Divide and rule

Asset allocation is the best partner in your investment journey

Saravanan S. Saravanan S.

BEFORE UNION Finance Minister Nirmala Sitharaman gave an adrenaline shot on September 20, the Indian equity markets had been going through a relatively rough patch. Just a day before she announced an array of measures intended to improve economic growth, newspaper headlines alerted many investors that all their equity gains in the calendar year 2019 had evaporated. Such moments certainly give anxiety to investors and they might even think of selling their holdings to prevent further loss. However, the market rallied soon after the finance minister announced the measures.

So what should an investor do in such situations?

Never keep all your eggs in the same basket. This is the philosophy behind asset allocation. If you keep all your investments concentrated in a single asset class, the probability of your portfolio getting hit in the tough times will be high. If you have spread your investments across different baskets, it is very unlikely that all of them will be negatively impacted at the same time or for the same reason.

Different asset classes respond to an event in different ways. If one asset in your portfolio is not performing well, another asset can cushion the blow. In a falling market situation, this could translate into reducing the possibility or extent of losses. For instance, in 2008, the year which saw a global financial crisis, equity returns stood at (-) 51 per cent, while government securities earned a return of 28 per cent.

According to a study, right asset allocation contributes more than 91 per cent of the portfolio performance over a long time. The factors that are often given more prominence, like selection of securities and market timing, contribute less than 5 per cent and 2 per cent, respectively.

Bringing asset allocation into practice is not that easy because investors are prone to emotional decision-making. If you see the equity market going up, it is highly plausible that you would want to invest more in equities. There could also be an element of greed that could prevent you from diversifying your investments just because you see your equity investments growing. Even if you convince yourself to follow the approach of buying when the market is low and exiting when it is at the peak, the challenge remains, as it is not easy to predict the peak or the bottom. The market movements are based on several domestic and international factors. Moreover, selling of a financial asset involves taxation and paperwork. Hence, it is a good idea to entrust the responsibility of asset allocation in your portfolio to experts.

To facilitate investors with their asset allocation, the capital markets regulator, Securities and Exchange Board of India, has allowed mutual funds to have a category in hybrid schemes, called dynamic asset allocation or balanced advantage schemes. One of the best performing and largest funds in this category is the Asset Allocator Fund from ICICI Prudential Mutual Fund.

In order to prevent their own emotions from driving the decisions, the fund managers rely on an in-house market valuation model. This model evaluates the market valuations on an on-going basis and indicates the call that should be taken. If the equity market valuations are high, it would suggest to reduce exposure to equity. If the equity market valuation goes down, it would encourage the fund managers to increase investments in equity.

Investors should take advantage of such mutual fund schemes. This will not only ensure that they have a reasonable asset allocation at all times, but also, as a consequence, result in optimal risk-adjusted returns.

The author is director of Purplepond Investment Advisory Private Limited.