Managing Portfolio: Gain from tactical allocation when markets consolidate

A portfolio is diversified into asset classes and sub-asset classes the capacity of the portfolio may be adversely affected to a certain extent as tail-end investments never add much to portfolio performance.

Asset allocation is something that is closely linked to the risk profile of each investor. The fundamental orientation of this allocation, either to fixed income, equity, or even to other alternates, does not undergo any drastic changes at any point in time in the normal course. This is due to the fact that the investor’s capacity to invest, the awareness of financial markets and products, and psychological disposition towards risk, do not undergo drastic changes, once they are measured using a risk profiler and the same has revealed the suitable allocation.

There is always a thinking at least among some advisors, that a portfolio allocation should be made to all asset classes and sub-asset classes. But this is not the correct approach. In some cases, the allocation may be entirely into fixed income, and in others, it may be only equities. There are investors who have their exposure only to private equity or mezzanine debt. The more a portfolio is diversified into asset classes and sub-asset classes the capacity of the portfolio may be adversely affected to a certain extent as tail-end investments never add much to portfolio performance. Also, over-diversification may, in fact, enhance the level of risk.

Striking A Balance

One of the approaches to this subject is to split the portfolio into a core and a non-core portfolio. The core may be either 10 percent or 20 percent of the portfolio, which may be deployed in long-term assets, some of them may have a lock-in too. This approach is generally seen in corporate entities, which may need to allocate cash in such a way that they stay ready for a dividend payment or an acquisition. In the case of individuals also, this approach is prominent where some family event is coming up and the allocation needs to be made appropriately.

There is always a consideration for liquidity that is a part of all allocation strategies. This aspect is forgotten quite often in the hurry to invest in the markets. But this aspect required careful consideration, as any deficiency in this aspect of allocation can weaken the investment portfolio and its basic premises. Apart from this, there is also a possibility of the allocation being divided into two parts, a major part is strategic allocation and a smaller part will be what is called tactical allocation. In the former, the allocations will have a longer-term orientation, whereas in the latter, what is important is the short-term opportunities that the markets hold forth for investors. The tactical allocations will have the time element as an important component of action because -- since it is a relatively short-term call -- timely action will alone bring in optimum results.

Recently, there have been a lot of discussions on increasing allocations to the fixed income space. This was not restricted to the domestic market but much more discussion have been happening in the international markets. This, in effect, amounted to enhancing the allocation in the portfolios to fixed income for the immediate future. This thought emerged based on two or three factors. The first factor is that in the last one year or more equities have not provided any significant returns as such. In fact, it has been negative or marginally positive. The second factor is that moving into fixed income would boost the current income through coupon receipts, and it is a better option than getting nothing at all. Third, central bank policies have pushed up market yields, and therefore, any entry into fixed income at this juncture would carry much less price risk compared to any time in the recent past. This idea is good from a portfolio positioning perspective.

Timing The Exit

A tactical allocation into debt is worthwhile considering a portfolio that is otherwise predominantly equity based. But to be specific, these allocations should be made to the very short end of the curve, where the rates are at their highest levels, due to yield curve inversion, which is a passing phase. But a timely exit is more important here because the moment central bank policies start moderating, equities will also gradually consolidate and prepare for the up-move. This inflection point should be seized without much loss of time.

Yet another idea on predominantly fixed income portfolios is to switch from the long end to the short end. There is a pickup in yield and a reduction in maturity, both of which are good for the portfolio. The long end may come under some pressure with almost 70 percent of the government's borrowing concentrated at the long end of the curve. Once there is some northward movement at the long end, and as policy rates are on hold, there is immense sense in switching back to the long end of the curve.

Joseph Thomas is Head of Research, Emkay Wealth Management. Views are personal, and do not represent the stand of his publication.