An asset allocation fund is a portfolio of mix of equity, fixed income securities, and cash equivalents; asset allocation funds have access to main asset classes exposure via one single investment.
Types of Asset Allocation Funds
Basically, there are three types of asset allocation funds:
1) Balanced funds which maintain a relatively fixed ratio of stocks and bonds
2) Life-cycle funds which start with higher-risk investments but will move toward lower-risk ones as approaching the pre-determined date, e.g., retirement
3) Life-style funds which are actively managed based on the investor’s objectives, specifications, or views on market .
Benefits of Asset Allocation Funds
1) As a portfolio of assets with different characteristics, asset allocation funds can be utilized to reduce the negative impact of market volatility.
2) Low fee structure
3) Managed by experienced investment managers, asset allocation funds can relieve investors from selecting investments, tracking, and rebalancing portfolios.
4) Asset allocation funds can be shifted towards equities, bonds, or money market instruments based on the investment manager’s market outlook; more importantly, this alteration of asset mix is not subject to tax.
Issues with Implementing Asset Allocation Funds
1) Benchmark selection: This issue is related to whether the relative performance of asset allocation funds can be fairly presented given the absence of appropriate broad market indices.
2) Potential conflicts of interest:
- Case 1: Investment managers may select a proprietary product to the asset allocation portfolio where they have substandard capabilities.
- Case 2: Investment managers may alter the asset mix where more weights are applied to the asset classes that they have stronger capabilities, regardless of fundamental quality of the selected businesses.
- Case 3: There is also a possibility that an investment manager chooses to use underlying managers that pay higher-level “shared revenue”.
3) “Bundled program” issue: Asset allocation funds in a bundled program are particularly difficult problems, especially during underperforming periods.
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