ET Wealth | Asset allocation for lazy investors

A diversified portfolio is the best protection against the swinging fortunes of different asset classes over time. For instance, gold has given stellar returns of 21.24% in 2019, and 31.27% so far in 2020. Due to falling interest rates, debt too has done reasonably well and generated 11.18% and 8.73% returns respectively during the same period. However, equity has generated a mediocre 7.39% in 2019 and marked a loss of 10.55% in 2020 year-to-date. So how do you make portfolio allocation work for you?Most investors dream about moving smartly between asset classes to make additional returns. For example, you would have earned very high returns if you had shifted out of equity to gold two years ago. You could have done it by either relying on your own expertise or that of a reliable financial adviser with required expertise in all asset classes. However, finding a reliable adviser who is not a product pusher, who has expertise in all asset classes and is not expensive is easier said than done. Therefore, shifting between asset classes is also not easy. Most investors end up doing just the opposite. “Different asset classes will generate high returns at different periods of time. Instead of buying undervalued assets, most investors chase historical returns and get in at the wrong time,” says Jitendra P.S. Solanki, a Sebi-registered investment adviser (RIA).Permanent portfolios stay steady even in times of volatilityDespite wild swings in returns of equity, gold, etc over past year, returns of permanent portfolios have been stable.78460159Since different asset classes outperform at different times, a fixed asset allocation will earn you average returns. This is clear from the first chart. While returns of equity, gold, debt and cash show wild variations, the returns of two diversified portfolios marked PP1 and PP2 are reasonably stable. Permanent portfolio 1 (PP1) is a portfolio comprising 25% each in all major asset classes, while permanent portfolio 2 (PP2) comprises 40% in equity and 20% each in other asset classes. PP1 generated a loss of only 0.24% in 2008, when the equity market was down by 47.84%. However, it generated a return of only 22.63% in 2009, when the equity market zoomed by 96.83%. This shows fixed asset allocation strategy will not generate the best returns, but will reduce risk and save heartburns.How much in each class?Asset allocation is the process of deciding how much of your portfolio should be invested in each asset class. Investment advisers take several factors into consideration while deciding necessary asset allocation and the most important among them are age and time period to goals.The age-based asset allocation rule states that young people have higher risk taking ability and therefore, should allocate higher portion to risky assets like equities. The ‘100 minus age’ thumb rule is most commonly adopted. According to the rule, investors who are 30 should invest 70% of their corpus in equity. On the other hand, those who are 60 should invest only 40% in equity. However, experts say that investors should also consider other conditions, like years to retirement, etc. “Younger people or working professionals with reasonable income may prefer to follow 100 minus age as a guiding principle, whereas older working professionals at the time of retirement may adopt a more conservative approach of life expectancy minus age,” says Unmesh Kulkarni, MD & Senior Advisor, Julius Baer India. If we assume a life expectancy of 80 years, equity allocation for a 50-year-old under this rule will come down from 50% to 30%.In time period to goal rule, equity allocation is higher for long-term goals and low for short duration goals. “If the investor is young and goal period is more than 20 years, I prefer an equity heavy portfolio, say around 70%, for that goal,” says Kaustubh Belapurkar, Director- Fund Research, Morningstar India. The equity portion here is decided for each goal and the overall equity portion will be based on the type of goals one has – higher if most goals are long-term ones and lower if most goals are short or medium-term ones.Why 25% in each asset class?What if you do not have access to an investment adviser and are too lazy to actively track your portfolio? Creating a simple diversified portfolio, including all major asset classes in equal proportion, is the best solution. The permanent portfolio concept was introduced by investment analyst Harry Browne in his book Fail Safe Investing. He says a fixed portfolio guards investors against mood swings and the resultant wrong investment timings. Since this can be easily executed, the strategy saves time, effort and money that would have otherwise gone to the adviser.The concept of a permanent portfolio is also good economic logic. For instance, your 25% equity exposure will generate good returns when the economy is doing well. Demand for funds fall during recession and this will force the interest rate structure to slide. Central bankers also keep interest rates low during recessionary times to get the economy back on track. Since interest rates and bond prices are inversely correlated, the 25% debt portion will generate good returns in the form of capital gains when rates are falling. High returns generated by debt during 2019 and 2020 is a good example for this.The 25% investment in gold will protect you against inflation and currency depreciation— critical for Indian investors. Gold also goes up during uncertain times and the current gold rally is an example. You may ask why you should invest 25% in liquid funds that would generate around 4-5% returns. In addition to bringing stability to the portfolio, the 25% cash or overnight debt portion will gain when money is tight and short-term rates are up. For instance, the cash portion has generated 9% plus returns during four calendar years— 2008, 2012, 2013 and 2014—in the past 15 years.The 40:20:20:20 variantSince India is an emerging market with more growth opportunities, there is a view that one needs to have a higher equity component in one’s portfolio. So, we have tested another version of a permanent portfolio —40% in equity and 20% each in long duration debt, 20% in cash or overnight debt and 20% in gold. This version has generated almost similar returns to that of the 25% each version. Experts say a fixed asset allocation is more important than the exact portion of each asset classes in it. In other words, investors