What Is an Asset Allocation Fund?
An asset allocation fund is a fund that provides investors with a diversified portfolio of investments across various asset classes. The asset allocation of the fund can be fixed or variable among a mix of asset classes, meaning that it may be held to fixed percentages of asset classes or allowed to go overweight on some depending on market conditions.
Popular asset categories for asset allocation funds include stocks, bonds, and cash equivalents that may also be spread out geographically for additional diversification.
- Asset allocation funds are a product of modern portfolio theory.
- The standard applications of modern portfolio theory investing include an efficient frontier of stocks, bonds, and cash equivalents.
- An asset allocation fund attempts to create an optimal portfolio given an investor's risk tolerance.
- Asset allocation funds come in potentially endless variations. The funds will all seek optimal diversification, but they all have different mixes of asset classes and follow unique internal rules.
- Some of the most common asset allocation funds include balanced funds and target-date funds.
- Investors can access asset allocation funds by purchasing shares in mutual funds or exchange traded funds (ETFs).
Understanding an Asset Allocation Fund
Asset allocation funds were developed from modern portfolio theory. Modern portfolio theory shows that investors can achieve optimal returns by investing in a diversified portfolio of investments included in an efficient frontier.
The standard applications of modern portfolio theory investing include an efficient frontier of stocks, bonds, and cash equivalents. Furthermore, modern portfolio theory outlines how a portfolio can vary its asset mix to tailor to the risk tolerance of the investor.
Types of Asset Allocation Funds
Asset allocation funds provide a simplified application of modern portfolio theory with varying allocations and combinations of assets for investors.
One of the most common types of asset allocation funds is a balanced fund. A balanced fund implies a balanced allocation of equities and fixed income, such as 60% stocks and 40% bonds. Investors will find numerous funds deploying the 60/40 mix as it has become a popular standardized strategy for investors seeking broad market diversification.
Asset allocation funds also offer varying levels of diversification based on risk tolerance. Investors seeking additional investing categories beyond just 60/40 will find many options, including conservative allocation funds, moderate allocation funds, and aggressive allocation funds.
Life-cycle or target-date funds, usually used in retirement planning, are also considered a type of asset allocation fund. These funds are managed with a targeted mix of asset classes that start out with a higher risk-return position and gradually become less risky as the fund nears its targeted utilization date.
After determining a targeted asset allocation, funds can manage their investment selection in a number of ways. Some funds may choose to invest in a variety of exchange traded funds (ETFs) to represent different market exposures. Other funds may take a more active approach by using fundamental analysis to select top-performing securities in each asset class. Overall, most funds will actively monitor and allocate or rebalance securities in response to evolving market conditions and economic environments.
Popular Asset Allocation Funds
Below are examples of some of the investment industry’s top asset allocation funds.
- iShares Core Aggressive Allocation ETF (AOA): The iShares Core Aggressive Allocation ETF is a tracker fund that seeks to replicate the performance of the S&P Target Risk Aggressive Index. The fund invests in targeted ETFs that seek to replicate the Index. The Index is heavily weighted towards equities, targeting investors with a high risk tolerance.
- iShares Core Conservative Allocation ETF (AOK): The iShares Core Conservative Allocation ETF is a tracker fund that seeks to replicate the performance of the S&P Target Risk Conservative Index. The fund invests in ETFs that seek to replicate the Index. The Index is heavily weighted towards fixed income, targeting investors with a more conservative risk tolerance.
- Vanguard Balanced Index (VBINX): Investors seeking asset allocation funds will find a number of options with Vanguard. The firm’s Vanguard Balanced Index fund invests approximately 60% in stocks and 40% in bonds. Its holdings seek to track two indexes, the CRSP US Total Market Index and the Bloomberg Barclays U.S. Aggregate Float Adjusted Bond Index.