How can multi asset allocation funds help manage risk effectively?

The balance between risk and reward is a key consideration for investors. Within mutual funds, this debate commonly involves choosing between debt and equity – with debt instruments such as bonds considered less risky but with lower return potential than equity funds, which have the potential to yield higher returns but come with significant risks.

That’s where multi asset allocation funds can come in. Such funds invest in three or more asset classes and can alter their allocation pattern in response to market movements with the aim of reducing risk. Read on to find out the how multi asset allocation fund manage risk.

• Table of contents

1. Understanding multi asset allocation funds
2. How multi asset allocation fund manage risk
3. How to choose the right multi-asset allocation fund

Understanding multi asset allocation funds

According to the Securities and Exchange Board of India, a multi asset allocation fund must invest in at least three asset classes, with a minimum allocation of 10% in each asset class. These typically include debt and equity along with real estate or commodities such as gold and silver.

The fund may have a typical investment allocation pattern and range, but fund managers may routinely rebalance the portfolio based on market conditions and the economic outlook. As a result, fund managers can increase the allocation to the asset class that is performing better in the market at a given time, and reduce exposure to those that aren’t.

How multi asset allocation fund manage risk

Given below are some ways how multi asset allocation fund investment manage risk.

• Greater diversification: While no financial market investment is fool-proof, portfolio diversification can help mitigate risk and better leverage market fluctuations. Instead of putting all your eggs in one basket, a diversified portfolio spreads your investment across different securities and instruments.
• Most mutual funds offer portfolio diversification opportunities, but the flexibility is higher with multi asset allocation funds. The fund manager can combine multiple asset classes and alter the allocation ratio according to the prevailing market condition. This helps a multi asset allocation fund portfolio manage risk. In comparison, equity funds always require a minimum 65% investment in equity and related instruments and debt mutual funds invest predominantly in fixed-income instruments.
• Greater flexibility: A multi asset allocation fund has greater scope for portfolio rebalancing, which helps especially when market conditions change. For instance, if equity is performing well in a current market cycle, the fund manager can increase the fund’s equity component. Or, during increased volatility, the fund manager can make the portfolio debt-heavy to offer relative stability. The involvement of a fund manager in this process means that the investor does not need the time or expertise to track and time the market.
• Different asset class movements: Typically, not all asset classes move in the same direction. The flexibility to increase or decrease the exposure of an asset class based on the prevailing market conditions is one way how multi asset allocation fund investment manage risk.

For instance, when the stock market is performing well, the fund manager can skew the portfolio allocation in favour of equity. During a slowdown, when debt has historically fared better, the portfolio can be rebalanced in favour of debt.

The inclusion of third or fourth asset class – such as gold or real estate, can create an additional investment option if both debt and equity are underperforming, such as during a global recession. Do note, however, that no combination of asset classes is risk-free.

How to choose the right multi-asset allocation fund

These funds are suitable for investors with a moderate-to-high risk appetite. When choosing a fund, you should consider the following:

• The risk-reward ratio: The selection of the fund should depend not just on its historical performance but also its risk level, which will be displayed on its website as well as in the scheme-related documents. Choose an investment that offers good returns at a risk level that you are comfortable with.
• The fund manager: The role of a fund manager is crucial in a multi asset allocation fund. Check the past performance of the fund manager of a scheme before investing.
• Read scheme details: Check the scheme information document to see if the typical asset allocation range of the fund aligns with your financial goals. For example, if you’re not comfortable with too much equity in your portfolio, a particular fund may not be right for you.
• Consider your investment horizon: Multi asset allocation funds are usually recommended for a medium-to-long duration so that they can make the most of more than one market cycle. This is especially so when the equity component of a fund is high as stock market performance can be volatile in the short term.

Conclusion

A multi asset allocation fund can help manage risk by investing in multiple asset classes and varying the exposure to each based on market conditions. However, it is important to assess your risk appetite before choosing a fund. It is best to consult a financial advisor before making any investment decisions.

FAQs

How do multi asset allocation funds help manage risk?

By spreading your investments across three or more asset classes, such as debt, equity, and gold or real estate, multi asset allocation funds diversify your portfolio and can help navigate market volatility by altering asset allocation as per prevailing conditions.

How does investing in more than one asset reduce risk?

Different asset classes usually perform differently at a given point in the market cycle. For instance, debt may go up when equity goes down, or gold may emerge as a safe haven when both equity and debt are performing poorly. This helps mitigate risk.

What are the benefits of multi asset allocation funds?

Such funds offer portfolio diversification and flexibility, which can help better leverage market fluctuations. Additionally, the involvement of a fund manager to regularly review and rebalance the portfolio makes such investments accessible to all investors.

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.