should not postpone their asset allocation decision just because they don’t know how much each component should be or they can’t afford professional advice. “Asset allocation rules like 25:25:25:25 or 40:20:20:20 will be ideal choice for small investors who can’t afford professional advice,” says Solanki.How to execute this strategyOnce you decide on a fixed asset allocation, it can be executed in different ways. The first option is to invest in lump sum. This will be useful for HNIs and retail investors who are retired or close to retirement or people who have money to invest at one go. Compared to the components of equity and gold, which were very volatile, both permanent portfolios have generated smooth growth during the past 15 and 10 year holding periods. Values given in the Cumulative Returns Charts are based on the assumption that the investor has not done any rebalancing. However, experts say that investors can increase their returns by doing this at least once in a year. For instance, an investment of Rs 100 in PP1 would have gone up to Rs 505.04 in 15 years if rebalanced annually, instead of Rs 456.37 without rebalancing. Similarly, the value would have grown to Rs 233.62 at the end of 10 years if rebalanced annually, instead of Rs 221.01 without rebalancing.78460256Starting and ending values play a big role in historical analysis like this and therefore, we have repeated the same on a five-year rolling basis —measuring performance assuming you have invested in different time periods and exited after five years. So we find the five-year holding period returns for equities have been negative of late. Similarly, the five-year holding period returns for gold went below zero in 2017 and 2018. The permanent portfolios, on the other hand, generated less volatile five-year rolling returns. This reduction of volatility and lower losses in market downturns are thus the main advantages here.Stability of perma portfolios in 5-yr rolling returnsSome asset classes show high volatility and negative returns even after 5 years.78460288The second option is to start monthly systematic investment plans (SIPs) in different schemes from different asset classes based on your ratios (25:25:25:25 or 40:20:20:20) and stay remain invested till you reach your goals. Here again, the performance for different holding periods are calculated on the assumption that there is no rebalancing. Permanent portfolios have generated decent returns over 15 years and 10 years through SIP investments. We have repeated the rolling return analysis for the SIP strategy as well. Even in five-year SIPs, equity and gold have generated negative returns in between (see chart). Compared to volatile five-year SIP returns for equities and gold, permanent portfolios have generated much smoother returns.Permanent portfolios have generated smooth returns on SIPs tooOther asset classes like gold and equity have displayed high volatility over the same periods7846033978460346Perma portfolios ace 5-year rolling SIP returnsEven five-year SIPs could not remove volatility from some asset classes.78460367The third option is to use multi assets funds. Lower volatility is the main attraction of multi asset funds and these offer better risk adjusted returns. Most of the present multi asset funds are reclassified ones. There are only a few original multi asset funds, which started as multi asset funds and have a long term history. Axis Triple Advantage is one of them. While Axis Triple Advantage has generated a 10 year CAGR of 7.92%, UTI Nifty Index Fund has made 7.48%. However, standard deviation of Axis Triple Advantage is only 15.65, while the standard deviation of UTI Nifty Index Fund is 21.22.Low volatility is the main attraction of multi asset fundsThese funds are useful for small investors as it helps them to diversify and avoid managing several funds.78460392Investors should check whether multi asset funds suit them or not before getting in. First check whether your portfolio diversification needs will be met by investing through these. The gold portion of most multi asset funds are in the 10%-20% range. That won’t suffice if you are holding this multi asset fund as one the schemes in your portfolio. “The purpose of diversification can be achieved better if you invest in separate asset classes yourself. For example, if you invest 20% of your portfolio in a scheme with 20% gold allocation, your effective gold allocation will be just 4%,” says Vidya Bala, Co-Founder, Primeinvestor. in. Debt-like taxation is another issue with these funds. While some funds maintain equity above 65% to get equity tax benefit, the same increases its risk profile.Experts say multi asset funds are useful for some class of investors. “It makes sense for small investors to keep an SIP of Rs 2,000 in one multi asset fund and not split into several schemes of equity, debt, gold, etc,” says Solanki. This one scheme helps them to diversify and avoid the headache of managing several funds and also the shift between them at regular intervals. Multi asset funds are also useful for investors who look at performance of each investment separately and not the portfolio as a whole. “Multi asset funds helps to manage behaviour issues of some investors as volatility of each component will be visible in the first case and not in the second case,” says Belapurkar. For example, investors who have the tendency of chasing historical returns would have got out of gold five years back (because its five-year return was negative) and would have loaded gold now (because its five-year return is high).METHODOLOGYWe have back tested efficacy of both permanent portfolios (25:25:25:25 and 40:20:20:20) simulating actual investment scenarios. Instead of selecting benchmark index and assuming that its return is the actual return for investors, we have shortlisted schemes that have completed 15 years and selected three MF schemes with highest AUM for the first three asset classes. The schemes selected for equity are Aditya Birla SunLife Frontline Equity, HDFC Equity and HDFC Top 100. The combined returns generated by these schemes were assumed to be the equity returns for this period. Similarly, the schemes for debt are Aditya Birla SunLife Corp Bond, L&T Triple Ace Bond and Sundaram Corp Bond and the schemes for cash are Aditya Birla SunLife Liquid, HDFC Liquid and Kotak Liquid. For gold, we have taken the actual gold price in Mumbai as the proxy.

from Economic Times https://ift.tt/36yNeCI