ASSET ALLOCATION is the cornerstone of wealth creation and capital preservation. With market cycles constantly shifting, the ability to allocate assets optimally can significantly impact long-term investment returns.
ALLOCATION OVER TIMING
Investors often chase returns, trying to predict market movements. However, a renowned study on portfolio performance attribution reveals that 91.5 per cent of long-term portfolio returns come from asset allocation, not market timing or stock selection. This means that choosing how much to allocate to equity, debt, gold/silver, or REITs/InVITs matters far more than trying to pick individual winners.
Historical data supports this. In 2008, during the Lehman crisis, equities dropped by 51 per cent, while government securities (g-secs) delivered a 28 per cent return. Conversely, in 2009, as markets recovered, equities soared by 78 per cent while g-secs delivered -9 per cent.
THE RIGHT ASSET
Market cycles determine which asset class performs best at any given time. For instance, equity broadly thrives in expansionary phases, debt performs well in contractionary economies and gold acts as a hedge against uncertainty.
A clear example of this dynamic is the performance of different asset classes over the years.
Equities: Delivered strong returns in 2014 (33 per cent), 2017 (30 per cent) and 2021 (25 per cent), corresponding with economic growth.
Debt (g-secs): Provided stability in downturns, such as 2011 (2 per cent), 2016 (15 per cent), and 2023 (7 per cent).
Gold: Historically, gold has been a safe-haven asset in times of crisis, though its weight fluctuates based on macroeconomic conditions.
THE RIGHT TIME
Investors frequently make irrational choices, buying high and selling low because of fear and greed. This is evident in valuation metrics:
In September 2013, when markets were undervalued (P/E ratio of 15.34 and market cap-to-GDP of 60 per cent), domestic institutional investors (DIIs) withdrew Rs9,130 crore. Similarly, in September 2024, when markets were overvalued (P/E ratio of 24.26 and market cap-to-GDP of 147 per cent), DIIs invested Rs30,857 crore.
This pattern repeats because investors tend to panic in downturns and overcommit during booms. The solution? Follow a disciplined asset allocation model that reallocates funds based on valuation signals rather than emotions.
THE RIGHT ALLOCATION
The key to maximising returns while managing risk is dynamic asset allocation. Unlike static allocation, which remains fixed irrespective of market conditions, dynamic models shift between asset classes based on relative valuations.
Historical market data shows that equity exposure should be increased when markets are undervalued and reduced when they are overvalued. An analysis of asset allocation strategies from 2010 to 2024 shows that portfolios adjusting equity exposure based on market valuation delivered superior risk-adjusted returns compared to a static allocation approach.
ALLOCATION STRATEGY
A well-structured asset allocation plan should:
Diversify across asset classes: Avoid overexposure to any single asset class, as winners rotate over time.
Use valuation-based rebalancing: Increase exposure to undervalued assets and vice versa with overvalued ones.
Cut emotional biases: Follow a structured investment process rather than reacting to market noise.
Investors seeking a dynamic asset allocation strategy can consider the ICICI Prudential Asset Allocator Fund. This fund actively adjusts allocations across equity, debt and gold mutual fund schemes/ETFs based on an in-house valuation model. As of January 31, 2025, it has delivered 11.90 per cent over one year, with CAGR returns of 12.92 per cent and 13.87 per cent over three and five years, respectively.
IMM Services stands as a premier boutique investment firm, distinguished by a team of consummate banking professionals. Our refined expertise and bespoke approach enable us to craft sophisticated financial strategies, meticulously tailored to meet the distinctive needs of our discerning clientele.
Thabresh and Singhal are co-founders of IMM Services and Jeyaprakash is consultant, IMM services