There have been many instances where investors have told me that their mutual fund portfolios are not growing in tandem with the market. My initial reaction was to congratulate them that they have a good asset allocation strategy and there have been very rare situations when all the assets have performed together.
Usually, a portfolio with judicious asset allocation will show growth in one or more categories but maybe not all the asset classes at the same time.
The whole idea of dividing the investable funds into different asset classes is to benefit from the growth in a performing asset class thereby increasing the catchment area of the portfolio. In other words, not all the asset classes will perform at all the times. However, if we are invested in different categories, we will see that one of the assets will out-perform more often than others.
Just to illustrate the above statement by an example, I will take the case of a portfolio, which is invested into large, mid and small cap funds and debt markets funds. The large caps will perform when the Forgeign Institutional Investors (FIIs) invest into the markets. Usually, they invest into the large caps and debt markets, however it may not be the time for mid or small caps to perform.
Mid and small caps usually perform when retail investors gain the confidence to put their money in the markets and invest into the next cheaper segment, thereby moving these two classes into the green zone. The debt asset class has completely different set of dynamics from the equity asset classes. Commodities like gold and silver also classify into asset classes and should also find allocation in the portfolio.
There are many Exchange-traded Funds (ETFs), gold mutual funds and bonds, which are available nowadays and are not only a good alternative to physical gold but are also a preferred route to invest in commodities. If trading in commodities is your thing then exchanges like the MCX, NCDEX, NSE and BSE are at hand to facilitate the transactions. However, for the sake of this write-up and brevity I shall stick to asset allocation through MFs. Just to give you an idea of the quantum of investments into the Indian equity markets by FII in the last 10 years and how it has grown, consider this: In December 1991, Rs35,929.8 crore and this year till Novemeber the FII fund flows were a whopping Rs9,88,663.9 crore. Most of these were in the large cap equity markets.
Asset allocation has its advantages as the large caps and debt funds provide security, while the mid and small caps give higher returns.
A well-planned portfolio will be diversified across all the categories, depending upon the risk profile, return expectation and the tenure of investments of the particular investor. The asset allocation has to be dynamic and tactical with the allocation percentages changing with changing situations in the markets and one’s individual needs and desires.
Since asset allocation balances between risk or reward ratios of the portfolio, it has to be reviewed and re-balanced at regular intervals. There should be a strategic asset allocation in the portfolio, which should be tactically adjusted. The investors’ risk perception changes over a period of time as they are biased to market situations. At times they feel they should have taken more risk, thereby generating more returns in a rising market and vice-versa.
It is very difficult to cater to such situations by the investment advisor or fund houses and this becomes a challenge. Since the returns of different asset classes are not perfectly co-related, the tendency is to exit the lower or non-performing assets and invest more into performing assets.
This increases the risk of concentration of a particular asset class and throws the whole concept of a balanced portfolio out of whack. My recommendation is to stick to your original asset allocation, irrespective of market fluctuations. One can tweak the portfolios slightly but not change it altogether. Asset allocation is the key to a good portfolio. Happy investing!
The author is a wealth advisor and Founder, Tangerine Ideas