Go multi-asset to offset equity-market volatility, say analysts

Determine your ideal equity allocation, based on drawdown capacity

With experts expecting higher volatility in equities in 2022, new investors who have entered the markets over the past 18 months and have never experienced a steep or prolonged downturn need to watch out. If they are invested only in equities currently, or are heavily overweight on equities, they should diversify at the earliest.

According to S Naren, executive director and chief investment officer, ICICI Prudential Mutual Fund, “Market volatility could spike in 2022 as and when the US Federal Reserve (US Fed) starts to taper its bond purchase and hike rates. Another risk remains in terms of impact and severity of Covid variants.”

He favours a multi-asset approach. “Historically, whenever any asset class is fully valued, it tends to become volatile. Hence, a multi-asset approach is required at this juncture,” adds Naren.

How much equity allocation 

Investors must reconsider how much equity allocation they should have. They should decide how much drawdown they are prepared to accept. During the 2008 financial crisis, equities fell 56 per cent from peak to bottom. Let us assume a similar drawdown occurs again.

For simplicity, let us say you have a portfolio of Rs 1 crore. Assume equities fall by 50 per cent and the value of the rest of the portfolio remains unchanged (though gold would provide some upside). If 50 per cent of your portfolio is in equities, the portfolio value will come down to Rs 75 lakh. Broadly, this is how you should think when trying to arrive at your equity allocation. Age and time left for a goal can be other factors.

Building a diversified portfolio

Once you have decided on your equity allocation, take allocation to debt and gold. Gold acts as a diversifier: It does well when equity underperforms. Says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors: “Take a 5-10 per cent allocation to gold. Invest the balance in fixed income. Among debt funds, use a combination of target maturity funds and short-duration funds with portfolio duration of one-three years.”

On the equity side, he recommends 70-75 per cent allocation to domestic funds and 25-30 per cent allocation to international funds. Among domestic funds, he suggests a passive fund in the large-cap space, and active funds in the flexi-, mid-, and small-cap space. On the international side, he suggests a fund that gives broad exposure to developed markets, such as the HDFC Developed World Indexes Fund of Funds.

Avinash Luthria, a Sebi-registered investment advisor and founder of Fiduciaries, says investors should not have an equity exposure of more than 50 per cent. He suggests a simple, low-cost portfolio with 50 per cent allocation to equities and 50 per cent to debt. On the equity side, he suggests 50 per cent exposure to a Nifty50 index fund and 50 per cent to an international index fund based on the S&P 500 index. On the debt side, he suggests overnight funds. “Since the portfolio would already be taking high risk on the equity side, why expose it to credit or duration risk on the debt side?” he says. He does not recommend exposure to gold since it can have prolonged periods of underperformance.

Invest in a multi-asset fund?

Multi-asset funds in India have given allocation to domestic equities, debt and gold. (Balanced advantage funds move between domestic equity and debt.) ICICI Prudential’s recently launched Passive Multi-Asset Fund of Funds gives allocation to international equities in addition. Its expense ratio is attractive: 40 basis points on the direct plan and 100 basis points on the regular plan.

The only risk arises from the fact that the fund manager will change allocation across asset classes. Within asset classes, he will choose different exchange-traded funds, both domestically and globally. “The concept is good. But wait for a track record to build to see how the rebalancing as well as choice of assets, sectors, etc, works,” says Dhawan.