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Achieving Effective Asset Allocation

Asset allocation entails investing your portfolio investments across multiple asset classes like equity, debt, gold, etc., such that sharp falls in any one asset class do not have an inordinately high impact on the overall performance of your portfolio.

M Praveen Kumar, Managing Director, Future First Financials Pvt Ltd
M Praveen Kumar, Managing Director, Future First Financials Pvt Ltd

If you hail from a region that has good monsoons, you would know how annoying it is if you are out and it suddenly starts raining and you are caught off-guard without an umbrella. At such times, you would give anything for an umbrella or any other similar protective gear. But, does this mean you will lug around an umbrella throughout the year? Most likely not, since it might be of little use to you in the winter months. At that time, you will look for another type of gear like a light jacket.

Creating a long-term and robust investment portfolio is similar in nature. Due to the changing nature of the economic landscape and investment environment, some investments in your portfolio might do well at certain times while correspondingly other investments might not. Now, if you were heavily skewed towards a particular investment, and got caught in a downside, then it would have an inordinately high impact on your portfolio. To avoid this, it is important to follow a customised asset allocation strategy that is well-aligned with your return requirements, risk profile, and investment time horizon.

So, what exactly is asset allocation?
Asset allocation entails investing your portfolio investments across multiple asset classes like equity, debt, gold, etc., such that sharp falls in any one asset class do not have an inordinately high impact on the overall performance of your portfolio. Case in point being that if you are highly skewed towards equities then during equity market rallies you would surely rejoice. However, when markets fall, your investment portfolio would be severely impacted. 

On the other hand, if you also had the right amount of debt in your portfolio, then equity market falls would not bother you as much. Such is the power of asset allocation. Make no mistake in thinking that asset allocation is just about investing in a bunch of asset classes in a random manner. The trick here is to get the allocation proportion right. For this, you have to take into consideration your return requirements, risk profile, investment time horizon and then create an investment strategy that clearly underscores the exposure to multiple asset classes. 

Having your cake and keeping it too
In reality, achieving this exposure through multiple investments can be a challenging task. Overall, for an individual investor, it can become challenging to identify the right amount of exposure to multiple asset classes and then either maintain that exposure or rebalance in response to the changing environment and personal circumstances. As a result, many investors instead opt to invest in Fund of Funds (FoFs). 

Similar to regular mutual funds, these funds also pool investor money and then further invest that money. However, unlike other mutual funds that invest in different asset classes, FoFs invest in other funds, thereby enabling you, as an investor, to gain access to multiple investment options, through a single investment. Further, these mutual funds can invest in both domestic as well as international funds, depending on the investment mandate of that particular scheme. This means that the FoF option can potentially provide increased diversification benefits. There are multiple types of FoFs, depending on the different types of funds in which the FoF invests. 

Within this broad category of FoFs, Asset Allocation FoFs present a great opportunity to achieve optimal diversification through asset allocation. These FoFs invest in a diverse pool of equity (domestic and/or international), debt, and gold mutual funds. As a result, they can reap the investment benefits of several asset classes and achieve optimal asset allocation. Through this arrangement while the equity exposure provides the return potential, the presence of gold ensures hedge against inflation and debt aids in providing downside protection. 

To conclude, asset Allocation FoFs provide an ideal solution for a lay investor as they give you the requisite exposure to various asset classes through a single investment that are professionally managed by investment experts. In effect, you do not need to worry about fund selection or rebalancing. All you need to do is start investing and remain invested for the long term.  
 

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