“Don’t put all your eggs in one basket” is often said when talking about the need for diversification in one’s investments. However, the important thing to understand here is why one needs to diversify investing across asset classes.
In calendar year 2008, at the time of the global financial crisis, gold returned 28.61%, while both Indian and global equities were in the red, down 56.54% and 30.27% respectively. However, in 2009, equities worldwide rebounded and delivered returns to the tune of 90.96% (domestic) and 25.72% (global). Gold also gave a positive return of 22.42%. Similarly, in 2012, while equities in general gave over 17% returns, gold was at 12.92%. A year later, gold gave a negative return of 7.90% and equities also yielded 35.76 per cent with global equities, while Indian equities were losing ground at 4.82%. This clearly shows that the winners in terms of asset classes change every other year and the correlation between all these asset classes is also minimal. Therefore, the best way to maximize leverage is through judicious asset allocation and rebalancing whenever required.
asset class mix
The major investment asset classes under consideration are equities, debt, gold and real estate. Real estate is not relevant to an average investor as it requires a huge lump sum investment. With these, over the years, a fourth asset class has taken shape in the form of global equities. Indian investors are increasingly investing in innovative global companies like Apple, Meta, Netflix, Microsoft, etc. through international funds or ETFs offered by domestic fund houses.
How to go about asset allocation?
To better diversify the portfolio, you can consider investing in all the four asset classes. However, due to the limited understanding of the specifics of different asset classes, we tend to stick to those asset classes that we understand well. Another option is that we invest in mutual fund schemes which do this for us. Within each asset class, there are a variety of offerings from which one can choose. For example: within domestic equities, there are market capitalization based funds, thematic or sectoral funds and even smart beta funds.
If a person invests in various asset classes either directly or through mutual fund schemes, one has to review from time to time and take a call to increase or decrease the risk in the specific asset category based on the future potential performance Does matter. There are two problems with this strategy. One, it is difficult for an average investor to accurately predict the future performance of a specific asset category and second, even if one is able to do it correctly every time, one has to bear capital gains tax at the time of rebalancing . In the long run, the tax imposed is likely to dent the overall investment experience.
best solution
There are two ways to tackle these challenges. First, invest in a mutual fund scheme that invests directly in all these asset classes or second, invest in a fund of funds that invests in schemes available in these asset classes. The second option has the better potential to fetch you better returns as it will help you to leverage the focused expertise of the fund managers concerned with the underlying scheme.
To address the challenges related to optimum asset allocation, ICICI Prudential has launched the Passive Multi-Asset Fund of Funds, a scheme that is designed to invest in all the four asset categories discussed earlier, each The asset class has been given certain limits. As a result, overall volatility is expected to be much lower than investing in a single asset class. Further, tactical calls taken by the fund manager from time to time are likely to help generate better risk adjusted returns with less volatility in the long run. Since this is a fund of funds, the spending limit will be 1%.
Taxation
For the purpose of taxation, Fund of Funds is treated as Debt Fund. Any profit on sale/redemption of units would qualify as long term if held for more than 36 months. Long term capital gains after indexation will attract a flat tax of 20% while short term capital gains will be included in your regular income and taxed at the applicable slab rate.
Balwant Jain is a Tax and Investment Specialist and can be contacted at jainbalwant@gmail.com and @jainbalwant on Twitter
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