Even for seasoned investors, market volatility may be a frightening and stressful experience. Despite the fact that there is no foolproof method to foresee and guard against such market volatility, investors can try to reduce the impact such swings can have on their portfolio. This can be accomplished by following asset allocation. Asset allocation is the process of diversifying an investing portfolio among several asset classes, such as gold, debt, equity to name a few.
Understanding asset allocation
The fact that not all asset classes react to market pressures in the same way, at the same time is what makes asset allocation effective. Different assets operate in different ways. For instance: In general, the equity market does well in expansionary phase, which are characterised by low interest rates, an increase in money supply, and rising demand. On the other hand, debt typically does well during contraction phase, as seen by increased interest rates, declining money supply, and a reduction in demand. So, if the investment in one asset class is underperforming, the presence of other asset classes тАУ which may be performing better тАУ will aid in cushioning the portfolio.
Challenges an investor faces
Asset allocation, however, is not a simple task. Asset allocation necessitates not only regular portfolio reviews but also regular rebalancing across asset classes to prevent the portfolio’s bias towards one particular asset class from undermining its entire objective. For instance, during the bull market, the exposure to equities may have increased. As a result, some pruning is required. Another challenge comes in the form of knowing when to enter and exit an asset class. The task is further complicated by the need to ensure that each rebalancing choice is made in a tax-efficient manner. So, in actuality, exercising asset allocation is a difficult endeavour.
Options available
Investors should be conscious of the allocation decisions they are making because asset allocation is the foundation of wealth creation. A better course of action is to seek the advice of a financial advisor if one is unsure on how to proceed. The other alternate option is to invest in asset allocation based mutual funds, where the fund manager will make the necessary allocation across various asset classes on the investor’s behalf. For an investor, one of the easiest ways to allocate to all of these asset classes is through a multi-asset fund. It is preferable given that we are approaching a period characterised by high inflation, high interest rates, poor liquidity, higher volatility, and geopolitical concerns.
Investors today can choose between an actively or a passively managed multi-asset fund. A multi-asset fund, as the name suggests, allows investors access to many asset classes through a single fund. Investors looking for low-cost multi-asset can take into account passively managed multi-asset funds. Such an offering will use corresponding asset class index funds or ETFs to provide the required exposure.
Domestic equities here will contribute to capital appreciation, while debt will help produce steady returns. Gold can potentially serve as a hedge against inflation, while investing in global equities will allow you to diversify geographically and participate in major trends. Such an approach will ensure that the investment strategy is both tax and cost efficient while providing an investor with a sufficient variety of assets within each asset class. Such an offering can also be considered by investors looking for lump-sum investment options.
To conclude, volatility is a given when investing in an asset class like equity. But through offerings such as the multi-asset, one can meaningfully aim to balance risk and returns based on oneтАЩs risk appetite, investment tenure and financial goals.
(The author of this article is Head Investment Strategy at ICICI Prudential AMC)
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