Stock Market Portfolio: In a weak market diversify your portfolio to protect downside & maximise upside

The importance of asset allocation would not have come to the fore if for the experience of the past couple of years.

Extreme volatility has been observed across asset classes driven by frequent unknown events over a short time horizon. And the instability has transcended from financial assets in capital markets to real assets as well.

Portfolio diversification could protect investors during such times while ensuring the long-term goals are on track.



It is always prudent to focus on the asset allocation basis the profile of investors and more so given the current global uncertainty around inflation, interest rates, geopolitics, and the pandemic.

An investment plan incorporating risk and return objectives, liquidity needs, time horizon, tax, and legal requirements should be an ideal starting point.

This plan should highlight optimal products to take exposure to relevant asset classes like equity, fixed income, gold, alternatives,

. as different assets would behave differently to different factors.

The is to protect the downside while positioning the portfolio to benefit from any potential upside.

Equity
Equity is the only asset class that provides a sure-shot way to create wealth in the long term. But it is accompanied by volatility and a high risk of capital loss.

It tends to have a positive correlation with low-to-moderate inflation and can thus provide positive real returns in an environment of rising prices. But hyperinflation could have a negative impact on corporate margins and profitability, especially when consumer sentiments are weak, and the demand for recovery is subdued.

Within equities, an investor can allocate to different market capitalization segments depending on several factors such as valuation, risk sentiments, liquidity, earnings growth, and technical indicators.

The strategic allocation to equities can be built through a combination of products like Mutual Funds, ETF, PMS, AIF, and direct stock equity.

Additionally, a small allocation can also be made to global equities from a logical diversification perspective. Offshore investing provides exposure to multiple currencies and differentiated themes not available in domestic markets.

Additionally, it reduces overall portfolio volatility as well. Investors must always have a strategic asset allocation towards international equity and take active tactical positions depending on changing market (country) dynamics and fundamentals.

Fixed Income
Debt instruments provide investors with a fixed return on a consistent basis over the tenor of the product till maturity.

The probability of capital loss is also relatively low in sovereign and AAA-rated bonds when compared to equity unless one invests in high-yield credit.

Inflation impacts fixed-income investments the most due to its inverse relationship with interest rates. They are also subject to duration risk which is a function of the yield curve and interest rate outlook.

At times, central banks could take actions around monetary policy and systemic liquidity to manage interest rates or yields on debt products but eventually, fundamentals would catch up.

The strategic allocation for debt can be built through a combination of Mutual Funds, PMS, ETF and direct instruments like G-Secs, SDLs, Corporate Bonds, MLDs, PTCs, etc.

Inflation-protected securities are a category of bonds that adjust yields to inflation which could be considered in times of rising inflation. Similarly, short-duration bonds/funds could also be looked at at times of rising interest rates.

Gold

Gold has peculiar attributes that make it a valuable strategic asset in investment portfolios – return-generating ability over long periods, great diversifier due to its low correlation with other asset classes in both expansionary and recessionary periods leading to better risk-adjusted returns, liquidity like other mainstream financial assets and no credit risk.

Investors also look at gold as an ‘alternative currency’ or ‘currency of last resort’, especially in countries where local currency is losing value.

It is also a good inflation hedge as it tends to protect portfolio values ​​in times of rising inflation, hence it is also called a ‘premium store of value’.

A small allocation to gold will also provide portfolio protection against uncertainty and volatility. But if central banks raise interest rates steeply under inflationary pressure, then non-yielding assets like gold could become relatively unattractive for some investors.

Gold also has an inverse relation to the dollar index and hence US dollar strengthening could put downward pressure on gold prices.

We believe the above assets are a must-have in an investor’s portfolio to meet their varied risk-return objectives. For a select few risk-aware investors, alternative asset classes composing of Real Estate (Real Estate Funds, ETFs, REITs, InvITs), Commodities (Thematic Funds), and Private Market (PE, VC, Direct investment) could also be considered.

.

Epnamer