Minimising risk to the downside Every asset class plays a role in the portfolio. While equities generate growth and debt brings regular income, gold because of its lower correlation to the other two provides diversification and lends stability. We saw these characteristics play out as recently as this year when stock markets fell off the cliff and gold climbed to new peaks, in addition to gold’s history of improving portfolio risk-adjusted returns.
Yes, the recovery in stock markets since the collapse of March has been phenomenal, and could continue going forward, but let’s not forget that the steep fall wiped off a third of investor capital within a matter of days. For an investor to participate in and benefit from the unprecedented equity market rally we’ve seen this year, he should have firstly been able to digest the massive losses of March and stay on.
An all equity portfolio for the three months ending March 31, 2020 was down 28% compared to a diversified portfolio with 40-40-20 allocation to equities, debt and gold which fell by only 8% based on Sensex TRI, Crisil Composite Bond Fund Index and domestic price of gold.
Those with diversified portfolios were hurt less and probably are the ones who managed to stick it out through the volatility and reap the benefits that followed.
So, while it is true that investing in shares can give you a better return than investing in gold, it’s important to appreciate that the presence of portfolio diversifier like gold, which tend to do well when risk assets like equities perform poorly, is what enables us to take on higher risk that comes with equity investing.
No asset class can go up in a straight line The optimism surrounding the economic rebound and the cheap liquidity backdrop is expected to encourage further risk taking in search for yield and continue to propel equities in 2021. This could be a headwind for gold and could limit its rise next year.
If the recovery falters or is weaker than expected, investors might question the rich valuations resulting in repricing to historical averages and market corrections. With investors vulnerable to a host of potential disappointments, cautious optimism seems to be the way forward.
The writer is associate fund manager, Alternative Investments, Quantum Mutual Fund