Investors seek higher returns. Asset allocation and alternatives must be part of your portfolio to achieve this. The promise of asset allocation is to achieve steady wealth growth with minimum variability.
Asset allocation has two key ingredients. Volatility management and estimating returns. Let’s explore both.
Volatility/Risk Management
First of all, investors can tackle the sharp volatility in their portfolio with an offsetting asset class. Simply put, low risk and complementary investments are mixed with high-risk investments to stabilise a portfolio.
This is largely been used by pension funds, insurance companies, and retirement planners to deliver income to match future liability. The key goal here is to meet the cash outgo needed to pay known liabilities with minimum variability.
But does this sound like you? Are you dependent on your portfolio to meet your cash flows? Not unless you are retired perhaps. Even then you might have pension income. Hence, the personal portfolio can be quite different from a traditional asset allocation.
However, there is also an alternate method to reduce volatility. Did you know volatility reduces also with time? For example, for NIFTY500, the volatility of daily returns in the last 1 year is 75 percent more than over 10 years, and 16 percent more over 3 years.
As compared to equity, for bonds this is relatively unchanged over the same period. Asset allocation between equity and bonds averages out the volatility.
Alternatively, time allocation towards equity also reduces volatility. Hence, in your asset allocation decision, time is a very important factor, and time erodes risk. It implies the future is more certain than the present. Surprising, isn’t it?
Expected Returns
The second ingredient for asset allocation is an estimation of returns for the underlying investment. For equity, a simple yet effective method is to use the ratio of long-term PE and current PE scaled by expected EPS growth adjusted for dividend yield.
Similarly, for bonds, we need to use the expected interest rate and hence implied bond yields. Real estate and commodities are mostly driven by the supply-demand of economics and currency pegs used to price them.
Eventually, a personalized asset allocation needs to factor in your age, income levels and continuity, ability to understand the complexity, and life longevity.
Age drives your expected near-term goals. For example, long after you retire, you might be saving for inheritance and not necessarily consumption.
Hence, personal asset allocation is a flexible regime while institutional asset allocation is rigid given fixed goals. Often this rigidity has been imposed on personal wealth leading to slower wealth growth.
The good news is that it is easy to fix with suitable asset allocation. You can unlock your capital from traditional thinking to more modern methods of asset allocation. We encourage you to discover the true potential of your wealth.
How to position for 2021
As a generic allocation advise, we are overweight small-caps and government bonds. Smallcaps have underperformed large caps for the longest time in history recently.
Also, a SEBI circular applicable for multi-cap funds might result in an additional purchase of about Rs 40,000 crores in small-caps.
Moreover, the Indian response to COVID-19 so far has been through monetary economics. Fiscal incentives are expected which might drive smaller companies better.
The government is focused on reducing its cost of capital for domestic economic growth. This can lead to interest rates anchored lower for longer and can produce a capital appreciation for constant maturity funds that have locked in a higher yield from previous tranches of GOI bonds.
Capital appreciation seen in large caps may feed into rebalances towards other asset classes. This can make large caps less attractive in the shorter term.
Gold can be positioned in government bonds if using sovereign gold bonds or commodities if you are using physical or gold EFTs. The real estate which is your primary residence cannot be part of your asset allocation.
In fact, net worth calculations explicitly require primary residence to be excluded. If you are investing in real estate you can use portions of P2P Loans, Corporate Loans, Private Equity, REITS in large caps, etc to acquire real estate exposure.
As 2021 is expected to be volatile due to sudden changes in consumption of oil, travel, export/import led currency moves, trade barriers, Brexit post-deal mechanics etc, International exposure, liquid alternatives are an essential ingredient. Lotusdew Biotech Pathfinders and Lotusdew American Ambition strategies can help you with such allocations.
As generic allocations, we advise you to consider additional allocation towards small-caps both domestic and global. Also, balance it with additional allocation towards government bonds.
In future articles, we will explore in-depth each of these asset classes and analyse it from the perspective of both retail and HNI investors.
(Abhishek Banerjee is the CEO of Lotusdew)
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
Find the best of Al News in one place, specially curated for you every weekend.
Stay on top of the latest tech trends and biggest startup news.
