Multi Asset Allocation Funds
The whole gamut of your investments has two major factors at play, among others- risks and returns. Investing in only one asset class may result in higher risks; what if it underperforms? Hence, you need to have diversity in your investment portfolio in order to hedge your risks, i.e. if one of the asset classes underperforms, there shall be others that will perform well and hence, your returns may not reduce considerably. In this tussle between the risks and returns, the one thing that plays a prime role is your asset allocation. The asset classes that are weakly/ negatively co-related and tend to perform at different periods of time and its may prove to be difficult for an individual to chase it
#According to various studies, more than 90% of the portfolio returns are based on asset allocation decisions. Hence, staying invested across Asset classes and sub-asset classes is very important. A multi asset allocation fund in your portfolio wherein, the allocation is distributed between asset classes like gold, equity, debt etc. can provide you with the desired diversification.
#Source: Does Asset Allocation Policy Explain 40%, 90% or 100% of Performance?
Importance of Asset Allocation
Over the last decade, we have seen divergent returns among asset classes, i.e. if one asset class is performing well, the other may be underperforming. Out of the past 10 years, gold, equity and debt have outperformed for 5 years, 3 years and 2 years respectively. Not only have there been varying trends, but even the magnitude of variance has been very drastic. Thus, to account for this variation, asset allocation becomes the prime factor that can help.
Benefits of Asset Allocation:
1. Asset allocation is the key driver of portfolio returns
2. Since different asset classes have a weak or negative correlation; asset allocation helps in portfolio diversification
Asset Allocation leads to relatively better risk-adjusted returns by reducing the overall risk (volatility) due to diversification.
How do we achieve asset allocation?
You may wonder if it will be easier to have a single product that can provide asset allocation benefits, rather than figuring out the allocation yourself. Yes, there is.
A Multi-Asset Allocation Fund endeavours to achieve the above benefits by investing across minimum three asset classes. It invests in a combination of asset classes which are weakly/negatively correlated and seeks to provide relatively better risk-adjusted returns with much lower volatility. Multi-Asset Allocation Fund also provides Tax efficiency through rebalancing within the fund
There are essentially three ways through which these funds aim to achieve this
View-based asset allocation
In case of a view-based approach, the fund manager takes a view on a certain asset class and tries to be overweight on that asset class while being underweight on the few others. However, the problem with this approach is that as much as the fund manager can be right, there could be times when he may be wrong as well, and this could lead to a kind of double whammy. Not only is he getting his view wrong on that asset class on which he is overweight, but also on other asset class in which he is underweight if the latter tends to outperform. The risk of going wrong with a view-based approach may be higher simply because there are too many factors at play that may make it difficult to predict which asset class is going to outperform/underperform.
Model-based asset allocation
The second approach is a model-based approach where a Quant based model tries to assess which asset class will outperform/underperform and accordingly make investment decisions. But even this approach has the same problems as in case of a view-based approach. There could be too many dynamic factors at play which may be very difficult, if not impossible, to incorporate in a model.
Constant asset allocation
The third approach is a constant allocation approach. It’s a simple approach, and yet can be very effective. The key here is meaningful allocation to each different asset class (weakly correlated) with a view to harnessing superior risk-adjusted returns across market phases.
While you may think a multi-asset allocation fund can be the answer to your asset allocation woes, the approach taken by the fund is of equal importance. Therefore, one may invest in a Multi-Asset Allocation Fund, which adopts a constant allocation approach with an aim to achieve long term wealth creation!