Moneycontrol
you are here: HomeNewsBusiness
Mar 08, 2018 03:32 PM IST | Source: Moneycontrol.com

Asset Allocation is key: Here’s how to make your portfolio shock proof in 2018

“Asset Allocation is the most important thing when we talk of Wealth Management”. Most of the market participants would agree with this statement. However, the irony is that almost all of them give little or no attention to the actual asset allocation.


By Shantanu Awasthi

“Asset Allocation is the most important thing when we talk of Wealth Management”. Most of the market participants would agree with this statement. However, the irony is that almost all of them give little or no attention to the actual asset allocation.

They get lost in single stock, sector, sub-asset class or product details in order to generate alpha through timing or looking for multibagger opportunity.

This might give one a sense of achievement if they get the story right but has a negligible impact on the overall portfolio. One might argue that the strategy has worked for him or her but an important question is can they keep getting it right all the time and the cost of such a mistake could be very high.

However, the most important question is how to get your asset allocation right. To answer that, one must begin by understanding one’s personal risk profile.

There are two parts to this:

Risk profiling is based on demographics like age (higher risk-taking ability exists at a young age); clearly drafted financial goals (goals expressed in monetary terms and achievable within a specific time period), personal expenses, number of dependents, stability and predictability of income and profession.

Personal risk tolerance ability – this would differ for each individual and emanate from personal choices and preferences.

Most Wealth outfits would have a questionnaire or process which will help you assess your Risk profile or risk-taking ability. Further, depending on your profile being Conservative, Moderate or Aggressive one can decide the Strategic asset allocation.

Strategic asset allocation is static in nature; however, changes in various factors like macroeconomic environment, interest rates and market dynamics lead to the need for tactical asset allocation.

The asset class movements are generally not incoherence, i.e. the asset class which is outperforming today may be out of flavour in the near future.

Negative correlation among asset returns forms the base for asset allocation, and proper asset mix results in higher returns with lowest possible risk (volatility); it also protects the portfolio from downside when huge fall is observed from a single asset class. So in simple words “Do not put all your eggs in one basket”.

The most commonly used model for asset allocation is based on mean-variance optimisation and mean reversion concept (i.e. over long time prices and returns eventually move back to the long-term average), which takes inputs of risk, return scenarios for optimal asset allocation.

At Karvy Private Wealth the Strategic Asset Allocation for Conservative, Moderate and Aggressive is depicted in graphs below:

untitled

Karvy Private Wealth proprietary tactical asset allocation model is highly efficient to capture the change in market dynamics, based on a predictive algorithm which helps to generate an alpha of 7 percent-10 percent on the overall portfolio vis a vis strategic asset allocation.

Alternatively, we use a simple yet distinguished model based namely on three parameters namely,

Liquidity:

One needs to assess liquidity requirements in the short term. These could be two types transaction oriented and precautionary. The transaction will mean any foreseeable expenses within one year could be regular expenses or other financial goals. Precautionary would refer to any amount one would like to set aside for any unforeseeable expenses in near future.

Protection:

This is the amount required to protect oneself against any exigency due to medical requirements, death, and disability or any other risk which can be covered by paying a premium to insure oneself.

Growth:

This is the category into which one can allocate the balance funds once the liquidity and protection are taken care of. The objective is to allocate funds that can generate post-tax returns which are higher than inflation and help you grow the corpus for all your future needs and requirements.

We can further classify/ group various asset classes into each of these categories –

Liquidity – Fixed Deposits, Liquid Funds, Ultra Short Term Funds, Short Term Funds.

Protection – Debt Mutual funds, MIP, Debt PMS, Insurance (Health Insurance, Term Insurance, Critical Illness cover, Disability riders and Home, Business and other general insurance)

Growth – Equity ( Mutual Funds, direct stocks, Equity PMS), Balanced funds, Real Estate other than primary residence, Private

Equity, AIF – Category 1,2 and 3, ETF, International investments through LRS, Feeder Funds and Listed ETF’s.

From the Indian perspective, we have seen equity as an asset class (~16.2 percent CAGR return over 15 years) outperform others in the long run (the probability of double-digit positive return increases with the increase in time).

Fixed Income (~7.5 percent CAGR) provides alternatives to investors in the form of capital protection and regular Income. Aggressive investing may take an exposure to high duration funds while moderate investors may do well with Accrual Funds (Yield outlook may change exposures for any debt market products).

Real Estate provides a yield of around 12.5 percent CAGR in the long run, while the commercial rental yield of 7-8 percent provides an attractive investment opportunity. Gold, popularly known as an inflation hedge and a safe haven asset, complements a well-structured portfolio.

To summarise, asset allocation is the foundation for every investment decisions. Lack of proper asset allocations results in taking unnecessary risk and often results in lower return.

Asset allocation is a dynamic concept which changes with a change in investment goals, market dynamics, age, and risk-taking abilities.

Disclaimer: The author is Head – Family Office, Products and International Business, Karvy Private Wealth. The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Sections
Follow us on
Available On