The importance of allocation over return chasing was better appreciated in 1986, when three researchers, Brinson, Hood, and Beebower (acronym BHB), explained the impact. In their research, BHB theorised that asset allocation is the primary factor for a portfolio’s return variability and active portfolio management i.e. security selection and market timing are minor factors.
The study looked at the quarterly returns of 91 large US pension funds from 1974 to 1983, and compared the returns with that of a hypothetical portfolio with similar asset allocation in passive investments. BHB’s conclusion was that asset allocation explained 93.6% of the variation of a portfolio’s returns, which is better than active management i.e. timing the market etc.
Then where do we allocate? For a retail investor, staple asset classes are equity and debt. Equity leads to growth in your wealth over the long term, and debt lends stability in the portfolio as well as growth in wealth. Other than these, gold, real estate etc. are the other asset classes available.
Even though judicious allocation is key, based on the investor’s risk-return profile, horizon, investment objectives, etc, usually portfolios tend to get skewed in favour of one asset class. The reason for the skew may be preference for one asset class or going with the momentum of the times.
Investors who prefer relatively higher returns are heavy on equity and those who prefer relative stability are more into debt investments.
Sometimes, over a period, due to uneven growth in various asset classes, the initially decided allocation ratio gets altered. The asset under management in the mutual fund industry i.e. AUM, is a pointer to the skewed allocation we are discussing.
In the industry with an AUM of Rs 32.2 lakh crore in March 2021, the share of gold ETFs is Rs 14,000 crore i.e. 0.44% and that of feeder funds investing overseas is Rs 11,000 crore i.e. 0.35%. This is not an absolute indicator, as there are other avenues for investment as well other than mutual funds, but this at least gives us a perspective.
Another perspective to the need for multi-asset allocation is that there is wide fluctuation in returns, every year, in various asset categories like domestic equity, international equity, gold, and to a lesser extent in debt. In certain years, equity gives phenomenal returns and in certain years, the returns are in the negative. Same is the case with gold. The only way to smoothen out the impact of the volatility in these various investments is to focus on allocation, and still earn optimum returns.
Your returns will be optimum over a long holding period as asset classes will perform as per market movement and volatility would be lower.
That brings us to the question: How do you do the allocation? While direct investment in asset classes like equity, bonds or gold is possible, it is advisable to go through the mutual fund route, as there is a team of experts (fund managers) and other professionals working for you. There is an expense charged every year, but you are saving the time and money you would have otherwise spent on research and execution of the investments.
Within mutual funds, there are various categories of funds like equity, debt, hybrid (mix of equity and debt), etc. and you can invest in those. The other way of executing multi-asset investment in mutual funds is to invest in one fund that offers all the asset classes i.e. equity, debt, commodities, etc. If you do the allocation through one fund, then the AMC is doing the allocation as per the mandate and you are holding units in it. The allocation as per the mandate of the fund and the decision of the fund manager within the mandate, does the job for you.
Here’s a look at some of the asset allocation funds.
Axis Triple Advantage Fund, launched in 2010, is a relatively older fund with a corpus size of Rs 946 crore as of March 31, 2021. The asset allocation pattern of the fund is 65% to equity, 20% to debt and 15% to gold. SBI Multi Asset Fund has a corpus size of Rs 340 crore, UTI Multi Asset Fund has assets worth Rs 684 crore and Tata Multi Asset Opportunities, launched in March 2020, has a corpus size of Rs 663 crore. ICICI Prudential Multi-Asset Fund is the leader of the pack, with a corpus of Rs 11,165 crore.
What are the return expectations?
The returns will be the weighted average of the performance of the assets invested in, as per the allocation in the fund. In the short term, performance of the fund can be volatile, as per movement of the underlying asset classes. In the long run, you will get optimum returns.
In this context, optimum means returns comparable with the best-performing asset, with lower volatility. As an example, if one were to consider the performance of the past five years, while Nifty 50 TRI has delivered returns to the tune of 15.12%, one of the benchmark of a multi asset fund – Nifty 200 Index (65%) + Nifty Composite Debt Index (25%) + LBMA AM Fixing Prices (10%) has delivered 14.48%. The highlight here is that this double-digit return was accompanied with much lower volatility, which makes a solid case for investing in this category of fund.