KNOWLEDGE CENTRE Mutual Fund Types / What Are Dynamic Funds?

What Are Dynamic Funds?

A recent entrant to the ever-evolving world of investments is Dynamic funds.

What are dynamic funds?

Dynamic fund is almost similar to a balanced fund as it entails a mix of equity and debt in its portfolio. But a Dynamic Fund is a lot more aggressive as the fund manager has much more leeway to shift the asset allocation either in favour of equity or debt.

How exactly does dynamic funds work?

A dynamic fund has a mix of equity and debt in its portfolio. Unlike balanced funds, the dynamic funds show massive variations in terms of percentage of equity and debt in the portfolio. It can even go up to 100% in equity or 100% in debt as the case may be. The decision will largely depend on the view taken by the fund manager. For example, if the fund manager is of the view that stocks are available at attractive valuations, then he can substantially increase the exposure to equities. Similarly, if the fund manager feels that the interest rates are headed down, then he can substantially increase his exposure to long-duration debt to benefit from capital appreciation. In short, the asset mix is designed largely to capitalize on opportunities, which is what makes it more an asset allocation scheme. This is how dynamic funds make smart asset allocation.

Financial planning with dynamic funds

One of the big challenges in financial planning is to generate alpha. After all, your core aim is to capture the opportunities in the market to generate higher than market return. Currently, the investor in consultation with his financial planner makes these changes to enhance returns. But in a dynamic fund, the fund manager himself takes up the responsibility of shifting allocations between debt and equity. From a financial planning perspective, an exposure to dynamic funds can go a long way in generating alpha under volatile market conditions. Apart from managing money, you are also able to outsource the task of asset allocation to a fund manager. To begin with, you can allocate a small portion of your overall allocation to dynamic funds.

What are the benefits of dynamic funds?

How exactly would you classify the market conditions today? One way to describe the market will be “Volatile and uncertain”! The reasons are not far to seek. Globally, there is turmoil on the geopolitical and the monetary policy front even as the US economy has failed to keep pace with the expectations built up by Trump. Domestically, there is the big question mark over the implementation of GST and the RBI stance on rates. In these circumstances it makes a lot of sense to be fleet-footed via a dynamic fund. A dynamic fund will set equity allocations based on a valuations rule. The upper band of the P/E indicates a sell signal and the lower band indicates a buy signal. This ensures that your profits are automatically monetized at regular intervals and also you are liquid when the market corrects and throws up opportunities.

What are the tax implications of dynamic funds?

Balanced funds with an exposure of 65% to equity are classified as equity funds for tax purposes. In case of dynamic funds, unless the fund manager manages to maintain 65% allocation to equity on a median basis, the tax benefits of an equity fund will not be available to a dynamic fund. That will put a dynamic fund at a disadvantage with respect to a balanced fund. Capital gains on an equity fund are treated as long-term if the holding period is one year, as against a non-equity funds where the holding period has to be 3 years to qualify as long term gains. Also, in case of equities, long term capital gains are tax free and short term capital gains are taxed at a concessional rate of just 15%. These tax benefits have resulted in balanced funds being more popular than dynamic funds in the Indian context.

To encapsulate, dynamic funds are a great alternative for smart asset allocation. However, the issue of fund manager discretion and unfavourable tax implications have been a challenge to the growth of dynamic funds in India.

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