A one-stop portfolio diversifier

Senthil R. Senthil R.

THE MOST COMMON way of investment by retail investors is to invest in an asset class that has performed well recently. Equities are a preferred choice for investing based on the juicy returns of the past year.

A typical investor strives to attain reasonable returns with a low probability of losing capital, rather than a sporadic jump in the net asset value for a brief period. So, although the current period offers umpteen reasons to invest in equities, one must remember that a single asset class has periods of outperformance and drawdowns. Therefore, a well-thought asset allocation is required to generate long-term returns. If an investor is aiming for long-term capital appreciation with superior risk-adjusted returns, multi-asset funds are an ideal choice of investment.

Why allocate across asset classes

Over the last decade, the asset returns have been quite divergent in nature. Different asset classes outperform in different cycles, therefore staying across asset classes is a quintessential way to achieve healthy and consistent returns. Several empirical studies have proved that 90 per cent of the portfolio returns are based on asset allocation, and less than 10 per cent of the return is generated by stock selection. Allocating funds solely to a single asset class is not prudent, and chasing last year’s top-performing asset class can be detrimental.

For instance, gold posted the best return in 2020, with a return of 31 per cent, followed by 20 per cent by international equities, 16 per cent by local equity and 12 per cent by debt funds, while in 2019, the international equities delivered a return of 34 per cent versus gold, which posted a return of 21 per cent. So, changing the asset allocation by looking at last year’s returns could dent wealth creation. From 2007, if one invested in the asset class based on its previous year’s winner, it would have resulted in a return of around 8 per cent on an annual basis, while if invested in the asset class which was the worst performer in the previous year, it would have delivered a return of 11.8 per cent. The most optimal returns have come if the investor invested equally in the four different asset classes, with a return of 13 per cent. This shows that combining multiple assets not only offers superior returns in absolute levels but also carries low volatility.

Why multi-asset funds

Now that we know the importance of being invested in different asset classes, it is time to consider how this can be achieved in practical terms for a lay investor. The challenge here is multifold—to recognise which asset class to invest into, when to rebalance and how to minimise the tax incidence when re-balancing. So, in effect, it is not easy to execute a multi-asset strategy without sinking in some time and effort. To address these challenges, several fund houses over the past decade have been offering multi-asset funds.

As per the SEBI scheme categorisation definition, a multi-asset fund is one that invests in at least three asset classes with a minimum allocation of at least 10 per cent each in all three asset classes. One stand out name here is the ICICI Prudential Multi-Asset Fund, which invests across equity, debt, gold and REITs/InvITs. Here, equity brings in capital appreciation, debt offers stable returns, gold provides a hedge against inflation and REITs/InvITs play a role in yield enhancement. Over the last decade, the 10-year daily rolling returns of the fund have been more than 12 per cent, nearly 81 per cent of the time. When considered over a five-year time frame, the fund has never delivered negative returns. Over the last year, the fund has outperformed its benchmark by 12.6 per cent, and when it comes to returns the figure stands at 42.7 per cent.

The author is founder & MD of Orange Rise Pvt Ltd.