In the dynamic world of investments, the concept of a multi-asset portfolio has been gaining traction, offering savvy and new investors diverse options for risk and returns. We will embark on a journey through the realm of multi-asset investing.Why does investing in multiple asset classes make sense?
Asset Class winners change over time.
In the world of investing, what’s hot today may not be tomorrow’s winner. As illustrated in exhibit 1, Since 2005, various asset classes have taken turns as leaders in terms of returns.
For instance, during certain periods, domestic equities may shine, driven by strong economic growth, while during economic uncertainties or inflationary periods, gold might take the lead.
Meanwhile, bonds (debt) can provide stability during market downturns. Recognizing that winners among asset classes change over time highlights the importance of diversification.
By including a mix of these asset classes in your portfolio, investors are better positioned to capture opportunities regardless.
Different asset classes have different risk and return profile
Each asset class behaves differently across different market cycles. Asset classes like domestic equity, international equity, gold, debt exhibit varying risk and return characteristics.
As illustrated in exhibit 2, diversifying among these asset classes can provide better risk-adjusted returns as compared to having invested in a single asset class.
Asset allocation across different asset classes reduces dependency on a single asset to generate returns. It mitigates the volatility of portfolio returns and keeps drawdowns in check, allowing your investments to weather the various economic cycles and remain resilient.
3-year rolling risk and returns of different asset classes
Correlation & Diversification
As demonstrated in Exhibit 3, the correlation matrix of domestic equity, international equity, debt, and gold unveils the true beauty of diversification. It showcases the fact that these asset classes don’t move in lockstep with each other.
When one asset class experiences a downturn, another may either remain stable or even show positive performance. This low correlation is a clear indicator of the effectiveness of combining these assets to spread risk.
For instance, during a market downturn, while domestic equities may face challenges, assets like gold and bonds often exhibit inverse or uncorrelated movements.
This means they act as a hedge, helping safeguard and preserve the value of your portfolio. This diversification not only serves to enhance the risk-adjusted returns of your investment portfolio but also reinforces its resilience, even in the face of turbulent market conditions.
Creating a well-diversified portfolio is achieved by strategically combining low or negatively correlated assets such as domestic equity, international equity, Debt, and gold.
As portrayed in Exhibit 3, all four asset classes consistently display low or negative correlations with one another, reaffirming the wisdom of their combination.
Correlation among different asset classes since 2002
Before we wrap up, let’s explore an analogy that brilliantly encapsulates the essence of building a multi-asset portfolio. Imagine you’re a skilled chef preparing a gourmet meal. Would you rely solely on one ingredient to create a masterpiece?
In the world of investing, a multi-asset allocation strategy is akin to the art of fine cuisine. Each asset class – whether it’s domestic equities, international equities, gold, debt, or other options – is like a unique ingredient in your financial recipe. Just as a skilled chef carefully selects a variety of ingredients to create a harmonious and flavourful dish, a well-thought-out investment portfolio combines these diverse asset classes.
Consider domestic equities as the hearty protein, international equities as the exotic spices, gold as the precious seasoning, and debt as the stabilizing base.
Much like a chef blends these elements to craft a culinary masterpiece, an investor strategically combines these assets to create a well-diversified portfolio.
Just as a gourmet meal is more than the sum of its ingredients, a diversified investment portfolio transcends the individual assets within it.
It’s the careful balance and synergy between these asset classes that allow your investments to thrive, providing both growth potential and stability.
In this ever-evolving world of investing, one thing remains constant: the power of diversification. Investing in multiple asset classes is a smart approach that recognizes the changing nature of investment winners, the diverse risk-return profiles of different assets, and the benefits of combining low correlated assets.
Building a well-balanced portfolio that includes domestic equity, international equity, debt, and gold can enhance resilience and potentially lead to more consistent, and robust long-term investment returns.
The key to successful multi-asset investing is aligning your portfolio with your financial goals and risk tolerance, not attempting to time the market.
In our upcoming blog, we will take a more in-depth look at how both new and seasoned investors should navigate the world of multi-asset funds.
We’ll explore the nuances of investing in these funds, offering valuable insights into the potential pitfalls that can arise in discretionary multi-asset strategies.
(The author is Head of Research – Passive Fund, Motilal Oswal AMC)
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)