Portfolio Diversification – Why is it important?

17 August, 2021


          
            Portfolio Diversification – Why is it important?

The primary aim of investing is to grow my money and make it work harder for me. That means firstly focusing on avoiding negative returns, keeping funds safe and only then planning for gain. Diversification is what helps to grow money with a lower risk of losing. A portfolio that is well-constructed not only ensures participation during market rallies, but also helps in downside protection. A key step to building such a portfolio is to diversify across asset classes. It doesn’t just mean holding on to too many schemes. Here’s how you must go about diversifying your investments meaningfully.

Spread across Asset Classes

Even if you like taking risks, you need a bit of debt investments in your portfolio for your short-term financial needs. On the other hand, even if you are too conservative, you surely need a bit of equity to get higher returns.

That’s the crux of asset allocation. Different asset classes do not rise and fall at the same time. For example, in FY2020, large-cap equity funds fell in value by 23.92%, while international schemes declined just 6.96%. However, in the same year, gold appreciated 37.34%. But the tide turned in the current year. While large-cap equity schemes and international funds gained 72.84% and 54.59%, respectively gold managed to deliver only 0.2% return.

 

Asset Allocation can be Made easier via Multi-asset Funds

Multi-Asset Funds in mutual funds invest in a combination of different asset classes – typically, Indian equities, fixed income, and Gold primarily. There are a few funds that may also invest in global equities. There are funds that also invest in commodities. Since there are multiple asset classes involved, the strategies of individual funds could vary quite significantly. Real Estate Investment Trusts (REITs) can be considered, to avoid the hassle of buying and maintaining physical real estate. At the moment, however, options in REIT are very few. And surely with a financial advisor as your guide, asset allocation can be managed with best practices and discipline to ensure sustainable alpha returns on your portfolio.

Multi-Asset Funds in mutual funds invest in a combination of different asset classes – typically, Indian equities, fixed income, and Gold primarily. There are a few funds that may also invest in global equities. There are funds that also invest in commodities. Since there are multiple asset classes involved, the strategies of individual funds could vary quite significantly. Real Estate Investment Trusts (REITs) can be considered, to avoid the hassle of buying and maintaining physical real estate. At the moment, however, options in REIT are very few. And surely with a financial advisor as your guide, asset allocation can be managed with best practices and discipline to ensure sustainable alpha returns on your portfolio.

 

Diversify within an Asset Class

Over the past one year, small-cap funds gave 93% returns. Mid-cap funds delivered 73% returns. Large-cap schemes managed 56% return. Doesn’t mean you invest everything in small-cap funds. The fortunes of small-cap funds head south as swiftly are they head upwards. But you shouldn’t avoid them altogether. Diversify across large, mid and small-cap funds, Know More.

 

Diversify across Geographies

Many Indian investors have deployed money in foreign funds over the past two years. And rightly so.

In the COVID-19 pandemic, we have seen various nations going through various phases of recovery. Last year, the Indian economy was recovering fast, while Europe and US were battling with the COVID-19 surge. Now, the Indian economy faces a lock-down if the 3rd wave hits and the US is doing better. Diversifying overseas helps reduce country risk and also help us to invest in businesses that are not available in India. Some developed markets share low correlation with Indian stocks.

“Businesses that enabled working from home took a leap over the last one-and-a-half years as a result of the pandemic. Similarly, internationally pharma companies and IT / Infotech are flourishing because they are feeding the demand. Investing in them at the right time resulted in alpha returns.”

MIMI PARTHA SARATHY

Diversifying in Fixed Income

Events of the past two years have shown that it is not easy to pick a debt fund. Liquid and ultra-short duration funds are meant to park money for the short term. If you wish to start a systematic transfer plan (STP) into an equity fund, these are the ideal schemes to help you do so.

Short duration funds and corporate bond funds are ideal, if you wish to stay invested for at least three years. Gains earned on sale of units held for more than three years are treated as long term in nature. They are taxed at 20 percent after indexation.


“Credit risk and Default risk are very important issues to be mindful of while investing in debt funds, corporate bond funds and fixed deposits. It is important to stick to AAA rated debt and not take risks with debt since default in debt means loss of capital.”

MIMI PARTHA SARATHY
Managing Director,
Sinhasi Consultants Pvt. Ltd.


If you are taxed at lower slabs, then you may also consider debt options such as postal time deposits and National Saving Certificates, if you can hold them till maturity.

The key to growing your money and achieving financial success is Asset Allocation. Reviewing and subsequently rebalancing your assets is a must. They help you achieve your financial goals. Portfolio diversification is achieved by investing across asset classes, across fund management styles, across time, & even across geographies. But most importantly they will be derived from the asset allocation master plan which is in turn derived from the financial plan which is dependent on the financial goals that you have set. Have you spoken to certified planners to take their view on what kind of portfolio diversification you will require?

Reach out to us

For a better understanding of the process.

              

The key to growing your money and achieving financial success is Asset Allocation. Reviewing and subsequently rebalancing your assets is a must. They help you achieve your financial goals. Portfolio diversification is achieved by investing across asset classes, across fund management styles, across time, & even across geographies. But most importantly they will be derived from the asset allocation master plan which is in turn derived from the financial plan which is dependent on the financial goals that you have set. Have you spoken to certified planners to take their view on what kind of portfolio diversification you will require?

Reach out to us

For a better understanding of the process.

              


Bibliography

Did you know? Investing across Geographies can spread your risk, MINT | Top performing categories, Money Control


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