Trend-based asset allocation strategies hold the key

The equity markets have been in a huge roil in the last few weeks, of course, same is the case with most asset prices. The recent green shoots in the economic activity limping from the pandemic induced shocks (initially demand and then the supply) have been stunted due to the evolving geo-political environment. The Russian-Ukraine conflict has not just created a political impasse, but has disrupted supply chains and access to some of the important minerals and food items as well. This is further aggravated by the already elevated prices of these items fanning further inflationary flames. When markets react to such event news which is changing daily, it's difficult to come up with a stable strategy to address these gyrations. Even for the seasoned investors, the sudden drawdowns and the subsequent volatility questions their resolve. So, at such times how should one approach investing. How should one react or respond to these dynamic changes in the market?

We've heard multiple times about not holding all the eggs in one basket, the adage for diversification. In investing, diversification of assets and thus asset allocation is the key, but how many of us duly follow this principle to the fore. Also, we do have questions about how much the allocation to each of these assets to be and how to reallocate them from time-to-time depending upon the market. Should one do at all, at the first instance?

One should have a grip on themselves before even attempting at any asset allocation strategy. This is because each has its own way of allocating or even considering the assets. For instance, some don't consider real estate investment, while they would ponder the allocation within financial assets. Ideally, an investor is better off to have a comprehensive view of the assets instead of looking at sub-classes. Also, it's better to not consider the place of residence as an investment. With these basic tenets, one could assess their current spread of investments. Keeping a basic framework of asset allocation i.e., 70-30 in equity-debt or 60-20-20 equity-debt/gold-real estate, etc., in place helps one start from. Traditionally, Indians have carried some notions towards real estate and equities respectively that its scarce, so value would only appreciate and are volatile, so riskier or loss making. Though, it's a proven fact that equities have provided best of the returns over long-term and they remain transparent (in valuations) unlike real estate. Also, building a real estate portfolio needs higher initial sums unlike that of equity where even smaller amounts could be used to invest in mutual funds or through fractional investing.

It's one thing to have a strategy and follow it consistently. For instance, when the valuations of the assets go up then the overall balance could be changed, especially this is true when the assets are non-correlated (ideal too). If the equity portfolio goes up substantially within the portfolio over the defined proportion, then one could partially exit or profit book to maintain the balance. How would it be if the real estate exposure increases in valuations, it's difficult to part-sell a land or flat? Moreover, real estate valuations are tricky specifically when there is litigation on an open plot or unfinished flat (if the builder defaults) and so are to be valued to null, at least, till the matters are resolved.

And if the equity portfolio is falling, should one add more funds to average on the downside. On the face of it, averaging down seems a smart move till one overdoes it. Embarking on a lower cost of acquisition, one could unknowingly add too much exposure to a particular stock or sub-class of equity thus skewing the overall allocation mix and so increasing the risk. Averaging down purely due to the change in valuation is not good idea but if one were to observer that the reasons are not fundamental to the business or company then one could add more of that business or stock.

So, it might be difficult to always stick to this fixed allocation strategy or could turn impractical at times. Instead, one could try a more practical approach of goal mapping or investing based on the timelines. We know that each of the assets have their own cycles and one could play along which matching their own requirements. For example, when the need is short term i.e, 3-to-5-year period, it's ideal to avoid allocations to equity or even real estate. The latter is considered by many where they extrapolate certain factors (like construction period, growth momentum, etc.) but reality could be different and unpredictable.

For long-term goals like retirement, an exposure to equity and even to real estate is could help build wealth for the investor. Also, when investing, one should have a portion sidelined in cash as one doesn't know when an opportunity beckons. Mind you, this is apart from the emergency fund that has separate function altogether.

(The author is a co-founder of 'Wealocity', a wealth management firm and could be reached at [email protected])