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How to do Asset Allocation the Right Way | Best Mutual Fund Asset Allocation Strategies | ETMONEY - YouTube
Channel: ET Money
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chemical elements in isolation can be
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very volatile
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like sodium like chloride but when the
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same elements come together they form
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something spectacularly useful
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in this case being table salt an
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investment portfolio is no different
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from a chemical compound
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when we invest in fixed deposits mutual
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funds stocks etc
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the underlying element of our investment
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portfolio
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are the multiple asset classes where the
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money gets invested in
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these asset classes range from bonds to
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equities to gold
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commodities real estate cash futures
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and even bitcoin and derivatives hi
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everyone
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my name is shankarnath and in this video
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we expand our understanding
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of one of the most important aspects of
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investing
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that's asset allocation in the next 15
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minutes
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we see what asset allocation really
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means before detailing
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three different asset allocation
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strategies that you can deploy
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on your investment portfolio starting
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today
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a lot like our previous videos this too
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will have a lot of data
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and insights so do take your time to
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assimilate
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as much as possible and feel free to
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post your comments in the comments box
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below
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hindi subtitles let's begin
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[Music]
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diversifying one's portfolio across
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multiple assets is an accepted practice
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as it helps spread out the risk in one's
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portfolio
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financial planners love this concept and
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if you have been doing some reading up
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on mutual funds or personal finance
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it's probable that you might have seen a
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table like this
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this colorful table here represents the
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changing nature
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of asset performance over the years for
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instance
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in 2016 debt performed the best
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amongst all asset classes in 2017
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it was domestic equities cash in 2018
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international equities in 2019 and gold
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in 2020.
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five different years five different top
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performing assets
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it's not uncommon to see financial
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advisors
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display this very image that comes with
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its own tagline and warning that reads
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don't put all your eggs in one basket
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but asset allocation is a lot more than
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this
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so let's start our understanding with
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the definition itself
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simply put asset allocation is the
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process
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of investing across diversified asset
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classes
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there are two words one needs to focus
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on here a
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it's a process and b the assets are
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diversified
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let's start with the process asset
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allocation is a process
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because it is constantly looking to
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balance the risk
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and return in an investor's portfolio
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the purpose here
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being to achieve a better risk adjusted
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return for the portfolio
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let's understand this with a simple
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b-school 101 graph
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so on the x-axis we plot the risk and on
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the y-axis we have the returns
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now traditionally return and risk are
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positively correlated and by that
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logic we can plot multiple points
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anywhere on the graph
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let's plot two reference points one
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where we receive a low return for taking
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low risk so a low
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low and another one where higher returns
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are a product of taking higher risk
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so a high high point now the purpose of
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asset allocation should be to achieve a
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better return risk equation
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for the investor this graphically means
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that the objective here should be to set
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up your
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investment portfolio in such a way
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that either you achieve higher returns
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at the same risk
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or you achieve the same level of returns
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but at a lower risk
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in other words you move from a high high
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to a high medium
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or move from a low low to a medium low
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both these movements represent an
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improvement in your risk adjusted
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portfolio return
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which is the true goal of doing asset
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allocation
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the second point in our definition of
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asset allocation
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is investing in diversified asset
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classes
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with diversified being the operator word
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diversified in the context of
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asset allocation means assets which are
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not correlated
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in terms of their performance let me
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explain this with a couple of examples
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the table here shows that over the last
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two decades
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the performance of equities and gold
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have been rather tangential
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over different time periods this quite
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clearly shows
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that equities and gold have a weak
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correlation
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and hence constitute two diversified
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asset classes
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which is good for developing an asset
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allocation strategy
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the second example we have here features
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the nifty 50
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and the nifty mid cap 150 index
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observe here that the performance of the
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nifty 50 and mid cap 150
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is pretty tightly correlated over long
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periods of time
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in this case we have taken the last 15
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years of performance data
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this means having a portfolio that
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consists of only
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nifty 50 and mid cap 150
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does not really serve our asset
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allocation purpose
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although it might have other advantages
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in fact
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let's draw the performance of gold on
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top of the same graph
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do notice the divergence in the
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performance of gold
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versus the two equity indices in many
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years
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to sum up what we have learnt here so
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far always remember
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two points one asset allocation is
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effective
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only when you do it as a process which
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improves your risk reward equation
