Asset Allocation

Market moves in cycles and different strategies work in different phases of cycles. Identifying cycles and positioning the portfolio accordingly can be tricky at times. One simple way to overcome this difficulty is “Asset Allocation

Asset allocation is the process of deciding what percentage of your money to put into different asset classes such as stocks, bonds and cash.

Each asset class responds differently to shifts in the economy and financial markets; some investments may be up while others may be down. With asset allocation, a portfolio may experience less fluctuation in value than individual assets within the same portfolio.

Having a disciplined approach towards investing helps in generating above average returns. Investing with discipline involves selecting investments that are in line with an overall asset allocation and diversification strategy based upon your needs, goals, time frames and your ability to assume risk. To meet their goals, investors must carefully identify their financial objectives and an investment mix to help them reach those goals.

Higher the risk, higher the reward – Is This True?

It is generally believed that, Higher the risk, higher the reward. But Asset allocation helps you in achieving similar (sometimes better) returns with lesser volatility. To give an example, since January 1995 we analysed HDFC Equity Fund and HDFC Balanced Advantage Fund (earlier HDFC Prudence Fund). Both the funds are from the same fund house and are managed by the same fund manager in a similar style. While HDFC Equity is a Multicap fund, HDFC Balanced Advantage fund is an asset allocation fund having close to 75% equity and 25% debt exposure.

As seen from the table, HDFC BAF has delivered better Risk-Adjusted Returns

Asset allocation technique may have a significant impact on the ultimate success of your portfolio. In fact, asset allocation has more influence on portfolio variance than any other single investment decision. In an important study published by the research team of Brinson, Singer, and Beebower in 1991, asset allocation was shown to account for as much as 91.5 of the variation in total return, far outweighing other significant factors such as market timing and security selection.

Developing Your Investment Strategies with Your Advisor

For deciding your Asset allocation framework, the following factors are to be considered:

  1. Time Horizon
  2. Risk Tolerance
  3. Investment vehicles
  4. Planned current and future contributions
  5. Goals

Asset allocation is not a static strategy. To be effective, an asset allocation plan should be reviewed periodically. Also, any changes in your financial goals, lifestyle, time frame and financial circumstances coupled with changes in market conditions, could necessitate revision of your asset allocation plan.

Juxtaposing investments on life cycle

Life cycle directs all of human actions and investments is not an exception. Earning and investments typically start with third decade of life. At the onset an individual has less of financial capital but a lot of human capital as defined by potential to earn. As life advances, human capital reduces and financial capital increases. At certain stage everybody likes to have freedom to retire that is to be free of compulsion of building financial capital. While the stages of life and investments I am about to discuss aren’t thumb rules and in-fact circumstantial deviation from this is inevitable. However, it will get you initiated; make you understand where you are and attempt to charter your way forward.

I refrain from digging deeper in the nuances of each of above twelve squares as it depends largely on investor than the investments. Person comes first in ‘personal finance’ never let the later take over!

Life Stages & Investing

At different stages in life, the objectives and needs are different.

During one’s earning life, money is saved from the current income to take care of the future. This is the Accumulation Phase.

The investment objectives in the 4 stages in Accumulation Phase are:

  1. Single, starting employment
    • Starting a saving habit
    • Emergency fund equal to at least 6 month’s expenses through bank deposits
    • Small beginning of equity investments through SIP
    • Start PPF, NPS accounts
    • Setting aside “margin money” for housing loan
    • Getting adequate term insurance & accident insurance
  2. Marriage
    • Monthly and annual budget of income, savings and expenses
    • Buying a house and getting a housing loan
    • Monthly instalments of housing loan build your house ownership
    • Family floater health insurance
    • Increasing equity fund SIPs
  3. Starting a Family
    • Changes in monthly budget
    • Buying a car and getting auto loan
    • Education funding for children – short term through debt funds, long term through equity SIPs
  4. Approaching Retirement
    • Children education goals nearing completion, responsibilities reduce
    • Income increases as career advances
    • Housing loan EMIs as percentage of income come down
    • Increase equity investments through SIPs and stock portfolio
    • Term insurance needs come down
    • Joint names and nomination in investments

After achieving financial stability, one has earned the “freedom to retire”. The income and cash flows from the accumulated wealth enable living with self-respect and comfort. The 5th & 6th stages in the life cycle fall in this Distribution Phase. The investments considerations are:


  • Cash flows from existing investments used for expenses – systematic withdrawal plan
  • Golden period in life – when time, money & energy are all present
  • Discretionary expenses – such as travel – need to be budgeted
  • Portfolio partly shifts to fixed income investments, but equity still continues
    • Provision for health care expenses – top up on health insurance 

6.Succession & Estate Planning

  • Creating a will
  • Financial security for single spouse
  • Careful distribution after your life to next generation

Markets at New High!

