Monthly Archives: June 2017

Thursday Trivia ~ Asset Allocation (Series 3 of 3)

In our previous series of Thursday Trivia, we touched upon the definition of Asset Allocation and three strategies to achieve the same namely, Strategic Asset Allocation, Tactical Asset Allocation and Dynamic Asset Allocation. Following which we got various questions on emails, which we will answer here. Certain questions have been asked twice, so we have consolidated them.

To answer these specific questions, we have requested Mr. Saurabh Mittal, Founding Partner of Circle Wealth Advisors. His rich experience always helps to uncover deeper aspects on the subject of personal finance.

Following are a few questions we have shortlisted.

Question 1 : Hello, I am just starting my career. Would asset allocation matter to me? 

Answer : Asset Allocation is not just a factor of age, but also of the goals you want to achieve. It also takes in to account your risk profile. As a rule of thumb, your equity allocation should be 100 minus your age. But this is just a broad view of how allocation should be. Once you have created an emergency fund (which is around 3 months of your expenses saved in separate basket) and want to start saving for your long term goal of financial freedom then all investment towards this goal can go to equities.

Question 2 : Is there any strategy to Asset Allocation other than the three which are mentioned during the series?

Answer : Yes, there are several other strategies for asset allocation apart from the ones mentioned in the series. In our experience different strategies work for different people. But the safest form of asset allocation is Strategic Asset Allocation which helps reducing the risk and volatility on investments immensely.

Question 3 : My primary investment is in real estate, how can I do Asset Allocation for the same?

Answer : Real Estate by nature in not a liquid investment. Once you have a strategy in place and have decided the allocation in different assets, the only way to execute the strategy is by selling the real estate. This is how it works with not only real estate but any other asset class. To rebalance the asset allocation you would have to sell investments in assets that have become overweight over a period. The only draw back with real estate is that to rebalance the same you cannot sell it partially.

Question 4 : Can we use crypto currencies for Asset Allocation? If yes, then under which asset class it would fall?

Answer : Any asset in which you invest becomes a part of asset allocation. Its desired that you take exposure to that asset to the tune of its requirement as per your strategy. Crypto currency as the name suggest is a currency and a mode of payment. In our view, since it does not have a cash flow of its own, it should be treated as cash equivalent as an asset class.

Question 5 : Which strategy would work for a retired individual?

Answer : It again depends on the number of years left for the consumption of retirement corpus. For people who have recently retired, we advice people to invest through bucket strategy. Where the money required for consumption in next 3 years should be invested in debt funds and balance in equities. This should be rebalanced every year and the debt fund should be funded such that it is adequate for next three years of expenses. This strategy not only helps in having better longevity of the corpus but also brings a more certainty to the cash flow in terms of systematic withdrawal plan from debt funds.

Question 6 : What concerns must be taken in order to switch from Strategic Asset Allocation strategy to Dynamic Asset Allocation strategy?

Answer : Dynamic Asset Allocation is more focused on the current market conditions as compared to Strategic Asset Allocation. We advice that, Dynamic Asset Allocation should be done with the help of experts. Also it can be applied only to a particular asset as well. For example, as a strategic allocation if you decide to have equity allocation of 70% in the portfolio. This 70% portion can be dynamically managed.

Question 7 : What role do current market conditions play in the Asset Allocation decision-making process?

Answer : Strategic Asset Allocation process helps in ignoring market movements and conditions. While taking important decisions with our money, usually a strong reliance on given on market and it’s past performance, however with implementation of the above mentioned process, such actions are not to be taken into consideration. It’s just important to stick to risk profile and goal profile which has been charted out and rebalance the portfolio on particular time frame which is pre-decided.

Question 8 : Can we do a sector wise Asset Allocation? If for a certain period of time, infrastructure as an asset class is doing well, then can we build our portfolio around it?

Answer : Sector wise allocation can be done through Dynamic Asset Allocation strategy. However, it’s important to note that sector wise allocation would be a part of overall strategy which would include exposure to other asset classes as well.

