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Mar 07, 2013, 06.06 PM IST | Source: CNBC-TV18

How correct asset allocation can help beat inflation

In an interview to CNBC-TV18, personal finance expert, Harshvardhan Roongta of Roongta Securities spoke about the importance of allocating assets correctly and how it can help beat inflation and earn better returns in a volatile market.

In an interview to CNBC-TV18, personal finance expert, Harshvardhan Roongta of Roongta Securities spoke about the importance of allocating assets correctly and how it can help beat inflation and earn better returns in a volatile market.

Below is the verbatim transcript of Roongta's interview with CNBC-TV18. 

Q: Markets are volatile right now; investors are scared to invest in equities especially after the carnage that some midcap stocks saw and the big blowups without any intimation. How should one design his/her portfolio so that at least the basic principal is protected and at the same time he can benefit from investing in equities?

A: Any of the recommendations that financial planners make, they keep using the words ' diversification ' and 'asset allocation'. So, the idea irrespective of how good a particular investment looks at any given point in time; do not put all money into one avenue.

Let me explain the benefits of asset allocation with an example. Take a case of an investor who has about Rs 1 lakh to invest for five year tenure and he has given a clear mandate that he do not mind low returns because he is a safe investor by nature. He does not want higher returns but want his capital protected. So, the first obvious thing that he can think of is that he puts entire Rs 1 lakh into fixed deposit with a bank, earns about 9 percent returns on it. So, the value after five years would be about Rs 153,000.

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Option two, if he looks at asset allocation and the advantage of asset allocation; keep in mind that the mandate is he needs his capital protected. So, divide Rs 1 lakh as 70 percent into debt. Therefore, Rs 70,000 goes into fixed deposit, Rs 30,000 goes in a basket of well managed stocks. If put it into equity mutual funds , Rs 30,000 goes into that.

If one looks at five years from now the Rs 70,000 that has been invested at 9 percent becomes about Rs 107,700. The Rs 30,000, which was invested into equities we will take two-three scenarios. The first is if it gives 15 percent return, which one expect from equities to give over longer period. So, the value of Rs 30,000 becomes Rs 60,000.

If one combines Rs 107,000, which the FD has generated and Rs 60,000, which equities have generated, the portfolio is about Rs 168,000. This is much higher than what an only FD portfolio gives, which is about Rs 153,000. So, the weighted average of a portfolio, which is 70 percent debt and 30 percent equity, comes to about 10.93 percent, which is about 200 bps higher than what a fixed deposit would be.

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An interesting observation in this asset allocation is that the Rs 70,000 has grown to become Rs 107,000. Hypothetically assuming that equities become nil completely, you lose all the money that you have put into equities, which is unlikely to happen if you got a basket of good stocks but however if that becomes completely zero, his Rs 1 lakh is still intact because value of fixed deposit is Rs 107,000. So, these are the benefits of asset allocation. What percentage does one allocates, is different.

Looking at another scenario, the equity part of it, if equities go nowhere, Rs 30,000 remains at Rs 30,000. The portfolio value at the end of five years would be Rs 107,000 in FD and Rs 30,000 of equities would still give a return of 6 percent. Assuming that the market has done badly, one has been unfortunate with equity allocation; the fund has become half of its value. So, Rs 30,000 invested after five years is giving Rs 15,000. The portfolio still generates a return of 4.17 percent. So, the idea is if one invests very conventionally, very conservatively, one cannot even wait inflation. The weighted average return is negative in high inflation scenario.

So, all investors, however risk averse they are go in for asset allocation, get that extra additional returns, which helps beat inflation over a longer period of time. So, for safe investor as well if he does an asset allocation of 70:30 portfolio with five year horizon, one can get his capital protected.

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