Asset Allocation Funds are funds that invest their assets over a diversified range of investment avenues. They are more like diversified funds, but, could also hold cash and cash equivalents in sizeable amounts.
The asset allocation funds could be a dynamic in the sense, they could alter their portfolio in tune to the markets, or they could keep it stagnant.
However, it is important to note that some of these funds may not alter their portfolio at all. So, if they have a strategy to keep the bonds for a period of 2 years, then they will maintain the strategy, no matter how much the equity market tumbles.
Unlike a diversified fund, the portfolio of a Asset Allocation Fund could be well spread and could include gold, bonds, real estate and equities among others.
There is not much difference between asset allocation fund and a diversified fund, though it is doubtful, if the latter would park money in avenues like real estate.
Should you invest in a Asset Allocation Fund?
It all depends on your investment objective and psyche. For example, those who love to take risk, would park all their money in equities. They are willing to take the risk. Diversification, will hedge your risk, but, the returns may not be great.
For example, if equities help you make money, it is possible than you could have lost money in gold or real estate. Thus, while you tend to hedge risk, you may end-up being pretty neutral.This is perhaps one of the drawbacks of these kind of funds.