What is dynamic asset allocation and how do balanced advantage funds implement it?

Investing in the stock market can often feel challenging, especially as investors must adjust their investment strategies based on changing market conditions. This is where balanced advantaged funds become relevant, especially in the context of dynamic vs. static allocation.

Let’s take a closer look at balanced advantage funds to understand the significance of their allocation strategy.

• Table of contents

1. What is dynamic asset allocation?
2. What is static asset allocation in mutual funds?
3. Key differences between dynamic and static asset allocation
4. Dynamic vs static allocation: Key considerations for investors

What is dynamic asset allocation?

Dynamic asset allocation is an investment strategy wherein fund managers can flexibly and frequently alter the asset allocation ratio based on market conditions and their insights. The goal is to take advantage of short-term opportunities or mitigate risks. There maybe a broad allocation pattern that the scheme needs to adhere, but the fund manager has a high degree of flexibility to design the portfolio and adjust the asset allocation mix. For example, when stock market is likely to perform well, the fund manager can significantly increase the equity portfolio of the portfolio. On the other hand, during volatility, the fund manager may choose to increase the debt component to lend relative stability to the portfolio.

What is static asset allocation in mutual funds

A majority of mutual funds follow a static asset allocation pattern, which means that the asset allocation range is decided based on the fund category. Fund managers have minimal room to alter the ratio because they need to maintain a certain minimum or maximum allocation ratio based on SEBI guidelines. For instance, a large cap mutual fund must maintain at least 80% allocation to large cap companies in India. Meanwhile, a multi cap mutual fund must allot at least 25% of its portfolio to large cap, mid cap and small cap stocks respectively.

Key differences between dynamic and static asset allocation

The core difference between dynamic and static allocation lies in their response to market changes. In dynamic allocation, used in balanced advantage funds, the allocation ratio can be continually adjusted based on market trends.

On the other hand, static allocation involves setting a fixed asset allocation strategy, irrespective of market changes. For instance, a static fund may always keep a 60:40 or 65:35 ratio between stocks and bonds, regardless of market conditions.

Here’s a closer look at the fundamental differences between dynamic and static allocation.

Read Also: How dynamic asset allocation keeps balanced advantage funds flexible?

Adaptability to market changes

Dynamic allocation: This strategy used in balanced advantage fund is highly responsive to market fluctuations. Fund managers actively monitor market trends and economic indicators, adjusting the asset mix (equity and debt) to optimise the return potential and minimise risks. For instance, in a bullish market, they might increase equity exposure, whereas in a bearish market, they might shift towards more debt or take equity derivatives to hedge the portfolio.

Static allocation: This approach maintains a predetermined asset mix regardless of market conditions. Static allocation is based on the principle of long-term investment and does not react to short-term market volatility.

Risk management

Dynamic allocation: Offers a proactive risk management approach. By adjusting the investment mix, it aims to cushion the portfolio against market downturns and capitalise on growth opportunities during upswings.

Static allocation: Involves a passive risk management strategy. It relies on the inherent risk distribution of the chosen asset mix and the long-term principle of market correction.

Performance in different market conditions

Dynamic allocation: Potentially performs better in highly volatile markets as it aims to reduce exposure to declining assets and capitalise on growing sectors.

Static allocation: May experience sharper ups and downs in volatile markets but aims for steady growth over an extended period.

Investor involvement and expertise

Dynamic allocation: Generally requires more active involvement and trust in a fund manager’s expertise to make frequent adjustments.

Static allocation: More suitable for investors who prefer a hands-off approach or lack the time and expertise to actively monitor their investments.

Read Also: What are the Dynamic Bond Funds

Dynamic vs. Static Allocation: Key Considerations for Investors

When choosing between mutual funds on the basis of dynamic and static allocation, investors should consider:

Risk tolerance: Dynamic allocation may better suit those who prefer active risk management, while static allocation fits a more consistent, long-term strategy.

Market understanding: Dynamic allocation requires an understanding of market trends, or trust in a fund manager who does.

Investment goals: Consider whether the goal is long-term growth or short-term gains. Dynamic allocation can be more responsive to market opportunities.

Conclusion

Dynamic allocation offers flexibility and active risk management, while static allocation provides consistency and simplicity.
If you're looking to add a balanced advantage fund to your portfolio, then consider the Bajaj Finserv Balanced Advantage Fund. The fund dynamically adjusts its equity and debt exposure, aiming to capitalise on market opportunities while managing risks. Its balanced approach makes it a suitable option for investors seeking a mix of growth and relative stability.

FAQs:

What is the main difference between dynamic and static allocation?
The main difference lies in their approach to asset allocation. Dynamic allocation adjusts investments based on market conditions, while static allocation maintains a fixed investment strategy.

How does dynamic allocation differ from static allocation in terms of risk management?
Dynamic allocation actively manages risk by adjusting asset distribution in response to market fluctuations, potentially offering a cushioning effect during downturns. Static allocation maintains a consistent approach, regardless of market changes.

What factors should I consider when choosing between dynamic and static allocation?
Consider your risk tolerance, investment time horizon, market knowledge, and financial goals. Dynamic allocation may suit those seeking active management, while static allocation is more suited to investors favouring a steady approach.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.