In current week both Sensex and Nifty registered respective life highs. The newspapers projected this as a major historical event with photos of people distributing sweets while sitting in front of terminal. They also carried articles showing journey from 100 in 1979 to 39000 in April 2019. One is wondering why there is such Hype about price of something hitting a new high. If one assumes some growth rate for price of a particular thing, mathematically it is very logical that it will make a fresh life high every day. In fact, we have Liquid Funds whose NAV (that is price) makes life high every day but no one (including me) makes any buzz about it. I think there is more to read in the new high from equity markets as compared to Liquid funds.

Media is focused on Short term

The media weather print or electronic wants continuous flow of buzz and news. Most of the times the terms such as bull markets, Rally, gain, loss, selloff etc. are used loosely without context to the objectives of long term investors.

Media has vested interests in focusing on short term to ensure consumers remain adhered to its services.

For a long term investor what matters is business performance of investee companies which gets updated once based on the quarter end earnings release. Media can potentially create a news only for a day or two out of it.

Equity – a volatile asset class

Share prices and in turn Indices are volatile and more sentiment driven at least in the short term which is very different from Liquid funds. Volatile means prices move up or down from current levels that’s the reason why Equity Price movements get so much media attention. Liquid Fund prices almost always go up unidirectional hence it is not exciting enough to make a news.

Price as an indicator of sentiment?

Price has lead effect on the flows meaning when Equity prices start going up more fresh money gets attracted into the markets. This happens because investors are attracted to positive historical performance. Also most investors are Loss Averse. Imagine an investor who bought BSE Sensex at 38800 in August 2018 which turnout to be a top with the benefit of hindsight, has seen it going down to 33300 in October 2018.

At this time with notional loss of ~14% the regretful investor feels “I got stuck in this!” Come April 2019 the Sensex is close to 38800, investor’s buying level, and instinctively loss averse investor will exit here at no loss.

When price goes even higher that means the selling pressure from investors like in our example is over and there are no investors with a feeling of “I got stuck in this” and there will be potentially more investors who will be ready to invest fresh money as the historical performance has improved. This creates a typical positive feedback loop which drives positive sentiment. Hence after hitting new high and continuing to holding on to it builds foundation of positive sentiment. Positive sentiment, if backed by other fundamental factors such as earning growth and valuations can lead to sustainable up move.

What it means for long term investors

News about New High in Markets in the first place should not be looked at like red alert on standalone basis. One needs to look deeper into other aspects of breadth of the up move, valuations growth outlook. Long term investors benefit from mistakes of general investors who are driven by emotions of fear/ greed & biases like loss aversion through better understanding of fundamental factors and cyclicality in markets.

Financial planning: A case study

The Eisenhower matrix for decision making directs to schedule time, to do task that is IMPORTANT but not urgent. But, the urgency is not there even at the scheduled time and hence the fate of this quadrant is often procrastination. The primary reason for procrastination in financial planning is starting problem. Perhaps a DIY kit could help with that. But is there a DIY kit/instruction booklet for financial planning? The chances are pretty high! However, more important questions are- do I have time & resources to do it myself? And will an Excel spreadsheet or an online calculator personally understand me and my needs? Such programs are yet to reach that level. Here I endeavor to lay a sample case construct that will help you get started.

Client Profile

A tech entrepreneur in early 40’s with nearly 18 years’ experience, married to a finance professional turned entrepreneur nearing 40’s. They had two daughters.

Current Financial Position
Major Financial Goals
  1. Maintain current lifestyle after retirement at age 55: Cost of living increases every year due to inflation. So the client will want Rs. 7.8L per year adjusted for inflation post retirement. 
  2. To provide for education and wedding expenses of daughters. Education is a necessity and must be prioritized. Education expenses were modeled over today’s fees for school of client’s choice and higher education cost overseas. Wedding on the other hand, will be towards end of client’s earning period and is a discretionary expense. It may be difficult to put a number on such goal. After some consultation client decided to aim for Rs. 15 L of today’s value for each daughter’s wedding.
Unstated Financial Goals

At the time of our discussion there were no other goals such as new car or holiday abroad as these were either not required or were being comfortably managed from discretionary expense mentioned in table above. But many people do have such aspirational goals.  

Major Concerns

While looking through a telescope, a millimeter movement in the tube towards your eye results in focus shifting by a few kilometers in your frame. Similarly, even though one is earning comfortably today, like our client, everyone is concerned about shortfall risk- that is whether the goals will be sufficiently funded at the time they become due.

This is because both inflation and returns compound over longer term and result in telescope-like effect. If the investment portfolio doesn’t generate returns in excess of inflation (real returns) over longer term then the value of goal will be higher than the provision.

Behavioral Analysis

The ultimate objective of financial planning is to comfortably meet financial goals and have mental peace in the journey. Generating returns is means to achieve these goals and not an objective. Behavioral analysis aids to address the later part of the objective.

Behavioral analysis reveals following biases-

Familiarity – Investments in real estate were mainly due to the comfort in asset class.

