How important is it for you to be well diversified across asset classes?
You try to put your money across different asset classes. The fact remains that every asset class has its own merit, has its own behaviour and the performance of each asset class over a period of time can be very cyclical. So, if you are caught in one asset class more often than not, it goes through its ups and downs and when you need money and that day if that was the downside of that asset class here, you might be caught on the wrong side.
So, when you allocate or you invest, there are two sides to your investing. One is the return that you want and the second is the risk you are willing to take. Asset allocation merges both of them and gives a good mix across different types of assets like equity, debt, gold, cash. Some people look at real estate and the proportion with which you allocate it to catch a balanced return on your overall portfolio allocation across asset classes, becomes very important. The key to the mix is what you put or how much you put and where, will depend on your goal and the kind of risk that you are willing to take.
So, rebalancing becomes very important in this process?
You have stressed upon a very important part of investing, that is rebalancing. A rebalance comes post review of the investment portfolio. Suppose, the portfolio is 70-30. Now, first, between you and your planner, you fix up a periodic review time of say one year, two years, three years. That is between you and your planner. Suppose it is one year.
Just for simplicity, 70-30 should be your equity debt portfolio and the markets have run up and your equity has become higher say by 10% or depending on whatever the market is. Suppose it is skewed to becoming 80 and 20. It is very important to review the portfolio and see that your actual allocation is brought back to 70-30. This can be done in two ways, by taking 10% out from your equity and putting it to debt or adding further money in debt to balance it back to 70-30.
Why this is very important is that it maintains your actual asset allocation which is closest to your risk profile. Invariably, when you start investing, you think it is a process of generating returns. Over a period of time, you realise that it is a process of mitigating risk and the portfolio which is closest to your risk profile, gives you the best investment experience. That is what would have happened when you came to the conclusion of 70-30 to begin with.
When the markets would have fallen, suppose it has gone to 60% and your debt allocation has become 40%, it is then important to replenish 10% and bring it back to 70%. Now, over a period of time, when you do it periodically and follow your review with a very unemotional rebalance, you will see that your goal achievement will be superior because you are sticking to your plan. If you do not rebalance post a review, most of the time the process becomes meaningless.
I will give you a very interesting example. Typically, the industry’s hybrid fund is 70-30 and most of them rebalance every year, the power of increase in returns because it rebalances every year unemotionally is pretty substantial. Please never underestimate the power of rebalancing and you must make it mandatory to meet your planner and do the review and rebalance almost unemotionally.
Within the asset allocation strategies, can you explain the difference between active and passive strategies?
It depends on how you approach investing. It is up to the investor. Now, when you look at it at a fund management level, what is perceived to be an active and passive style of investing is very different from the investor looking at it from an active or passive style of investing. When you look at a review and rebalance, that would be an active way of looking at investing and that is the right way of looking at it.
My humble request would be to do it periodically and those times should be reasonable enough for the asset class to play out. If you are going to track your equity portfolio on a monthly basis, it is not going to work out. Every asset allocation has a horizon. We typically say equity is three years or debt is at least a year or so. Now, review to get better returns.
Some people buy and hold, there is nothing wrong with that, but it has the big disadvantage of not rebalancing at times. It all depends on the approach. I would be more favourable to the people who review and rebalance at a specific periodic level that gives a more sustainable process to investing and more scientific approach to approaching the volatility or catching the upside and the downside of the market through a very clinical mathematical approach.
What are some common mistakes that investors make when it comes to their asset allocation strategies?
Swarup Mohanty: Typically in investing, I do not think mistakes is the right term, it is the approach. More often than not, the focus on the outcome is far larger than the process, the ignorance of the risk profile is something which I have also come across, people invariably choose products over the process and that is where the process gets fundamentally flawed.
It is a very simple process, first identify why you want to invest, that is to fix your goal. That is how you give investing a tangible process and because of this goal, everything starts working backwards. If you do not know why you want to invest, it is impossible to know where you will invest. But typically, the focus goes more on where to invest.
Which is your best product is a question which I am often asked. Do you need that product? Is that product suitable for you? Do you already have products which are similar to that in your portfolio? That question invariably is meaningless. What you should ask yourself is why do you want to invest and hence this is my return expectation based on that return expectation; this is the kind of risk I can take and hence I can invest in a certain type of asset classes.
Now you continue doing that on your journey. Nine out of ten, the journey is discussed first, before the process starts, while if the reverse is done, the investment experience can become pretty predictable.