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and second it works most efficiently
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when the assets have a weak correlation
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in the next section we look at different
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asset allocation strategies that are
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available to you
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but before we move on to that don't
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forget to allocate
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yet another asset which is available to
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you and that asset
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is none other than you subscribing to
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the eti money youtube channel
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where we host videos on investing mutual
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funds
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nps insurance and many other topics that
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will help you make some money
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or help you save some money
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[Music]
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asset allocation strategies are of two
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types
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strategic asset allocation and tactical
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asset allocation
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strategic asset allocation refers to
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techniques
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that are aimed at providing long-term
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focus
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to your investment portfolio there are
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two commonly used approaches here
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the first approach is the age-based
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asset allocation technique
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this is where the investment decision is
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based on the age of the investor
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this approach calculates the proportion
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of recommended equity assets
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in an investor's portfolio as a result
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of deducting the investors age from a
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base value of 100
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for example if you are 35 years old per
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the age-based asset allocation method
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we subtract 35 from 100 and conclude
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that 65 percent of your portfolio should
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be in equities
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while this approach is somewhat of a
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start to asset allocation
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it is clearly not sufficient as this
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approach does not
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factor important variables like your
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investment objective and your risk
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profile
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this brings us to the second approach to
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strategic asset allocation
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which is the risk profile based asset
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allocation method
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this method is certainly an improvement
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over the age-based method
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and uses the investors risk tolerance in
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determining
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how assets need to be divided the way
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this works is very simple
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all investors including you and me can
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be classified
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as a conservative income balanced growth
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or an aggressive investor
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each of these five labels signifies the
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amount of volatility
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that one can take in his or her
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portfolio
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for example a conservative investor is
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risk averse
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and prefers a stable rate of return even
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if it means compromising
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on a little or a lot of returns
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similarly an aggressive investor
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is return centric and understands the
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variable nature of performance
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where investments can rise and fall
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heavily
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over a shorter period of time now once
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the investor
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is classified this asset allocation
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strategy goes on to
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proportion a fixed percentage of the
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asset class
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to each risk profile something like the
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table that you see on your screen now
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very quickly the table here says that
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the suggested long-term asset allocation
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for a conservative investor
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is 15 in domestic equities five percent
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in gold
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and the rest eighty percent in debt
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instruments
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then as the risk profile changes from
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conservative to income
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to balance to growth and then aggressive
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notice that the proportion of equities
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and gold increases
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while the proportion of debt decreases
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if you're wondering where these
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percentages have come from
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i can certainly tell you that we didn't
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calculate any of these
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these percentages are the average of
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three to four different studies we read
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over the internet
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as part of our research towards creating
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this video
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but here's what we did do once we
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compiled
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this table we back tested these
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percentages to
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actual data available with us so there
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are four asset classes here
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domestic equities international equities
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bonds and gold
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now thankfully for the back testing we
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found that all
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assets had some available benchmarks in
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the form of index funds
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so we have the nifty 50 index which
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represents domestic equities
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the nasdaq 100 index for international
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equities
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the snp bse india 10 year sovereign bond
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index for bonds
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and finally for gold we use the listed
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price of gold in india as its benchmark
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again there are dozens of indices to
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choose from but we settled for these
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four
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as the data here was readily available
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and it made sense to use these in our
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study
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now the data for these four indices was
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then
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examined over a decent number of years
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15 years to be precise
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we pulled out the annual returns of each
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index over these years
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and pleasantly noticed that there were
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many years of negative correlation
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between equities and bond and also
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between equities and gold which is good
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and close to what we are looking for
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when it comes to diversification
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the next step for us was most important
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when we populated this
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annual performance data over our five
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risk profiles
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this approach helped us calculate the
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returns
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that a conservative income balanced
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growth
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an aggressive investor should have
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achieved by applying the weightages that
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we had discussed earlier
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okay here we go now we won't go too much
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into the data but do
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notice that as the risk profile moves
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from conservative to aggressive
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the variability in performance increases
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and that's what the risk profile based
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asset allocation is all about
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it's a structured way of ensuring that
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your risk tolerance
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is given the highest consideration when
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deciding on which
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asset one needs to be invested in this
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risk profile based asset allocation is
