Things to know before investing in asset allocation funds

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Mutual funds offer diversification as they invest across asset classes and money market instruments to achieve a common investment objective. Mutual funds are ideal for investors who carry some risk appetite. Understanding your risk appetite before investing in mutual funds is essential because that way you will know if you should risk your finances with a particular scheme. What fund houses owning mutual fund schemes do is that they collect money from investors sharing a common investment objective and invest the capital raised across equity, stocks, bonds, certificate of deposits, debentures etc. Every mutual fund scheme follows a different asset allocation strategy.

For example, a multi cap fund invests across market capitalization to earn long term capital appreciation. On the other hand, a conservative hybrid fund will invest majority of its investible corpus in equity and the remaining of the assets in debt. Every mutual fund scheme has a designated fund manager who along with a team of expert researchers and analysts evaluate existing market conditions and pick stocks accordingly.

What are asset allocation funds?

Asset allocation funds are hybrid schemes that invest in both equity and debt. Apart from this, the scheme may invest in any third asset class as well. Asset allocation funds usually invest a minimum of 10 percent in all three asset classes. For example, if the asset allocation fund invests in equity, debt and gold, as per SEBI mandate the scheme must invest a minimum of 10 percent in all three asset class. Asset allocation funds are balanced funds that aim at generating capital appreciation over the long term.

Things to bear in mind before investing in asset allocation funds

Asset allocation funds may not be always diversified

Do understand that a multi asset fund manager must invest minimum 10 percent in all three asset classes. This means he can choose to invest the remaining 70 percent in any one of the asset class depending on the market scenario. If the fund manager feels that the country might face economic slowdown, he may choose to invest more in gold rather than equity. Investors expecting maximum exposure to equity should understand this before making an investment decision.

May not justify portfolio diversification

Investors choose multi asset funds especially because they offer the benefit of three asset classes. But does that mean investors do not need to target their asset classes individually? Understand the difference between portfolio diversification and a mutual fund scheme. A multi asset fund is merely a mutual fund scheme whereas asset allocation strategy of mutual fund portfolio is much more than that. You allocate a certain portion of your income to different asset classes and this is way different than just investing in one scheme that invests in three different asset classes.

Understand taxation on capital gains

The taxation on gains from multi asset funds may vary depending on which asset class it predominantly invests in. Investors are expected to thoroughly go through scheme information document (SID) to get a deeper understanding on the taxation policies of the multi asset scheme they are about to invest in.

Proper management is essential

Just like any other actively managed funds the performance of multi asset funds highly depends on the fund manager / s handling that particular scheme. Multi asset schemes do not follow any specific investment strategy. If your multi asset scheme’s portfolio is more equity oriented the fund manager may choose to invest in stocks across market cap. Hence, fund managers play a vital role in ensuring that the multi asset scheme is able to outperform its benchmark in the long run.