When all asset prices fall, your portfolio would also be vulnerable when marked to the market for current prices. In the long run, however, there are negative correlations, i.e. inverse movements between asset classes that help you earn optimal returns.
Research conducted by Brinson, Hood and Beebower (acronym BHB) shows that more than 90% of portfolio volatility can be addressed through asset allocation rather than chasing a single asset class such as equity or debt. In 1986, these three researchers pointed out that asset allocation is the primary factor in the variability of portfolio returns, and security selection or market timing is secondary.
There are large fluctuations in returns, every year, across asset classes such as domestic equity, international equity, gold and to a lesser extent debt. In certain years the equity gives phenomenal returns and in certain years the returns are negative. The situation is the same with gold. The only way to smooth out the impact of volatility in these various investments is to focus on allocation and still earn optimal returns.
The next question is how to execute the distribution. You can do it yourself by investing in stocks, bonds, etc. or investing in mutual funds. Within mutual funds, there are various categories of funds such as equity, debt, hybrid (mix of equity and debt) etc. and you can invest in them.
Another way to do it is to invest in funds that are spread across multiple asset classes. Shifting through pure equity or debt funds and gold ETFs/gold funds is common practice.
The small problem, however, is that the discipline of a multi-asset allocation tends to be interrupted by market movements. When there is a sharp rise or large correction in equity, say due to price changes, the allocation to equity, debt, gold, etc. in your wallet turns out differently than intended.
In other words, market momentum creates a distortion. The other reason for the distortion is that investors tend to follow the momentum, chasing the “flavor of the time” and consciously investing more. At one point, people invested in cryptocurrencies when prices were booming, even though it is not a proven asset class.
The overall distribution in the mutual fund industry provides perspective. Equity and debt are the main asset classes and have the major share in the industry allocation. AUM in gold ETFs of approx. 20,000 crores is only 0.5% of the total AUM of the industry. In a properly balanced portfolio, gold should make up say 10%, not 0.5%.
There are funds that offer investment with multiple assets in one fund ie. stocks, debt, commodities, etc. If you make the distribution through a fund, then the AMC makes the distribution as per the mandate and you hold units in it. Under the regulations, a multi-asset fund must have an allocation to at least three asset classes and have at least a 10% allocation to each class.
The advantage of doing your allocation through multi-asset funds is that exposure to different assets in the same fund, different exposure to equity, debt, gold, etc. balance each other and the fund provides optimal returns. To be catered for, the fund’s asset allocation model must match your risk profile and investment objectives.
Let’s look at one fund in this category to get some perspective. ICICI Prudential Multi-Asset Fund leads the pack with a corpus size of Rs 13,016 crore as on July 1, 2022. The corpus size of other funds in this category ranges from Rs 16 crore to Rs 1,600 crore. The asset allocation pattern is 65% or more in equity, as this is the growth asset and taxation is more efficient. Debt typically ranges from 20% to 25%, which is the stable asset class, and gold/silver in the 10% to 15% range, which is a portfolio diversifier.
In terms of performance, this fund has performed well. For 3 years till July 1, 2022, it has given 15.2% per annum in regular plan and 15.9% per annum in direct plan. If we look at the 5-year performance, which is just before the repositioning, it has achieved 12.2% per year in regular plan and 13.1% in direct plan. Notably, in the last one year to July 1, 2022, this fund has returned 15.5% in regular and 16.2% in direct, under volatile market conditions. The average return of funds in this category (other than this fund) in the last one year is 1.1% in regular and 2.5% in direct plan. It is managed with derivatives in the portfolio.
The writer is a corporate trainer and author
(Disclaimer: The recommendations, suggestions, views and opinions given by the experts are their own. They do not represent the views of Economic Times)