Global stock markets have seen huge gains post-pandemic. The past two years now seem like a distant dream for an investor as the markets began to correct. Year-to-date, the Indian stock market is down more than 10% and the short-term outlook looks uncertain. Some of the factors that could lead to market volatility are rising crude oil prices, aggressive monetary tightening and interest rate hikes by global central banks, a stiffer inflation profile due to disruption of supply and uncertainty surrounding the ongoing Russian-Ukrainian war. Therefore, this can be a difficult phase for an investor who is new to investing.
Given uncertain times, we believe the way forward requires careful investment strategies and starts with respecting asset allocation. Each asset class – stocks, debt, gold, international equities – has a distinct role to play in a portfolio. Historical performance data for various asset classes shows that a winning asset class keeps changing every two years. While the equity market tends to do well in expanding economies, debt tends to do well in contracting economies. Another asset class – gold – acts as a good hedge against inflation and therefore cannot be ignored in the composition of the portfolio. Thus, the key is to build a portfolio that has an optimal asset allocation to meet one’s needs.
Challenges faced by an investor
Emotional/behavioural biases: The most common emotions an investor encounters are greed and fear. Both limit an investor’s ability to make good investment decisions. Even at the bottom of the market, investors refrain from investing because fear acts as a powerful deterrent. On the other hand, investors tend to hold onto loss-making investments in the hope that one day they can recoup the losses and make the investment profitable.
Inability to decide on asset class exposure: It is a well-established fact that one should invest in all asset classes such as stocks, debt, gold, etc. Since each asset class has a unique role to play in a portfolio, no asset class can be ignored. However, as an individual investor, it is difficult to decide how much to invest in each asset class and, more importantly, when to exit or rebalance a portfolio. This requires some finesse.
Inability to select the right investment instruments: There are a variety of offerings available in the realm of equity and debt mutual funds. Each fund has its own unique investment strategy or philosophy. Choosing which of these schemes best suit an investor’s needs required an element of research. Additionally, if one wishes to gain exposure to international equities, there is an additional layer of complexity that comes into play.
Tax impact management: Every buy and sell transaction made within the investment journey is subject to long-term or short-term capital gains tax. Thus, rebalancing is a difficult exercise, especially in terms of taxation.
Passively managed portfolio
A passively managed asset allocation system is a system in which the underlying will consist of ETFs and index funds of all asset classes. For example, there are systems that offer investors a mix of all asset classes – domestic stock ETFs and index funds and debt ETFs. Although the fund invests in passive instruments, the fund manager is actively involved in identifying the class and composition of the assets. Additionally, the tactical decisions made by the fund manager from time to time are likely to help generate better risk-adjusted returns over the long term. Such a plan is both cost-effective and tax-efficient. Each time the fund is rebalanced, the investor does not have to worry about the tax consequences.
In summary, a passively managed multi-asset system combines the ease of investing with the help of skilled fund managers who are always looking for ways to improve portfolio performance. Given its exposure to various asset classes, the program is a unique low-cost investment for investors looking for asset allocation-based solutions.
(The author is Head – Product Development and Strategy, ICICI Prudential AMC)