Investors with limited knowledge trying to adopt an asset allocation strategy by themselves run the risk of incurring losses if they are unable to gauge the changing dynamics of any asset class.
Wealth creation is a long-term process. They say, investment is a marathon not a sprint. And rightly so, the longer you stay invested, the lesser impact the short-term cuts/ corrections have on your portfolio. While the power of compounding gets powerful when you invest for a longer period, events like market corrections and black swan events do put a dent in your corpus at least for the short-term period.
Historic data indicates that, during the period of deep cuts, the portfolio value may go down to as low as 60-70% (Source: NSE) from its immediately preceding peak value. Thus, there is a need for a strategy which can help investors navigate through the cuts and market crash without significant impact on their corpus.
Asset allocation is one such strategy which has stood the test of time in safeguarding investor corpus and has led to long-term wealth creation. Asset allocation is an investment style where investors diversify by investing in different uncorrelated asset class, such that any sharp correction in one asset class does not have any cascading impact on the other. In this style of investing, the investor aims to be opportunistic and switches from one asset to another based on his outlook on different asset class.
There are many forms of asset allocation combinations currently available with asset classes based on the risk appetite of investors such as equity, debt, gold, commodity, currency, real estate, Real Estate Investment Trusts (REITS), Infrastructure Investment Trusts (InvITs) etc. A prominent one is investing in equity, debt and gold where investment in equity is aimed for capital appreciation, investment in debt for principal protection and gold as a safe heaven. Another combination is Equity, Debt and Arbitrage Fund. Today mutual funds offer various asset allocation schemes across different combination of asset classes. Multi asset allocation fund has proven to be beneficial over a longer period.
Adopting asset allocation, however, is easier said than done. It involves having an unparalleled knowledge and understanding of various asset classes. For instance, what asset class to choose, how much should be the asset allocation, when to enter which asset class and when to exit from which asset class. Investors with limited knowledge trying to adopt an asset allocation strategy by themselves run the risk of incurring losses if they are unable to gauge the changing dynamics of any asset class. It is, therefore, advised to take guidance of the financial adviser or invest in Multi Asset Allocation/ Dynamic Asset Allocation funds offered by various mutual funds.
The dynamic asset allocation fund by mutual funds could be a good option especially at a time when valuations are pricey. Some of the funds run on a quant model for arriving at an optimum asset allocation level. The model analyses changing trend in the variables and calculates the optimum asset allocation level. The prime objective of such funds is to reduce the volatility of the fund through optimum asset allocation. For example, when markets are at expensive valuations, the model may suggest reducing exposure in equities and allocating higher proportion to debt. That way safeguarding the investment from any potential market corrections. In the event of cheaper valuations or market corrections, the model may suggest increasing higher allocation back to equites.
Asset allocation as a strategy has its advantage. However, it involves complex models and having superior understanding of various asset classes. Investors may consider investing in Dynamic Asset Allocation Fund/ Multi Asset Allocation Fund offered by mutual funds which are professionally managed by trained fund managers.
(By Jaiprakash Toshniwal, Sr. Equity Research Analyst & Fund Manager – Equity, LIC Mutual Fund Asset Management Ltd)
Disclaimer: The views expressed herein are the author’s personal views and are based on internal data, publicly available information and other sources believed to be reliable. The information / data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. Readers are advised to consult their financial planner before making any investment.