With stock markets on a bullrun, investors face the dilemma of where to invest and in which asset class. Should one invest further in equities? Or turn to other asset classes such as debt?

Answers are not easy to come by, because the stock market has risen by more than 30 per cent in the past year. One way to getting around this dilemma is to consider the type of fund known popularly as dynamic asset allocation fund. Equity funds invest predominantly in shares of companies, debt funds in fixed-income instruments. Dynamic asset-allocation funds, also known as hybrid funds, invest in a mix of both equity and debt.

The distinguishing features of such funds are that some (as fund-of-funds) essentially invest in other mutual funds; others invest in stocks of companies and fixed-income instruments. A dynamic asset-allocation strategy is based on pre-determined yardsticks such as a price-to-book value or price-to-earnings ratio. If these ratios move beyond pre-determined thresholds, fund managers reduce the exposure to equity stocks accordingly.

Weighing market conditions However, in general, equity oriented dynamic funds have allocations to equity assets that range between 65 and 100 per cent and 0-35 per cent to debt. This helps maintain their tax-status as equity funds, which don’t attract long-term capital gains tax if held for over a year.

The principle behind dynamic funds is that, depending on market conditions, they can seamlessly switch between asset classes. Investors may not have the information or expertise to make calculated shifts to other asset classes or may not know the assets to choose. Fund managers weigh all market conditions, valuations and other yardsticks to arrive at the right mix of equity and debt for investors.

With the stock market now ruling at higher levels, equities are stretched and richly valued. On the other hand, asset classes such as debt are going cheap as interest rates are nearly at their peak and inflation is expected to ease. The easing of interest rates would prove to be the catalyst for the debt market.

Hence, for small and large investors, equity dynamic funds are appropriate investment vehicles at this stage in the market. While largely holding on to equities as the economy is still on a structural growth path, these funds have begun in the last few months to take tactical exposure to the debt market.

(The writer is MD & CEO, ICICI Pru AMC)

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