It has to be understood that, targeting a particular sector is like timing the market. It is a riskier alternative and will need an expert’s advice from time to time. Additionally, it will bring more volatility into the portfolio and increase the transaction costs. Strictly playing the sectors through direct equity or mutual fund is absolutely not recommended.

Please find the link to our previous articles

  1. Thursday Trivia ~ Asset Allocation (Series 1 of 3)
  2. Thursday Trivia ~ Asset Allocation (Series 2 of 3)

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– Jinay Savla

Thursday Trivia ~ Asset Allocation (Series 2 of 3)

Previously in Thursday Trivia, we discussed about what Asset Allocation is and touched upon Strategic Asset Allocation. In a nutshell, it’s important to look at what an individual’s money is doing at an overall level rather than merely checking the stock prices everyday and wondering whether enough money could ever be saved. Many a times, in our profession as Wealth Managers, we meet investors whose only concern in equity market. When asked for other investment avenues, a standard reply is fixed deposit which most of them are not worried about unless the interest rates go low, in that case there is a strong urge to jump in the equity market. Not to discredit an important fact, that technology has eased entry points into the capital markets.

In this Trivia, we will look at Tactical Asset Allocation and Dynamic Asset Allocation.

Tactical Asset Allocation

As the name suggests, it is an active portfolio management strategy that shifts the percentage of assets held in various categories to take advantage of market pricing anomalies or strong market sectors. This strategy allows for taking advantage of certain situations in the market place to create some additional value. It can be termed as moderately active strategy than Strategic Asset Allocation. However, there is always reversion to original asset allocation mix once the short to medium term value is added to the portfolio.

5 brief characteristics of Tactical Asset Allocation are:

  1. It is a view based strategy in which asset allocation is based on views of relative asset class performance.
  2. It involves tactically increasing a portfolio’s exposure to those assets that are relatively attractive and reducing a portfolio’s exposure to overvalued assets.
  3. Short-term adjustments in asset allocation are frequently made so that the portfolio can earn higher returns and beat the performance of benchmark indices.
  4. Timing and active management of risk are key components of tactical allocation. Entry into asset classes and exits from investments have to be timed correctly.
  5. Factors that impact asset class performance are continuously monitored and assessed to take the correct calls.

Let’s simplify the concept using an example:

Aman and his wealth manager decided to carry out Tactical Asset Allocation. Since, Aman was keen on taking advantages on strong sectors in different asset classes. Once the advantage was taken care of, they would return to their original asset allocation mix. With Investment Capital of Rs. 1 crore, they mutually decided to keep 40% of their money in equity market, 30% in fixed income securities, 20% in commodities – gold and balance 10% was kept as cash.

After a year, on a periodic review, Aman’s wealth manager suggested to increase the allocation towards gold as data suggested a very good opportunity for the next 2 years. More than Aman, his wife was thrilled with the idea. Gold is always special, whether it’s physical or kept in a demat format through Exchange Traded Funds. However, as per their planning, original asset allocation would enable Aman to reach his goals in a very sound and smooth manner, Tactical Asset Allocation provided him an area where he could tap an opportunity.

With this opportunity, Aman’s portfolio now had 40% in equity, 20% in fixed income securities, 35% in commodities and 5% in cash. 15% of the portfolio now shifted from fixed income securities (10%) and cash (5%) to commodities – gold.

Had Aman strictly followed Strategic Asset Allocation, he would not have been able to capitalise on the opportunity present. Hence, Tactical Asset Allocation provides flexibility to take market calls as and when needed.

With this, now we head to third strategy of asset allocation.

Dynamic Asset Allocation

This particular strategy, may involve several portfolio adjustments over the short term to respond to market conditions. There is no target asset mix because allocations can be changed based on their assessments of current and future market trends. For example, if global market uncertainties result in sharp losses in the equity markets, investment managers may sell stocks and buy bonds because fixed income instruments, especially government-issued bonds, are considered low-risk and safe investments.

Wealth / Investment managers analyses market and economic trends to select and trade investments within the portfolio. They would aim to sell top preforming investments and buy undervalued assets (following the buy low, sell high principle of investing).  The goal is to achieve the best returns possible with the aim of out preforming the benchmark. It is considered more risky compared to other strategies as with more risk comes more returns. However, dynamic asset allocation could underperform market averages, especially in volatile markets, because of high trading costs associated with frequent portfolio rebalancing.

