The importance of allocation of investments to multiple asset categories such as equity, debt and others continue to be discussed, but it tends to get missed out in implementation. A case in point, over the last one year, the two asset classes that have given highest returns are international equity and gold.
Returns have been 48% from gold over last one year, including the rupee depreciation. U.S. equities, over the last one year, have given 20% returns. Investors have been underallocated to these two assets. Overall allocation in the Mutual Fund industry i.e. assets under management may be taken as an indicator. What we see is in the industry AUM of ₹25.5 lakh crore as on June 2020, the AUM of Gold ETFs is ₹10.4 thousand crore and that of feeder funds investing overseas is ₹3.8 thousand crore. That is, exposure to Gold ETFs and overseas funds, the ones that have run up this year, at ₹14.2 thousand crore is about 0.5% of the overall AUM. This is not an absolute indicator as there are other avenues for investment than Mutual Funds, but this gives us a perspective. The point is not to predict how much return would come from one asset class, but to follow a discipline in allocation of funds.
Why is allocation important?
It has been proven by empirical research that more than 90% of volatility is explained by asset allocation and not chasing one asset class such as equity or debt. The importance of allocation was highlighted in 1986 when three researchers called Brinson, Hood, and Beebower (acronym BHB) explained the impact. Research by BHB found that asset allocation is the primary factor for a portfolio’s return variability, as much as 93.6%. Active portfolio management i.e. security selection and market timing are minor factors.
What is the best way to follow this principle of allocation?
Investors can define the allocation i.e. percentage to equity, debt, international equity and gold and invest accordingly.
We can understand this concept from a simple perspective that there is wide fluctuation in returns every year in various asset categories such as domestic equity, international equity, gold, and to a lesser extent in debt. In certain years, equity gives phenomenal returns and in other years it is negative. Same is the case with gold.
The only way to smoothen out the impact of the volatility in these various investments is to allocate, and still earn optimum returns, as shown by the research mentioned above. Your returns will be optimum over a long holding of period as the asset classes will perform as per market movement and the volatility also would be lower.
How would you do the allocation?
While direct investment in assets such as equity, bonds or gold is possible, it is advisable to invest via mutual funds as there is a team of experts (fund managers) and other professionals working for you. Within mutual funds, there are various categories of funds like equity, debt, hybrid (mix of equity and debt), etc. and you can invest in those.
The other way to execute multi-asset investments in MFs is to invest in one fund that offers all asset classes i.e. equity, debt, commodities, etc. If you do the allocation through one fund, then the AMC is doing the allocation as per the mandate of the scheme and you are holding units in it. Examples follow:
ICICI Prudential Multi-Asset Fund has a corpus size of more than ₹10,000 crore. The first version of this fund was floated in 2002 and repositioned as a Multi-Asset Fund in 2018 when SEBI norms for fund categorisation took effect. Tata Multi Asset Opportunities Fund was launched in March 2020. The corpus size is a little under ₹400 crore.
Axis Triple Advantage Fund, with a corpus size of ₹350 crore, is an older fund, launched in 2010. Most do not have a fixed allocation of international equity and more importantly, allocation is decided by the AMC within the defined range, with higher weightage to domestic equity and some allocation to gold.
There is a new fund offer (NFO) coming in August, Nippon India Multi Asset Fund. The mandate of this fund is to invest 50% in domestic equity, 20% in overseas equity (i.e. in U.S., Europe, etc.), commodities 15% (including 10% in gold) and 15% in debt. This will give exposure to the multiple assets in one fund, in a disciplined manner.
What is the mode of investment of these funds?
Exposure to equity and debt is obvious and is similar to other funds. Investment in gold happens via gold ETFs of the same AMC. In May 2019, SEBI issued a circular allowing Mutual Funds to participate in Exchange Traded Commodity Derivatives (ETCDs). Hence if the Scheme Information Document (SID) allows, apart from gold, the fund can invest in other commodities such as crude oil, silver and the like.
Do consult your financial adviser as to how you could improve asset allocation of your portfolio but please do it; it is a critical wealth creation building block. Returns will be the weighted average of the performance of the assets invested in. In the short term, fund performance can be volatile, as per movement of the underlying asset classes.
In the long run, you will get optimum returns i.e. comparable to the best-performing asset. As an example, over 10 years, if equity gives X% returns, higher than debt or gold, a multi-asset fund would give somewhere around X%, but with lower volatility over these 10 years.
(The writer is founder, wiseinvestor.in)
