An investment into Nifty TRI since the year 1997 would grow over 22 times, whereas that in Warren Buffett’s Berkshire Hathaway stock would grow over 27 times in the same period. Impressive, huh? Now, get ready for the magic: an equal split of investment into the two – Nifty TRI and Warren Buffett’s Berkshire Hathaway stock – since the year 1997 would grow a massive 35 times, which is much higher than the individual returns in either of these two investments. How does this magic happen? DSP Mutual Fund Managing Director & CEO Kalpen Parekh spoke to FinancialExpress.com to reveal the trick.
Investment returns in 26 years since 1997:
Nifty TRI: 2243%
Berkshire Hathaway: 2658% (absolute INR returns)
50:50 in Nifty TRI + Berkshire Hathaway: 3466% (absolute INR returns)
Source: DSP Mutual Fund research, shared by Kalpen Parekh
The trick behind this magic lies in diversification into good quality investments, with low correlation, rebalanced periodically to the desired proportion. Yes, if that has begun to sound boring already, please read the numbers above once again; maybe that’ll bring your interest back into reading further.
Diversifying into assets with low correlation
Blending two or more good quality investments could give an investor higher returns than investing in just one, if those asset classes have a relatively low correlation to each other. In the long term, good quality investments usually grow; however, to protect the portfolio in the short term when a particular asset class doesn’t perform well, the pool of returns from various sources could cut the downside risk.
Asset allocation doesn’t work in isolation – a key factor to be considered is rebalancing. When one of the assets in a portfolio underperforms, the investor could either put more money into it, or move some money from the asset performing well to the underperformer, to bring the total corpus close to the original allocation ratio. Because of the low correlation, chances are all assets would not fall in similar measure at the same time; though, there’s no certainty.
Choosing strong investment assets
Now, while this may go against traditional sensibilities, Kalpen Parekh explained the logic – if the underlying assets are fundamentally strong, a bout of underperformance in any one would not derail its long-term trajectory. Therefore, investing when an asset is down could generate higher returns in the long run. This may limit overall investor returns to some extent in the short term, but the trade-off for less downside risk and reduced volatility might be worth it for some investors, he said.
An important factor to consider is that every security or asset class chosen must be backed by strong fundamentals. If the investment is fundamentally strong, then it is more likely to survive and grow. The onus of picking the right asset class and stock remains with the investors, Kalpen Parekh said. The future is unpredictable, he said, adding that especially since the present performance gives no indication or insights into future performance. Short-term trends change rapidly and rebalancing, along with portfolio diversification, helps protect the portfolio from this heightened risk and volatility.