The strategy of asset allocation is recommended to ensure a portfolio does not get too affected by gyrations in a single asset class.

In a recent panel discussion on the ‘Art of Asset Allocation’, a part of the investor education and awareness initiative of Aditya Birla Sun Life Mutual Funds in association with Outlook Money, experts highlighted the role and importance of this strategy.

The panellists for the discussion were K.S. Rao, head of investor education and distribution development at Aditya Birla Sun Life Asset Management Company; Amit Trivedi, an author, speaker, blogger and trainer; and Vinod Bhat, portfolio manager and equity strategist at Aditya Birla Sun Life AMC.

Here are some edited excerpts from the discussion.

What Is Asset Allocation?

Simply put, asset allocation is about dividing your money to be able to invest in different asset classes. “The goal is to reduce risk and enhance or optimise the return. Why do we do this? We do this because different investment categories behave differently in different market cycles. By combining the assets, you would be minimising the risk and optimising the returns,” says Rao.

He further explains it through an example. If you want to bake a perfect cake, you will need a set of ingredients and will have to mix them in the right proportion. Similarly, you need to get the combination of products right to build the right portfolio which suits your needs. And that’s what asset allocation is about.

Ideally, one should not wait for the right time to get into asset allocation. It requires discipline and long-term commitment. “You do it right from the word go. If you didn’t do it yesterday, do it today but start now. Don’t wait for the markets to turn nasty. While you can’t control market volatility, you can control your portfolio somewhat. Like it’s said, you can’t direct the wind, but you can adjust the sails,” says Trivedi.

Typically, asset allocation is down through two strategies—quantitative and qualitative. Quantitative uses a set model, while qualitative uses analysis of the market conditions, says Bhat. One could also use a mix of the two strategies.

Can MFs Help Allocate?

Mutual funds can help you invest in all asset classes, from equity to debt to gold. They also provide dynamic or balanced advantage funds that invest in multiple assets depending on the level of the market. This class of funds enables investors to invest in all asset classes without having to track which segment is doing well and which asset needs to be fed more in a particular market cycle.

“Investors can just look at some solution-oriented products like the asset allocation fund or funds that automatically diversify into different assets. We provide exposure to four different asset classes like domestic equity, international equity, fixed income and gold. There’s a dedicated portfolio manager who essentially tracks the market and decides which mutual funds or exchange-traded funds (ETFs) to select in each asset class. They also figure out when to rebalance the portfolio,” says Bhat.

So if equity market have corrected, they will invest more in equity to benefit from the low levels in the long term. Similarly, if the equity markets have rallied too much, they reduce allocation to the asset, and so on.

“The portfolio diversification ensures that you get stable and risk-adjusted returns,” says Bhat.

Another advantage they provide is taxability. “When investors make any changes in their portfolio, they have to pay either pay short- or long-term capital gains taxes. Whereas when this kind of changes are made in a fund, there are no tax implications for the investor,” says Bhat.

These funds are suitable for first-time investors who don’t understand the nuances of the market too well to be able to make informed decisions on their own. They are also suitable for those who do not like too much volatility in the portfolios, he adds.

Factors To Look At

Each individual’s asset allocation needs may be different according to his or her circumstances. “One has to keep three T’s in mind. The first is the time frame of investments. Second is the tolerance to risk and third is tolerance to declines in an asset,” say Rao.

Aligning your asset allocation with your goals can simplify the whole process. It’s like different people in the same family may prefer their tea differently—some may like milk tea or some prefer green tea, adds Trivedi. “It is all about preferences but when it comes to the portfolio construction it is all about one’s objectives,” he says.

Patience, perseverance and lessons from previous experiences can go a long way in helping people follow an asset allocation strategy, says Rao.