Asset allocation can work through mutual funds too

Asset allocation can work through mutual funds too

In an extraordinarily complicated environment, the challenge of ensuring long-standing financial security, freedom and prosperity continues to be determined by two fundamentals—optimal savings and prudent investments.

Consequently, the returns on those investments, which an Indian investor obtains, tend to be largely moderate vis-a-vis their potential. This may be attributable to investment methods that may be arbitrary, inadequately researched and/or unappreciative of the actual investment horizon and investment expectations of the investor. It is, therefore, essential for Indian investors and financial professionals alike that they appreciate the necessity of a methodical approach to investments.

The basic idea of investments is to deploy a saved corpus into a medium that can enable reasonable income and/or accumulation without minimal intervention or effort from the investor, while ensuring that such an investment factors in the risk appetite of the investor. Most importantly, such an investment approach must also build-in the restrictions (or opportunities) placed by the investment horizon. MFs play a significant role in addressing these requirements. In its essential detail, an MF is a pass-through vehicle through which investments can be made in a professionally managed portfolio of disparate asset classes.

Among the key benefits of investment in an MF is the potential of risk-adjusted returns, objective-driven investment, professional portfolio management service, competitive investment costs, and potential tax benefits. More crucially, through MFs, investments can be made in asset class portfolios comprising domestic equities, gilt, corporate bonds, money market instruments, gold and overseas equities. These asset classes may be constituents in MF portfolios in varying ratios and combinations and are managed within the broad framework of legally regulated investment objectives and investment strategies.

Thus, the investor’s allocation between varying asset classes (by means of these funds) can depend on investors’ unique circumstances and requirements. The choice may depend on the fair compatibility of investment objective, time horizon and the overall risk profile of the investor.

The idea behind employing asset allocation as an investment strategy dwells from the fact that various asset classes behave differently and have disparate influencing factors at any given point of time. In other words, the assets involved tend to have a weak to incidental correlation among each other and, therefore, hedge the concentration risk of the portfolio.

For example, in a high interest rate environment, where an investor has to incur a higher equated monthly instalment on loans, the investor’s otherwise low income-generating funds (kept aside for meeting immediate cash needs) may earn a relatively higher interest by means of investments in ultra short-term debt funds, while managing their liquidity demands. Thus, an investor can marginally alleviate the pressure of a high rate environment with astute application of cash management opportunities provided by liquid/ultra short-term debt.

To carry the idea forward, asset allocation reduces the overall risk of an investor’s portfolio since the volatility and the return effect of the underlying asset is limited to the extent of its exposure. Thus, it becomes statistically possible to estimate and to strive to reduce portfolio volatility, while maintaining the potential for relatively high returns.

Sandesh Kirkire is CEO, Kotak Mahindra Asset Management.