Equities form an essential component of any portfolio, but the risk of investing in the share market can be mitigated by having a balance of asset classes.

Creating a balanced investment portfolio through diversification makes sense.

The unit trust industry provides a range of funds that offer risk management as well as diversification benefits. These funds, collectively called asset allocation funds, invest in a wide spread of equities, property, bonds and cash with the primary aim of achieving capital growth.

Diversification is just one of the fundamentals of investing. Risk is another. Asset allocation funds use an optimal mix of the various asset classes, which often correlate differently, to reduce the amount of risk exposure to any one asset class, especially equities.

An advantage of investing in an asset allocation fund is that it gives the investor access to expertise in not only picking individual stocks for the fund, but also assistance in selecting the level of exposure to any one asset class in the fund.

This fund manager is usually supported by a team of specialists in each of the various asset classes who analyse and track the individual securities in their area. The fund manager is then able to focus his attention on the critically important asset allocation decision.

Asset allocation is not simply an educated guess of where to invest one's money. Fund managers make use of quantitative research, evaluate risk tolerance and take into account economic trends. Stability and consistency are dual imperatives.

There are three broad types of asset allocation or balanced funds: the most well known are the prudential funds, that are designed to meet all the requirements for investing in retirement funds, with their very specific investment requirements. These funds are often colloquially called balanced funds and come in a range of risk profiles. Generally, the higher the level of potential exposure to the equity sector, the more risky the fund can be - but also, consequently, the more likely to provide inflation-beating returns over time.

Flexible funds on the other hand, allow the fund manager to have wide discretion in terms of the level of exposure to any one class - with no limits set by any outside regulation.

These funds are ideal for investors who are comfortable leaving all decisions to an expert fund manager, and happy also to potentially take on more risk than balanced funds at times.

And then there is the very varied and broad category called Targeted Absolute and Real Return funds.

These portfolios tend to display below-average short-term volatility and are mandated to manage towards a predetermined, explicit benchmark or target, usually the inflation rate.

Galloway is head of retail at Stanlib