Asset allocation has proven to be a critical component in guiding investors through the tumultuous waters of major economic crises such as the 2007-2008 Global Financial Crisis, the COVID-19 pandemic, and periods characterised by unstable economies and high inflation rates. During these challenging times, diversified portfolios with well-balanced asset allocations have played a pivotal role in helping investors withstand market volatility and preserve wealth.
Source: MFI Explorer; Calendar year returns. Returns mentioned are in terms of CAGR—data as of December 31, 2023.
MCX prices are considered when calculating gold returns. For Equity Returns: S&P BSE Sensex values are considered. For Debt Returns: CRISIL Short-Term Bond Fund Index values are considered. Returns are calculated on an absolute basis. Past performance may or may not be sustained in future. The green colour represents the best value, and the red colour represents negative returns i.e. when there is capital loss.
In the aftermath of the 2007-2008 Global Financial Crisis, traditional safe-haven assets like gold and government bonds emerged as saviours for investors as equities plummeted. The Nifty 50, key benchmark index of the National Stock Exchange of India, which represents approx. 65% of the total market capitalisations, experienced significant declines in calendar years 2008, 2011 and 2015. Meanwhile, gold prices soared as investors sought refuge from the market turmoil, but gold had a tough performance in 2013,14,15 and 21. While 10-year government security (G-sec) yields, reflecting fixed-income investments, provided stable returns amid equity market turbulence but in many years its performance was below inflation.
This shows that in times of economic instability marked by high inflation or higher interest rates or political instability, asset allocation strategies incorporating inflation-hedging assets such as real estate, commodities, and inflation-linked bonds proved invaluable. While equities may underperform during inflationary periods, assets like real estate and commodities often appreciate in value as prices rise. Additionally, inflation-linked bonds safeguard against purchasing power erosion by adjusting their principal and interest payments in line with inflation rates.
The primary role of asset allocation during times of uncertainty and market volatility is risk management. By diversifying across asset classes with low correlations, investors can reduce portfolio volatility, preserve capital, and achieve long-term financial objectives, even in adverse market conditions.
Analysing annual returns from 2000 to 2023 reveals five instances of market crashes exceeding 20%.
Source: 1yr monthly rolling returns; source: MFI 360
What should Investor do during uncertainty?
Throughout history, despite facing challenging circumstances, markets have consistently endeavoured to deliver returns to investors through a variety of mechanisms and strategies. Some of these include:
1. Diversification: Investors diversify portfolios across different asset classes to spread risk and minimise the impact of adverse events. Holding a mix of assets with low correlations aims to achieve more stable returns over time.
2. Active Management: Invest in mutual funds, with active fund managers as they monitor portfolios and adjust allocations in response to changing market conditions. Tactical asset allocation, sector rotation, and hedging strategies are employed to capitalise on opportunities and mitigate risks.
3. Quality Investments: Investing in high-quality companies with strong fundamentals and resilient business models can mitigate downside risk. These companies are better positioned to weather economic downturns and outperform peers during market volatility.
4. Safe-Haven Assets: Gold, government bonds, and cash serve as safe-haven assets during uncertainty. These assets maintain value or appreciate when other markets decline, hedging against volatility and preserving capital.
5. Long-Term Perspective: Despite short-term fluctuations, markets trend upwards over the long term. Investors with a long-term outlook stay invested, trusting in market resilience and compounding returns.
‘Investing during every dip,’ also referred to as ‘averaging at every dip,’ is a strategy for capitalising on market downturns. It involves buying assets when prices decline, benefiting from undervalued opportunities, and averaging down costs over time. This strategy requires discipline, a long-term perspective, and fundamental analysis to identify attractive investment opportunities amid market volatility.
Asset allocation is instrumental in managing risk, achieving financial goals, and navigating market uncertainties. By diversifying across asset classes, investors can enhance portfolio performance, reduce volatility, and adapt to changing market conditions. In summary, asset allocation serves as a cornerstone of investment management, offering a roadmap for investors to weather market storms and achieve long-term success.
