Importance Of Asset Allocation In Current Market Conditions

Asset allocation is a fundamental key for a successful investment experience. Though it is an evergreen investment strategy which remains relevant and effective across market cycles, often investors tend to ignore the importance of asset allocation.

The strategy of asset allocation works on the principle that all investment asset classes are different and have distinct market cycles. At times they are in sync with each other but most of the time they are not correlated. Therefore, asset allocation offers a protective layer to your investment portfolio by ensuring there are no asset concentration risks and thus saving your investment value from sudden and undue erosion due to one particular asset class.

The current ongoing high volatility in equity market amidst expectation of its continuation has brought to fore once again the importance of asset allocation and its advantages. Since asset allocation helps in risk management while aiming to generate steady returns in the long-term, a neglect in terms of asset allocation may prove hazardous for one’s overall investment experience.

Investors had barely come out of the abrupt corrections and then an unexpected rally during the pandemic years of 2020 and 2021, that 2022 threw fresh volatility on the back of geopolitical tensions, high inflationary scenario amid steep interest rate hikes. In short, the year 2023 is the straight fourth year of continuous volatility and uncertainty in the market. Key stock indices have remained, more or less, at the same level since 2021. On the other hand, gold as an asset class has shown strengthening signs while debt assets over the past year is turning attractive.

Majority of investors who wish to invest in equities, are not prepared to digest high volatility that comes along with equity investing. As a result, steep corrections as seen during 2020 and 2008 tends to unnerve them. This leads to a confused state of mind and they end up making wrong investment decisions which ultimately proves to be detrimental to their financial health.

Why Asset Allocation?
It is in such situations that asset allocation strategy comes to an investor's rescue. It is needless to say that such challenging times in the market are part and parcel of one’s investment journey. The need is to keep investment portfolios flexible enough to accommodate any market situation. Asset allocation ensures that exposure to overvalued assets is suitably and timely cut while the amount is diverted to other assets for sustained value creation and stability.

It's worth noting that often, investors develop recency bias towards investments with a thought process that assets which have done better in the past would continue to do well in the future as well. Similarly, they believe that poorly performing asset classes will continue to do worse. This is actually not true, especially from the lens of long-term investment horizons.

For instance, taking cues from the recent years, investors who continued to remain heavily invested in equities when the key stock index crossed the 40,000 mark, just ahead of the pandemic outbreak, had to face an abrupt decline in their portfolios. Had their portfolios been adequately allocated across asset classes, the impact of the decline would not have been so sharp on the portfolios. Similarly, post the market recovery and rally while index crossed 60,000 level at the fag-end of 2021; investors who continued to have lion's share exposure to equity had to see nearly 20 per cent erosion in their wealth as the year 2022 was full of high volatility.

Hence, asset allocation process substantially reduces the knee-jerk reaction in a portfolio and offers a cushioning impact to your investments. Not only your investment-related stress is kept in check while saving a lot of your time and energy; investors have an overall happy investment experience.

Thus asset allocation aims for inflation-beating, risk-adjusted returns in your wealth creation journey by offering you the optimum benefits of several asset classes like equity, debt, gold and infrastructure-related instruments. Doing away with asset allocation does no good with long-term investments. Historical data suggest that during weak market cycles, those who exercised asset allocation emerged wealthier.

Several mutual fund categories like asset allocator funds, multi-asset funds and balanced advantage funds tend to help investors with asset allocation strategies. Given the present market conditions, it is advisable to consider investing through these schemes for risk-adjusted, stable returns.

Author: Chirag Gokani, Co-Founder, Valuex Advisors LLP