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Business News/ Opinion / A made-in-India asset allocation
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A made-in-India asset allocation

Here is an illustrative asset allocation that is likely to suit most investors

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Your financial adviser must have shown a typical asset allocation for you with an ideal distribution of your investible wealth across equities, debt and cash. One key reason for restricting the asset allocation to these three classes is historical advice coming in from Western countries, where affluent customers typically do not invest in gold, real estate and international investments. Another (and more probable) reason is regulatory in nature: banks, which are the pre-dominant advisers in India, do not offer real estate products or smarter gold products and, hence, you will not see these in your recommended asset allocation.

However, our on-ground experience from working with investors has shown that a majority favours real estate and gold as asset classes for investments. Hence, the asset allocation recommended to you is only for the financial assets part of your wealth, and by definition is incorrect since you cannot give asset allocation advice on a part of the wealth.

There are some advisers who have indeed started talking about real estate and gold in your asset allocation, but a sampling of such allocations on the Internet shows real estate allocation in the 5-20% range for the conservative to aggressive investors. In real life, how do you allocate 5% of your wealth to real estate? If you are investing in a second apartment in any of the metros, you need to have at least 50 lakh for it, and if that amounts to 5%, then your net worth should be 10 crore—hopefully, you won’t be needing basic asset allocation advice at that level.

Again, there is a bit of a Western advice hangover in that smaller allocation to real estate. It’s possible to do so through real estate investment trust (Reit) products, common in the West. The Indian regulations for Reits, however, are being formulated even as we speak. Till that happens, the real estate funds under the new alternative investment funds regulations start at a minimum investment of 1 crore.

We have decided to acknowledge that real estate is the elephant in the room, as far as asset allocation in India is concerned. Instead of veering the topic towards financial asset allocation, we need to take the issue head on, and need to make the discussion more comprehensive.

Instead of a single-step overall asset allocation, we suggest a two-stage approach. Here is an illustrative asset allocation that is likely to suit most of the clients we come across.

Stage 1: Overall allocation towards the super classes of financial assets, real estate and other real assets

The idea behind this is to make sure that the high-level distribution of assets among these super classes is separated from the next level of discussion about asset classes, sub-classes and instruments. A typical recommendation is 40-60% of your investments should be in financial assets, another 40-60% in real estate assets and 0-10% in other real assets such as physical gold, art, etc. Real estate assets here exclude primary residence, and include all other holdings (net of loans) such as land, physical properties taken from an investment perspective as well as contributions towards real estate funds (such as real estate equity funds, Reits, and others).

In general, the split between real and financial assets is driven less by risk appetite and more by client’s specific preferences. Hence, we have kept the first stage to allow for a more policy-driven discussion on how much to hold in real assets and how much in financial assets. The allocation indicated above are open to client discretion; the suggested split being an overall guideline.

Stage 2: Allocation of financial assets among equity, debt and alternate assets

This is closer to the conventional asset allocation most of us are used to. The alternate asset portion in this case excludes real estate and physical gold, which are already covered in the stage 1 allocation as stated above.

For an investor with a moderate profile, a typical allocation could be: 50% equity, 30% debt and 20% in alternate assets. Equity could have 45% in listed domestic stocks and 5% in international stocks. Debt would comprise 18% long term and rest in short term. High-yield debt such as secured real estate non-convertible debentures could form 15% of the 20% in alternate assets with the rest coming through gold exchange-traded funds. The equity component of the conservative and aggressive profiles would be 10% on either side of the moderate allocation, and other classes could be determined accordingly.

The second stage is driven more by risk appetite and the observed or expected risk-return characteristics of each financial asset class. Therefore, these fall into the usual conservative, moderate and aggressive types.

The overall split between real and financial assets suggested in stage 1 also mirrors the actual inflows at the level of the national household savings. Because real estate and gold figure so high in our investment consideration, we need a bespoke Indian approach to asset allocation, and cannot make do with the Western models.

We also need to be careful about the models proposed by advisers who advise only on financial assets, and might suggest that asset allocation pertains to only that super class.

Elephants need to be taken out in the open, and then the discussion will be realistic and truly in your benefit.

Sunil Mishra is CEO, Karvy Private Wealth.

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Published: 10 Feb 2014, 07:06 PM IST
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