However, the key difference is asset allocation here depends on market conditions rather than risk profile of the investor which is the very case of Strategic as well as Tactical Asset Allocation.

Let’s take the example of Aman in this case, what if he chooses Dynamic Asset Allocation strategy over Tactical Asset Allocation strategy. How would the process differ?

With his original asset allocation of 40% in equity, 30% in fixed income securities, 20% in commodities – gold and 10% in cash. Aman and his wealth manager decide not to rebalance the portfolio unless there is a major shift in the market conditions.

After 3 years from original allocation, Aman’s portfolio now stands at 55% in equity, 30% in fixed income securities, 10% in commodities – gold and 5% in cash.

Aman’s wealth manager advises him, according to the market conditions it is better to sell equity and gold and buy fixed income instruments. Since, equity levels have gone up, his wealth manager wants to be safe and protect his money incase of any equity market correction. Also, since the gold is held in demat form, it can be sold and be in instruments that are not extremely market linked.

One of the major characteristics of Dynamic Asset Allocation is to completely shift the original allocation and tailor make it to suit the current market conditions. Now Aman’s portfolio has just 10% of equity, 80% of fixed income instruments, 5% of commodities – gold and 5% of cash. As per the logic of the strategy, when the market will correct, Aman will be able to buy more of equity and gold without having any substantial effect on his investment portfolio.

In our next Thursday Trivia, we will cover specific questions which we have encountered over the years. Till then, in case you have any query please do write in the comment section below.

Please find link to our previous article – Thursday Trivia ~ Asset Allocation (Series 1 of 3)

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Disclaimer:  This particular series of Asset Allocation is only meant for educational purposes. We do not in any ways recommend it, as the case may differ for investors per se. These are simply model strategies of asset allocation, hence modification is required for each investor.

– Jinay Savla

Thursday Trivia ~ Asset Allocation (Series 1 of 3)

One day, Amar was sitting with his wife to decide about their investments. Normally, Amar’s uncle who works for a company which regularly deals with stock markets, advises him. Inadvertently, Amar always invests in the shares of the companies suggested by his uncle. Which has resulted in a list of 55 stocks, report of which is about 3 pages. Amar got too confused as he cannot keep a track of all these companies. His wife suggested it’s time they took an advice from a professional wealth manager. However, Amar was reluctant at the start as he didn’t need a third person to advise him on what he should be doing with his hard earned money. At the end, the couple connected with a wealth manager.

With professional advice, Amar was suddenly exposed to concepts such as goal planning and asset allocation. A term which was heard yet understood at the very least. An additional layer of reluctance was built up. Yet, he got enlightened to the fact that how unplanned his money management is and to build on that, he had only considered shares bought by him as investments.

It happens with most people when a question is asked ‘where are your investments?’, a standard reply is always shares and mutual funds. When a second question is asked, ‘are you tracking your investments?’, reply emerges as ‘yes, we get quarterly reports and we know what’s happening.’ Nobody is wrong here. Labour pays the highest returns, hence the focus is always on the task at hand. Yet, it becomes tremendously important to have that hard earned money, make money in return. Which is precisely where asset allocation comes into the picture. It’s a subject that every wealth manager discusses with his investors. Not just to educate them, but to make them better investors.

Asset allocation is defined as an investment strategy by which an investor or a wealth manager attempts to balance risk versus reward by adjusting the percentage of the amount invested in an asset of a portfolio according to the risk tolerance of the investor, his/her goals and the investment time frame. Too complex, isn’t it? Let’s break it down in simple words.

Asset classes are usually the very first word used by a wealth manager. Broadly, there are 4 types of asset classes:

  1. Real Estate
  2. Fixed Income Instruments such as fixed / time / recurring deposits / liquid funds, loan given.
  3. Equities such as shares of companies / mutual funds / PMS, etc.
  4. Commodities such as Gold / Silver, etc.

