It is often said that ‘one must not hold all their eggs in the same basket.’ This quote point towards the benefits of diversification or to the fact that different asset classes tend to react differently to macroeconomic events. For example, a stimulus relief package maybe a booster for economic growth and thus a favorable event for the equity markets. However, it may cause the borrowing yields to go up, thereby impacting the debt markets adversely. While the world copes with the current environment of uncertainty amidst the Covid-19 situation, there lies another investing dilemma amongst the investors regarding the choice of asset class best suited for the current conditions.
Such timing is challenging even in normal times, and with unprecedented times clouding the economic recovery, the task gets more complicated.
The historical data suggests that no single asset class has been a consistent outperformer. As per the historical performance of equity (represented by S&P BSE 100 TRI), debt (represented by CRISIL Short Term Bond Fund), and gold over the last decade (2010-2019), gold has been the best performing asset class for five years. Still, it has generated negative returns for three years.
Similarly, equities outperformed other asset classes in three years, while it managed to generate positive returns for another five years. While debt was an outperformer for two years during the data period, it could avoid negative returns for the investors for the remaining period.
As such, the best investing strategy can be to stay invested across different asset classes, which will help the investors with the benefits of diversification and further participate in the market returns as and when the respective asset classes outperform. The options amongst such asset classes may include equity, debt, commodities, international equities, etc.
In a risk-off environment, like the one prevailing over the last 10 years, on a relative basis, asset classes like international equities, gold and debt may outperform domestic equities, to balance out returns. On the other hand, in a risk-on environment like the one we witnessed between 2002-2008, domestic equities and commodities could outperform to generate superior returns for the portfolio.
Diversification is essential in an investor’s portfolio. When batsmen in a team fail to deliver, bowlers and fielders could still win the match. When one asset class goes through a rough patch, the other asset classes would come to the rescue of the portfolio.
Disciplined rebalancing is also important to ensure that the optimal asset allocation is maintained through the journey of investments. This would mean booking profits from asset classes which have performed well to allocating to other assets which have relatively underperformed. Without this rebalancing, the portfolio will keep getting skewed towards some asset classes. Investors attempting to do this rebalancing themselves would find it practically difficult.
For one, every time, personal biases would creep in. For instance, you invested in gold, and noticed it went up by 25%. Most likely, the investor may not redeem the investments aiming for higher returns, only to regret gold prices correcting at a later stage. The other issue is with taxation. Each time one rebalances the investments in different asset classes, one may be liable for income tax as per the applicable tax rates.
This is where multi asset funds can be beneficial, as they provide the convenience of diversification across different asset classes within a single investment product. The professional fund managers would make disciplined investments across asset classes, not only at the time of investing but also on an ongoing basis by rebalancing. Rebalancing within the investment portfolio does not attract additional tax compliances for the investors. The investors are liable to pay taxes only when they redeem the units.
Investing in multiple assets would be better than taking zero-one call on a particular asset class, any day. A team of good players would be superior to any individual player!