Financial planners preach it, fund managers recommend it and investment experts follow it like a religion. Yet, the importance of asset allocation is generally lost on retail investors. I have seen disciplined investors throw away the rule book and allow inherent biases to control investment decisions. The resulting asymmetry leads to sub-optimal outcomes and less than expected returns.
Unfortunately for investors, this usually happens when investment discipline is needed the most. A recent example was the market crash in March following the global outbreak of Covid-19. When they should have bought more by hiking their SIPs in equity funds, many investors actually stopped SIPs. Some even withdrew their investments. With one click of the mouse, they turned paper losses into permanent ones. Now that markets have recovered some ground, investors who panicked and withdrew will miss the uptrend.
Asset allocation is nothing but another name for diversification. It is how you spread your investments across asset classes— stocks, fixed income, property and gold. This could be based on your risk profile, nearness of your goals or your assessment of the markets. Asset allocation ensures all your eggs are not in one basket. Even if stocks crash, the other assets shore up your portfolio.
Where investors go wrong
It is also a profit booking mechanism that gets triggered when a certain asset class becomes overheated. The principle of asset allocation requires rebalancing if there is a portfolio drift. All asset classes don’t move at the same pace or in the same direction. Rebalancing realigns the portfolio so that exposure to underweight assets is increased and overweight assets are jettisoned. This allows the portfolio to carry the same risk-reward expectations despite market changes.
However, it doesn’t always work that way. Most investors tinker with allocation during external events, imposing their own perspectives on well laid plans of the asset allocation model. We have often noticed that investors become too greedy when the going is good. They are not ready to reduce exposure to equities when the markets are peaking. Some even add more to the already overweight asset class, thus increasing risk in the portfolio.
Tragically, the opposite is equally true. Many investors lose their nerve when markets go into a tailspin. They redeem investments at a loss, even though the rebalancing principle requires them to buy more equities.
Fixing the asymmetry
Investors who want to gain from asset allocation must first unlearn their biases. Advisers and wealth management firms have built asset allocation models to suit almost all types of investors. Before choosing a model, the investor must first understand his own risk profile.
Risk profiling is based on behavioural finance and psychometric testing and should not be confined to 2-3 generic questions. For example, an individual’s willingness to take risk is not the same as his capacity to do so. It cannot be assumed that an investor understands the risks involved just because he says so. Linking expectations to risk, both on the upside and downside is one of the key inputs that lead to good asset allocation.
Further, the model should be back tested for not just the good times but also for bad times. Good portfolios protect you in tough market conditions. Once you choose a model, let the quant do its work.
How good asset allocation works
To assess the performance of good asset allocation methodology, we built a few sample portfolios (see chart). Each model was divided into multiple equity and debt asset classes with varying weightages. Weightage of sub asset classes were determined using multiple parameters, resulting in particular risk, reward and duration outcomes. The portfolios were all a combination of equity and debt. The performance of the portfolios were evaluated over a year. We looked at one year specifically to understand the impact of the market collapse. The graph shows the performance returns of five portfolio models and compares them with Nifty and Crisil Hybrid indices.
Disclaimer: The comparison above is only for the purpose of illustrating the advantages of diversification and asset allocation. This is not any investment recommendation or advice. Readers are requested to consult an investment adviser before acting on it or taking any investment decisions. Past performance is not indicative of future performances.
Portfolios that have consistent asset allocation and superior product selection significantly outperform the market. The out performance in absolute returns is very large, resulting in a large alpha generation. While the portfolios were designed to generate alphas in the range of 3- 5% in the long term, they have given over 5X better results in a collapsing market.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
