Asset allocation is the most important investment decision. This decision — of how much to invest in equities, bonds, gold, real estate, etc. — drives the performance of the portfolio more than any other decision, like which security to invest in or when to invest.
This diversity can be exploited by the portfolio managers to balance risk with reward, and deliver steady, long-term returns for investors, particularly in volatile markets. Investors investing into multi-asset allocation funds should pay attention to some finer details available in the schemes information document to understand the risks better.
As per SEBI guidelines on Categorization and Rationalization of schemes issued in October 2017, multi-asset allocation funds are hybrid funds that invest in at least three asset classes with a minimum allocation of at least 10 percent in each asset class. Multi-asset funds may invest in a number of traditional financial assets such as equity and fixed income, either through active investment strategies or through index funds, financial derivatives as well as commodities such as gold.
Data Source: AMFI as on March 31, 2022
Currently there are 10 multi-asset funds offered by mutual fund companies in India. Though all of them invest in at least three asset classes, there is a huge difference in the returns generated as can be observed in the table above; from ~5 percent to ~50 percent.
The standard deviation in the one year return across the 10 multi-asset funds is 11.88 percent as compared to the 3.78 percent standard deviation in the returns of 30 large cap funds for the same period. They also differ in the risk profile on the riskometer from very high to moderate. This highlights that in spite of belonging to the same category, multi-asset funds differ significantly in terms of their risk profile.
A closer look at the asset allocation pattern reveals that some funds invest into REITs and InvITs, in addition to equity, debt and gold/commodities, whereas other do not. Not all of these funds invest into international stocks.
Different types of asset classes in which the scheme would invest carry different types and levels of risk. Accordingly, the scheme’s risk may increase or decrease depending upon the assets composition. Understanding risk is challenging within a single class. It becomes exponentially challenging with multi-asset class portfolios, as the fund is invested in various asset classes with each of them having their own set of dynamics.
Further, investment management across these asset classes follow different strategies, and philosophies. Investments in stocks can be managed according to the size measured by way of capitalisation as large-, mid-, small-, and micro-cap, by style majorly classified as growth investing and value investing, by sectors such as FMCG, financials services, pharma, auto, IT, etc., and by geography as global, Asia, Europe, Latin America, Japan, BRIC, etc.
For bond investments the duration (long, medium, and short term), credit profile (sovereign, AAA, AA, high yield, etc.), geography (global, US, emerging markets, etc.), and currency (US dollar, euro, and local currency) dominate the investment strategies. In case of gold/commodities, macro-economic factors play a large role.
Apart from the choices of asset classes, funds are also different in terms to the asset allocation patterns, and the tolerance bands. Take for example the UTI Multi Asset Fund’s asset allocation pattern. Its indicative asset allocation pattern has a 65-80 percent exposure in equity and equity-related instruments, 10-25 percent in debt and money market instruments, 10-25 percent in gold ETFs, and 0-10 percent in units issued by REITs and InvITs.
The SBI Multi Asset Allocation Fund, on the other hand, invests into the same four asset classes, but its allocation tolerance bands are much wider. Its indicative asset allocation pattern has a 10-80 percent in equity and equity-related instruments, 10-80 percent in debt and money market instruments, 10-80 percent in gold ETFs, and 0-10 percent in units issued by REITs and InvITs.
The tolerance band impacts the levels of risk. A scheme’s risk may increase or decrease depending upon the investment tolerance bands. Funds with broader asset allocation ranges will have wider fluctuation in the risk profile. Wider bands allow more room for favourable investment performance to extend, and vice versa.
While the benefit of a wider tolerance band is greater opportunity for growth in a positively trending market, there is also greater potential for loss if the forecast about the board market movements go wrong. Making the tolerance bands too wide or too narrow is one of the most important design feature of a multi-asset portfolio, which can dramatically influence the performance of the fund.
A wider range provides an opportunity capture the potential of a rising asset class, and retrieve during falling markets. But this could also prove to be counterproductive, especially during unexpected turn of events, when the fund managers have let asset holdings drift to their maximum potential in the pursuit of higher returns, but the market behaved differently than what the fund manager has forecasted.
Investors investing into these funds should pay attention to the asset choices, and tolerance bands in the scheme’s information document.
Rachana Baid is Professor, National Institute of Securities Markets. Views are personal, and do not represent the stand of this publication.