Asset Allocation Helps Weather Market Storms

Abhimanyu Sharma Founder - Swarn Associates LLP

When braving extreme cold and snow, people wear layers of clothing, hat or cap, mittens and waterproof insulated boots. Notice how they use a variety of equipment to make sure the biting cold does not affect them. They keyword here is ‘variety’. In the same way, financial investors should use asset allocation if they hope to have a fighting chance against bad weather in financial markets. By keeping their eggs in different baskets, asset allocation provides an all-weather solution to a common investor that is cost-effective, dynamic, and long-term in nature. In a simple way that has been shown to report proven results, asset allocation takes away the need for market timing in an environment that is globally volatile. Read on to know more.

Dial ‘Double A’ As financial markets evolve and become more complex, sticking to just one asset class is increasingly becoming risky. Historical data shows that while equities can go up by 80% in a year, they can also drop by 50% in one year. Fixed income or debt, which is expected to provide stable returns mostly, can throw up great returns once in a while just as much as when returns can drop to a trickle. We have all seen how gold has performed over the years; no one can place their finger on the precious metal which has its good years as well as bad years. So, a one-horse trick is not the way to create and maintain wealth. Asset allocation is the exercise to invest across various avenues such as cash, bonds, equities or gold (asset classes).

Optimal Performance By doing asset allocation in a disciplined manner, you can ensure that your hard-earned money is not hit by the volatility of any particular asset class. Different asset classes perform differently under the influence of several factors. Asset allocation is important to determine the performance of your overall portfolio and keep your financial planning intact. Asset allocation as a strategy has a proven track record of weathering the storms of financial markets. One study suggests that more than 91.5% of a portfolio’s return is attributable to its mix of asset classes. Individual asset selection and market timing accounted for less than 7% of a diversified portfolio’s return.

The Assets’ Family Just like a family has different members with diverse strengths and weaknesses, asset allocation creates a bowl of investments made with different ingredients. Each asset adds a flavour individually, as well as part of the group. The anti-correlation of performance of different asset-classes over time demands greater emphasis on selecting the right asset class over selecting the right security, as for example, developed country equities and gold had outperformed most of the domestic assets in the past year. One of the basic goals of optimal asset allocation is to result in lower losses in bad years. The combination of reduced downside with increased upside results in greater risk-adjusted return without the need for market timing.

Portfolio Creation Asset allocation in mutual funds is about creating the right portfolio. Given that portfolio construction requires the fund manager to be proficient in multiple asset classes, the investment process requires a broader understanding of asset class cycles along with global capital flows, regulatory environment, and other macroeconomic parameters. A typical market cycle is about eight years. The more the number of market cycles seen; the sharper is the decision-making. This gives an edge to experienced fund managers and market veterans who have seen multiple crests and troughs over the years. Investors must understand that it is not merely enough to have your fingers in multiple assets; it is important to be in the right asset as much as it is crucial to evade the bad asset.

Right Timing The last decade or so has delivered a full spectrum of highs and lows in global markets. Increasing uncertainty and lacklustre returns have sidelined portfolios that refused to adapt to the new realities. Global capital markets are coming to terms with new normal benchmarks like heightened volatility. As information flows across thousands of kilometres in a matter of milliseconds, swings are a given in this scenario. What compounds these volatile times is the leverage that investors take. The persistent volatility of global capital markets, compounded by ever-increasing leverage, makes the asset allocation approach unavoidable. Markets will be volatile and the extent of movements will get sharper still. It is only proper asset allocation that will result in an appropriate mix of exposures that will help investors achieve their long-term objectives.

The writer is a Founder - Swarn Associates LLP Email id : abhimanyu.k.sharma@gmail.com