Status Quo– Reluctance to divest from real estate despite being convinced that there are better options.

Lack of self-control– Expenses funded by credit card and personal loan despite high income level. A part of it was unawareness of 36% annual interest on credit card loans.

However, client was open to let go of investment control and assume oversight responsibility. He was rational and responsive to revelations of risk-return dynamics of various asset classes.  The factors discussed here, along with many other forms a client’s case and aid in decisions regarding asset allocation and selection of investment instruments.

This, along with risk profiling helps to decide whether client can tolerate risk. The purpose here is to get you started with understanding yourself and collect data. I am deliberately not putting any analysis and solution because, in my experience this leads to reverse-engineering: people try to frame the case keeping in mind the solution they desire. The objective is to find a key that opens the lock not the other way round!

Strategies for Alpha creation

Generating returns over and above the benchmark i.e. generating “alpha” is primary motive of almost all the investors. Sometimes simple strategies lead us to wonderful results. But key part is to execute these strategies without fail.

Here we will discuss some common strategies which can help you beat benchmark (Nifty 50).

  1. Market timing
  2. Active Fund Management 
  3. Passive Re-balancing – Asset Allocation discipline


Market timing simply means identifying market cycles and investing in times when market are rising and stay away from equities when markets are falling. This is not at all easy and one needs to have lot of understanding of multiple components and first-hand experience at-least 2-3 cycles. Flip side of this is going wrong on market call can significantly erode your wealth.

Active Fund Management

This strategy can yield you alpha in a fairy consistent and dependable manner but you need to bet on right horse (Choosing the right Fund & intern the Fund manager). Again, there can be periods (like CY 2018) where markets can be extremely narrow (only selected few stocks gaining whereas rest of the market struggling). To understand these intricacies of the markets and chose right funds you need able, attentive and active Financial Advisors.

Asset Allocation discipline

“Don’t put all your egg in one basket” is what it at the core of this strategy. Proper asset allocation and periodic re-balancing can help you generate alpha over long period of time in a consistent and dependable manner. To give an example, Nifty 50 index has delivered 11.41% CAGR return over 23-year period. If you had invested 80% of your assets in Nifty 50 and 20% of assets in an income fund (Debt mutual fund) and had done re-balancing every year your return would have been ~ 12% surprisingly more than Nifty 50 returns. This happens because when equities fall debt component help protect downside and hence saves capital erosion.

But again, to reduce equity exposure when equities are giving handsome returns and on a similar note reducing debt when equities are looking lackluster can be a tough mental challenge. In the game of investing often greed and fear take out rational thinking. A Financial Advisor who have seen cycles, understands how to select funds and disciplined enough to help you stick with your asset allocation will help you generate “Alpha” over Medium to long term horizon.

Election and Uncertainty

The election commission of india has came out with calander for general elections.

Recently, the election outcome related uncertainty alongwith tensions at the border have kept markets jittery. The media is creating more noise (as always) and adding to the chaos.

In the light of uncertainty what a long term investor should do

  1. Book profits and reduce exposure to Equities or
  2. Add to equity exposure or
  3. Do nothing

Looking objectively to market movements during and post elections in the past should help in answering above questions to some degree. Below table compiles market movements across last 7 elections and presents information about BSE Sensex performance 6 months prior to elections and 12 months post elections, split as 6 months immediately after election and Next 6 months.

As evident in above table, in 5 out of 7 periods of 6 months prior and post-election, the Sensex has delivered positive performance.

Key takeaways:

  1. If you stay invested, the probability of making money in election year is high.
  2. The Negative return outcome for 6 months post-election are concentrated in 1997 -1998 years which was period of Asian Financial Crisis.
  3. CAGR of BSE Sensex from 1994 to 2018 comes to ~11% and The 6 month period both pre and post are significantly higher than 11% for the most of the positive return.

So what is your plan to handle the uncertainty erupting from elections?

  • Being an Equity Investor you have to be an Optimist. Hence “Staying Invested” will prove to be the best strategy for the most of us. The above table confirms that it pays to stay invested even in an election year!
  • Equity return are not only outcome of political situation but also of Global market performance, Currency movement, inflation, interest rate, GDP growth, Profit growth, fund flows and host of other factors who have very low connection with election outcome. Hence focusing on only Election outcome will lead to missing the signal coming out from other factors.
  • Although past events as shown in above table shows high probability of making good returns in election year, one should not become over optimist and add aggressively as uncertainty still remains and the future might not pan out in the same way as in past.
  • For a long term investor who is looking at investing for funding children education or own retirement, the best way to approach elections as an event which will come every 5 years and will pass by. One should stick to the investment plan and follow the asset allocation discipline. This will allow you to buy more when the markets come down on disappointing outcome.

Financial Advisor like us who are experienced enough will help you to in sticking to your plan and handhold in this period of uncertainty and help you one step in achieving your financial objectives