Tuesday, Jul 05, 2022

Things You Need To Know About Asset Allocation But Probably Don’t!

Asset allocation entails investing your portfolio across multiple asset classes such that sharp negative movements in any one asset class do not have a disproportionately large impact on your overall portfolio.

Pawan Mehar, Founder, Fundvaliz
Pawan Mehar, Founder, Fundvaliz

Life, just like markets, is in a constant state of flux. From an individual investor’s perspective, there are two things that happen in tandem. One, the investor’s personal circumstances keep changing with changes in risk profile, income, and return expectations. Two, the economic landscape also keeps changing, thereby impacting investment returns across asset classes. So, what do investors do to keep up with these changes and perhaps, even leverage these movements as opportunities to make great investments. Just like all roads lead to Rome, all solutions for good investment experiences lead to diversification through optimal asset allocation. 

Asset allocation entails investing your portfolio across multiple asset classes such that sharp negative movements in any one asset class do not have a disproportionately large impact on your overall portfolio. However, it’s important to understand that asset allocation is not as simple as spreading your investments across debt and equity products. Increasingly, the correlation between debt and equity is getting stronger as a result of which investors who only invest in pure debt and equity products are unable to earn the true benefits of diversification through optimal asset allocation. 

Here is how you can create a well-diversified long-term investment portfolio.

Static vs Dynamic asset allocation: If both your personal circumstances as well as the investment environment are changing then why should your asset allocation strategy remain the same? Thus, you must adopt a dynamic asset allocation strategy so that your portfolio can easily adapt to the changing contours of both the external as well as the internal environment. This means that instead of having fixed or static allocations, you must alter your asset allocations in response to your changing circumstances and the shape-shifting investment environment. 

Exposure to precious commodities like gold and silver: Historically, precious metals like gold and silver have had very low to negative with both equity as well as debt investments. Gold has several attributes that make it a compelling investment choice for any investor. These include its value as a diversifier, its potential to generate strong long-term returns, and its ability to act as a hedge in volatile economic scenarios. Silver has similar qualities in addition to the fact that it is extensively used as an industrial raw material and thus, can benefit substantially from an economic recovery. Further, in the current day and age, you don’t actually need to buy the physical commodity in order to gain exposure. You can simply invest in a silver or gold Exchange Traded Fund (ETF) which will give you the desired exposure without the hassle of holding the physical commodity.

Dynamic debt duration management: Another thing about achieving optimal asset allocation is ensuring within asset class diversification. This means that it is not sufficient to just spread your investments across debt and equity. Even within these asset classes you must strive to achieve some level of diversification. For your debt exposure, you can consider investing in a dynamically managed debt duration fund. These funds manage duration dynamically based on the interest rate cycle. For example, in case when the rate cycle is in an up-trend these funds tend to have lower duration and when the interest rate cycle is in a down-trend the average duration of the fund increases. 

Exposure to Mutual Funds (MFs) and Fund of Funds (FoFs): One of the key tenets of asset allocation is to diversify portfolio investments across multiple instruments, themes, sectors, and even markets. As an individual investor, you might find it challenging to select, invest, and monitor such a wide spread of investments. Thus, you should definitely consider leveraging MFs and FoFs to diversify your investment portfolio. These are vehicles that pool investor money and then invest it across asset classes, themes, and markets as per the scheme mandate. An FoF goes one step further to invest in several other funds, thereby giving you diversification benefits through a single investment. 

In the long run, optimal asset allocation can ensure that your investment portfolio is well-protected from volatility. It helps you reign in your emotions and take astute investment decisions in a disciplined and value accretive manner. However, always remember that asset allocation is more than just spreading your investment between debt and equity. All of the points can put you on the path to creating a well-diversified and robust long-term portfolio.