‘Diversify portfolio through multiple asset classes to build wealth over the long term’

How can investors balance their risk and return to absorb market volatility during different market cycles?

The key to optimizing wealth in market cycles is portfolio diversification. It is nothing more than distributing your investible surplus across various asset classes like Equity, Debt, Commodities, Real Estate and alternative investments with the goal of asset optimization.

Asset allocation is needed because different asset classes play different roles in a portfolio. An investor should be prepared for different cycles by investing in different asset classes like Equity, Debt and Gold. Equity provides capital appreciation but can be volatile; Debt provides stability to the portfolio but relatively low returns and gold acts as a hedge against inflation and currency depreciation.

Why is diversification important for an investor?

Each asset class behaves differently in different economic cycles. Out of the last 23 financial years starting 1999, equities have been the best performing asset class in 12 years; Debt has performed best in 5 years and gold in 6 years. Thus an investor can see that each asset class has its ups and downs and it is impossible to predict which asset class will outperform at what time. Asset allocation reduces the reliance on a single asset class to generate returns and also reduces the overall volatility in an investor’s portfolio. Thus, asset allocation has the potential to generate better risk-adjusted returns.

How does a multi-asset fund like yours help investors with asset allocation?

When it comes to asset allocation, multi-asset funds act as a solution for the investors while taking care of the decision making. Most of the multi-asset funds invest in 3 asset classes – Equity, Debt and Gold. Asset allocation decisions based on past performance or without considering valuations may yield sub-optimal returns in the future. Multi-asset funds automate this process for investors by investing in different asset classes in a specified range and according to the valuation, fundamentals and relative attractiveness of each asset class. Such funds use model-based asset allocation to instill discipline and eliminate personal biases in asset allocation.

How should an investor review and manage their diversified portfolio in different market cycles?

One reason proper asset allocation works is because assets such as equity, debt and gold have little or no negative correlation with each other. Thus if one particular asset class is not doing well, another may do well and lift the overall performance of the portfolio. Therefore, each asset class has a role to play in an investor’s portfolio. In that context, as long as investors have diversified and regularly rebalanced their portfolios between different asset classes, the portfolio will perform well over the long run.

How should investors view asset allocation in today’s market conditions?

Looking at the current situation, the stock is performing well, while gold is underperforming. Now if you look at the time when the first covid pandemic hit India, gold was performing well and equities were underperforming. In that sense, it would not be appropriate to focus on a single asset class or change your asset allocation based on current trends or underperformance. An investor should not be concerned with the poor performance of individual asset classes and should focus on the risk-adjusted returns of the overall portfolio. It is important to stay invested in each asset class over the long term and look at the combined returns of the entire portfolio.

You can listen to the full interview Here.