Any money which we need within 18 months should be placed in instruments which are liquid and do not have any volatility or credit/default risk.
I can calculate the movement of the stars, but not the madness of men, said Sir Issac Newton, on his loss in investment in tulips, famously known as the South Sea Bubble. In the last four months since March 2020, we have noticed withdrawal of more than Rs 30,000 crore from the Employees’ Provident Fund ( EPF) and also opening of more than 3 lakh new demat accounts.
So in this scenario, when the economic situation is grim and there are job losses and salary cuts, we have on one hand people withdrawing money from their retirement funds and on the other hand new demat accounts are being opened.
When one invests in the asset classes of equity, debt, gold, bonds, the most important thing is portfolio construction. And within this portfolio construction is asset allocation. In a matter of four months—March to July 2020—we have noticed the Nifty PE move from around 29 to 17 and back to 30. This kind of movement has not been noticed, at such a short interval.
This is where asset allocation becomes very important. Asset allocation is basically investing across the various asset classes , balancing risk with reward , i.e., return. The factors to be considered in asset allocation includes one’s age, liquidity needs, risk appetite and volatility of the assets.
And there is never a better time to begin than now. Allocation among the assets can be predefined at the beginning of the portfolio construction and be reviewed at regular intervals of six months, or as required.
Before we construct the allocation, we need to understand our liquidity needs. Any money which we need within 18 months should be placed in instruments which are liquid and do not have any volatility or credit/default risk. These will be liquid mutual funds and/or bank fixed deposits. With this sorted out, investment in other asset classes for growth can be considered.
Gold as an asset class is a hedge against volatility. It can be 5-15% of the over portfolio and the asset allocation. This can be built up gradually. One needs to understand that returns in this asset class can be skewed. There can be considerable periods of underperformance or flat prices, followed by fast rise/fall in prices.
Typically, fixed instruments give constant secular returns at regular constant intervals. Predictability in returns is what attracts investors to this asset class, besides the perception of safety. Here we need to understand the choice of instruments, maturity period, liquidity and possibility of return of capital. This asset choice and the instrument could be a permanent feature in the portfolio. The percentage of allocation within the asset class and the overall portfolio can undergo a change taking into account the prevailing requirements.
Equity is looked upon as an asset class which can generate the maximum returns. However, the returns over the past five years are in single digit. The year 2020 has been very volatile and only select stocks have generated returns. The mantra is not go overboard on the returns generated in this period. We need to understand as an investor that the majority of us overestimate what can happen in a short period of time and underestimate over a longer period of time. So, stick to asset allocation.
The writer is managing partner, BellWether Advisors LLP