As the name suggests, these funds dynamically manage their equity portfolios, investing more when markets are down and less when they are up. These funds have a mix of debt and equity in their portfolio.

They allocate less to equities when market valuations appear expen sive, and increase allocation when market valuations appear cheap.

The equity portion of the portfolio would vary depending on the meth od of calculation. Each fund house uses a different method of calcula tion, which is either based on the simple Nifty PE or an in-house proprietary model to assess valuations.

2. What are the pros and cons of a dynamic equity fund?

Since dynamic equity funds tend to hold higher cash in prolonged rallies, they may underperform during strong market conditions. Dynamic equity funds automatically rebalances portfolios and hence it is recommended for first-time equity investors with a low risk appetite. If the market was to enter a corrective mode, dynamic funds with a lower allocation to equities could see a lower erosion in their net asset value (NAV) as compared to a pure equity fund. The volatility of returns in these funds is lower than that in diversified funds and even their returns could be lower. In the current scenario, dynamic equity funds have underperformed compared to di versified equity funds over time. Dynamic equity funds may be suitable for those who are very conscious of market valuations and are wary of over-valued markets.

3. What is the tax treatment of dynamic equity funds?

A big advantage of these funds is that they are structured in such a way that they are taxed as equity funds for investors. Most funds when they lower their exposure to equities ensure that equity plus arbitrage component of the scheme is at least 65% of the corpus, which helps it qualify for equity taxation. When the fund qualifies for equity taxation, investors who hold the fund for one year, need need not pay long-term capital gains tax, making the investments tax free.