Asset classes serve different purposes for an investor. Hence, an appropriate allocation should be created by investing a certain percentage of wealth in each of the asset classes. However, it should be taken into consideration that real estate, insurance and fixed income instruments with a maturity date are illiquid. Rebalancing of real estate and insurance cannot be done on a particular date every year. Even fixed deposits with a higher maturity period cannot be rebalanced. Such challenges must be carefully looked into while creating a portfolio.

Risk mitigation is also an important characteristic of asset allocation. As the investor’s portfolio is diversified in different instruments, risks arising from news-based events will not have major impacts. For example, if the Reserve Bank of India decides to cut interest rates, then the interest yield on fixed deposits will go down. Conversely, as this move makes loans cheaper for companies their profit margins will rise. Better earnings will attract higher price which will create a positive impact on equities. Hence, such an exercise takes away the pressure of any unforeseen event. With this, let’s look into different strategies for asset allocation.

There are 3 key strategies to asset allocation, such as:

  1. Strategic Asset Allocation
  2. Tactical Asset Allocation
  3. Dynamic Asset Allocation

Strategic Asset Allocation

A portfolio strategy that involves setting target allocations for various asset classes, and periodically rebalancing the portfolio back to the original allocations when they deviate significantly from the initial settings due to differing returns from various assets. Too technical? Let’s break it down to simple words.

For example, Virat Kohli and MS Dhoni are chasing down a target against Pakistan. In last 10 overs, they have to make 100 runs. With these 2 at the crease, every Indian is sipping a nice tea at home without any worry. In simple terms, they need to make 10 runs every over. So, the strategy would be at least hit a boundary in every over. If they stick to this strategy, then if in the first 3 balls MS Dhoni hits 1 six out of the cricket ground, resulting in just 4 runs to be taken during the over. It will help them in not hitting every ball for a boundary (controlling greed) and not be losing a wicket by playing any risky shot (controlling fear). If they just make 10 runs every over, India will win the game with relative ease and less stress. Not to forget, even the tea will taste damn good.

Similarly, when an investor parks his money in different assets. Their values change over time. But if the goal is to reach a specific net worth after which the investor won’t need to work for money. Then a rebalance in his portfolio can be made based on the investment period which a wealth manager and investor mutually decide. Usually, it’s semi-annually or annually. Rebalance helps in bringing back the investments to the same allocation which had been pre-decided and entered into.

When Amar sat with his wealth manager, he was delighted to have a new world open up to him. Conversations were around his most important goal – retirement, for which strategic asset allocation had to be implemented. Retirement was due after 15 years. As maths worked its way, Amar would need a corpus of Rs. 2 crores upon his retirement to maintain his current lifestyle adjusting for inflation. With his current corpus of Rs. 50 lakhs, exposure of 60% equity, 30% fixed income instruments and 10% in Gold was decided. With 10% returns on his portfolio for the next 15 years, a corpus of Rs. 2 crores looked achievable. It was mutually decided to rebalance the portfolio annually. The stress of life after retirement was suddenly taken off from Amar and his wife’s mind.

After a year, Amar met with his wealth manager. Investments in equity had gone up by 12% becoming Rs. 33.60 lakhs while his fixed income instruments and gold went up by 7%, resultant Rs. 16.05 lakhs and Rs. 5.35 lakhs respectively. As Strategic Asset Allocation demands investment to be brought back to original allocation (annual rebalancing), Rs. 60,000 worth of equities had to be sold and Rs. 45,000 worth of fixed income instruments and Rs. 15,000 worth of gold needed to be bought.

So now, Amar’s investments had grown from 50 lakhs to 55 lakhs. This way, his allocation remains the same as it was entered into a year ago. There is no need to rely on anyone to decide what to buy and what to sell. By just sticking to the strategy, decisions can be taken with a relative ease.

In our next Thursday Trivia, we will cover Tactical and Dynamic Asset Allocation. Till then, in case you have any query please do write in the comment section below.

Disclaimer:  This particular series of Asset Allocation is only meant for educational purposes. We do not in any ways recommend it, as the case may differ for investors per se. These are simply model strategies of asset allocation, hence modification is required for each investor.

– Jinay Savla