Is Asset Allocation in times of COVID crisis important?

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The onset of the COVID-19 pandemic has triggered a resultant collapse of global markets. After a high of 12362 in January, the Nifty 50 fell to 7610 in March, which is a drop of 38%. Besides this, equity volatility may intensify up due to the intimidation by China and India over border disputes. At this moment of crisis, it is reasonable to blend assets wisely in order to minimize the risks. This mixing of assets is termed as Asset Allocation.

Some of the recent studies show that markets tend to move in cycles. Also, assets perform differently in different market cycles. For each asset, however, a mean-reverting stochastic process is visible. This means that assets tend to deviate from and revert to their fair prices over time. This makes a compelling case for asset rotation. Besides mitigating risks, asset rotation extends the probability of alpha. A study points out that 91.50% of the portfolio performance to asset allocation. In this study, individual stock selection and market timing accounted for a paltry 7% of portfolio return.
According to one’s risk appetite and goal proximity, a portfolio is built by combining heterogeneous assets like equity, debt, gold, REITs (Real Estate Investment Trust), InvITs (Infrastructure Investment Trusts), etc. A diversified portfolio encompasses assets that show low correspondences. Besides construction, portfolio rebalancing is significant in order to achieve ideal outcomes. Rebalancing is necessary if there is a portfolio change from the ceiling limits.

Also, social predispositions alter investment decisions. The deep-rooted instincts of fear and greed have helped us become evolutionary winners. However, survival instincts falsify investment decisions. Warren Buffet says, “Be fearful when others are greedy and be greedy when others are fearful.” Investors rarely follow this basic principle and face a downhill by making the contrary decisions. They tend to opt to panic selling when markets become rough due to fear of losses more than we value gains. Such an irrational conservatism demands huge opportunity cost due to potential investment gains foregone. Apparently, it seems challenging to fix the innate biases as they are hard-wired into us. To fix this distorted condition, it will be wise to employ processes that dynamically recalibrates asset allocation while keeping emotions and sentiments aside. The calibration triggers emanate from a quantitative model.

The model helps in efficiently capturing the upside while simultaneously protecting the downside. Analysts suggest Dynamic Asset Allocation or Balanced Advantage Funds that work on the aforementioned principle. Besides Equity and Debt, exposure in gold is also suggested. Domestic momentum in Gold is expected to be sustained by a flagging growth, low-interest rates, high liquidity, and depreciation of the rupee. At a period when the equity market is in turbulence due to the Covid-19 pandemic, gold retains its glory.

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