When making investments, most of us are focused on capturing the highest returns, and for that we would obviously like to choose the best performing asset class or investment idea every single time. But there’s a slight problem with that. No one, not even the experts, can accurately and consistently know what the best performing asset class or investment idea over the next few months/years will be. Be wary if someone tells you otherwise, because those who try to predict and time the markets are one who usually get burnt.
Risk and return characteristics
The simple reason for this is that the best performing asset class is dependent on the state of the economy, which with its booms and busts keeps changing continuously. Assets, due to their differing risk and return characteristics, respond differently to these booms and busts, thus going through cycles of optimism (price increases) and pessimism (price falls). Typically, when interest rates are low, debt gives lower returns but equity will be outperforming; when the equity markets are down, debt would be an outperformer; in times of uncertainty cash and gold will rule: and so on. But don’t just take our word for it. Let’s look at the asset class returns history in India.
Grow and contract in cycles
For successful investing, the question to answer is not what will change, but what will not. And what does not change is the fact that asset classes grow and contract in cycles. To put it simply, there will be periods when equity markets will have a brilliant run, periods when only bonds will be dependable, and periods when gold will shine the brightest, and these periods will not typically overlap. Thus on its own, an asset class can be quite volatile, but a mix of assets can lower volatility, simply because historically when one asset type has average or poor returns; the other usually does well.
Once we have internalised this phenomenon, it is not rocket science to know that holding a diversified portfolio with multiple imperfectly correlated asset classes (equity, debt, gold) and rebalancing regularly can prove to be the easiest, smartest way to make consistent, meaningful returns through the ups and downs of the economy.
Thus, concentrating investments in a single asset class (In India that is typically fixed deposits) is one of the biggest mistakes that investors could make. At least a portion of the investment portfolio should be allocated to asset classes that perform well in different economic environments. Given the unpredictability of potential economic outcomes in today’s uncertain times, holding a balanced portfolio that includes diversified assets is prudent.
Hybrid multi-asset mutual fund
The hybrid multi asset mutual fund category is one such avenue to use asset cyclicality to your advantage and ensure a consistent rate of return with limited volatility. This category of funds invests in equity, debt and gold creating a balanced risk and return profile. It thus offers investors exposure to various asset classes in a single investment. The manager strategically moves in and out of these asset classes capitalising on their up and down cycles. The portfolio strives to optimise gains and minimise downside and is ideal for the diversification and asset allocation needs of investors with low and medium risk appetite.
Do not lose sleep over the ups and downs of high risk investments, diversify through true multi asset funds and have a relatively steady ride towards long-term wealth creation.
The writer is senior fund manager, Quantum Mutual Fund