about the dynamic asset allocation funds, on paper, their investment mandate looks very promising. They are the most unconstrained type of mutual funds available. Here, fund managers have complete flexibility to invest across equity and debt instruments in any proportion and then dynamically alter the mix of debt and equity, depending on their market outlook or several other factors that they may want to take into consideration.

Despite this unconstrained investment mandate, we are wary of this category because to be able to dynamically move between equity and debt often requires the fund management team to take a call on the markets. We think it's fairly difficult to get your call on the market right sustainably.

On the contrary, we are much more comfortable with hybrid asset allocation funds, which have a more defined asset allocation pattern. For instance, aggressive hybrid funds, which come with a much-defined asset allocation of about 75 per cent equity and 25 per cent debt, rebalance periodically to remain close to this kind of allocation. The advantage of this is, firstly, the fund manager does not need to take a call on the market. There is a defined asset allocation around which his actual allocations can revolve. Secondly, from an investor's perspective, it provides a very definitive cue about where the fund lies on the risk-return spectrum. Therefore, an investor can decide whether or not a particular hybrid fund is suitable for him, depending on his investment time horizon, goals, and if that kind of asset allocation suits his investment needs. Thus, we believe that hybrids that come with a more defined asset allocation are preferable.

Having said that, there are certain dynamic asset allocation funds which manage their equity-to-debt allocation in a much more pragmatic way. So rather than leaving it to the judgment of a fund manager or an investment management team, these funds have a methodical and a quantitative approach which decides what should be their asset allocation between debt and equity at a particular point in time. And I think that is far better than leaving it to the judgment of individuals. One such fund is ICICI Prudential Balanced Advantage Fund, which is very methodical in the way it goes about deciding its asset allocation, and you can see the changes happening systematically with the level of the market. The results show that it has done fairly well over the years. So I would say that even if one wants to go with the dynamic asset allocation funds, one should prefer the one which adopts a more methodical approach to asset allocation rather than deciding it arbitrarily.

Coming to the equity-savings funds, these are funds that typically invest about a third of your money each in equity, debt and arbitrage opportunities. You can think of these funds as an improvisation over the monthly income plans (MIPs), the category which is now known as the conservative hybrid funds. They are able to provide somewhat similar risk-reward outcomes but with a preferential tax treatment, similar to that of an equity fund. These funds invest in arbitrage opportunities. So at any given point in time, they are able to keep their equity allocation above 65 per cent of the assets and that fetches them a preferable tax treatment, similar to that of an equity fund. But from a risk-reward perspective, they are similar to a fund that invests 65 per cent of its money in debt and 35 per cent in equity. So overall, we believe that it's a fairly tax-efficient category for conservative investors or even retirees who are looking for only a measured dose of equity in their portfolio.

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