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certainly an improvement
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over the age-based strategy and can be a
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good methodology to adopt for really
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long-term goals like your retirement
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before we move
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on to tactical asset allocation let's go
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back to the table once again
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where we had the asset allocation for
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the conservative balanced and
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aggressive investors now let's add a
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table that shows the performance of the
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four
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asset classes that is the nifty 50
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nasdaq hundred
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the ten-year bond and gold what's
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interesting to note here
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is that if we had not done asset
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allocation
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and put the entire fate of our portfolio
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on say
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the nifty 50 we would have performed
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somewhere around what a balanced
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investor would have achieved in these 15
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years
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if you connect back with what we had
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said earlier in the video
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the idea behind asset allocation is to
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improve
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one's risk adjusted return and this
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table really proves that
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because the balance investor actually
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ended up generating
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the same returns as the nifty 50
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investor
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but he or she did that by taking a
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significantly lower amount of risk
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this is the essence of asset allocation
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and something one should never forget
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[Music]
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as the name suggests tactical asset
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allocation
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aims to improve your risk adjusted
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returns by taking advantage
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of short-term opportunities without
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losing sight of the long-term direction
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in other words tactical asset allocation
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tries to give
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investors the best of all worlds this
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is done by using active management or
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risk return models
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to increase or decrease exposure to
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certain asset classes
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based on macro fundamentals valuations
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and of course the market movements
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i'm sure this sounds a little
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complicated so let me simplify it by
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talking about a set of mutual funds
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that actually do this tactical asset
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allocation
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as a part of their offerings the dynamic
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asset allocation funds are a category of
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funds
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that follow a methodology of adjusting
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their
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investment proportion based on the highs
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and lows of the market
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often moving between equity debt and
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cash
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these dynamic asset allocation funds are
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also known
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as balanced advantage funds and the
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principle here is simple
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as the market opportunities change so
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should the asset allocation
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and hence the word dynamic these
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funds operate on the principle of
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reducing the overall portfolio risk
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by exiting risky investments which are
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at abnormally high valuations
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and on improving returns by buying
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assets at low valuations
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a good way of understanding this is by
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looking into the portfolio
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of one of the bigger funds in this
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category the icici prudential balance
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advantage fund
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what we have here are the last 12 months
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of
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net equity held by this fund notice how
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the front changes the proportion of
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equity
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depending on the market levels so when
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the stock market stand
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in march and april of 2020
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the fund increased the equity portion to
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as high as 74 percent
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and then in december of the same year
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when the stock market started reaching
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all-time highs
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the dynamic asset allocation model
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focused on reducing the portfolio risk
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by bringing down the equity proportion
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to 40
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this is the very essence of the tactical
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asset allocation strategy
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which aims to align the asset allocation
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with the conditions of the market
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[Music]
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in this final section we shall present
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some quick tips and strategies
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which will help you plan your asset
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allocation better
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tip one is for you to not frame oneself
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and to start adjusting to the conditions
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for example
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many investors often just make up their
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mind
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i am a conservative investor or i am an
[959]
aggressive investor
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and continue to play that part for many
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years
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the problem with this approach is that
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they miss out on big opportunities
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or end up taking too much risk so always
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remember
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when circumstances change so should your
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asset allocation
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our second tip is on personalization
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what i mean by that
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is you cannot pick an off-the-shelf
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asset allocation strategy
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your strategy has to be unique to your
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goals
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your present situation your risk
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appetite and your investment horizon
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a third tip and this is entirely based
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on our experience
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is that it is absolutely okay to have
[1000]
multiple strategies for multiple goals
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in fact this is something we recommend
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as it allows you to smartly bracket
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your investments on the basis of the
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goal you're chasing
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for example your retirement goal which
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is 30 years away
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might have a different asset allocation
[1016]
strategy as compared to a five-year goal
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which might have a completely different
[1021]
strategy
[1022]
tip four and we have discussed this
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earlier is to choose
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diverse assets most returns have a low
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correlation with other asset classes
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and a final tip is that asset allocation
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needs
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periodic monitoring and adjustments over
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time
[1038]
to ensure your portfolio's actual
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performance
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is within reach of your goals this is
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where rebalancing comes into the picture
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and we'll have a video on this very soon
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and with this we come to the end of this
[1051]
video
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i hope you like this video and will draw
[1054]
many learnings
[1055]
from the data and the insights presented
[1058]
don't forget to subscribe
[1060]
like comment and share this video with
[1063]
your friends and colleagues
[1064]
thank you for watching and i look
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forward to catching up with you next
[1067]
week
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with another insightful video until then
[1071]
mutual fund investments are subject to
[1074]
market risks
[1074]
read all scheme related documents
[1077]
carefully
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