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Amit Ganatra, senior fund manager, HDFC Asset Management Company, talks about the importance of diversification and how asset allocation is the key to creating wealth over the long term. As a fund manager of the HDFC Multi-Asset Mutual Fund he shares his views on how diversifying a portfolio amongst various asset classes such as equity, debt and commodities can benefit investors. Edited excerpts from his interview with Mint:

How can investors balance their risk and returns to absorb market volatility during different market cycles?

The key to wealth optimization across market cycles is portfolio diversification. It is nothing but distributing your investible surplus across various asset classes such as equity, debt, commodities, real estate and alternative investments with the goal of wealth optimization.

Asset allocation is required because different asset classes play different roles in a portfolio. An investor must be prepared for different cycles by investing in various asset classes such as equity, debt and gold. Equity provides capital appreciation but can be volatile; debt provides stability to the portfolio but offers relatively lower returns and gold acts as a hedge against inflation and currency depreciation.

Why is diversification important for an investor?

Each asset class behaves differently across different economic cycles. Out of the past 23 fiscal years starting from 1999, equity has been the best performing asset class in 12 years; debt has performed best in 5 years and gold in 6 years. Thus an investor can see that each asset class has its own ups and lows and it is impossible to predict which asset class will do better at what time. Asset allocation reduces the dependency on a single asset class to generate returns and also reduces the overall volatility in an investor’s portfolio. Thus, asset allocation has the potential to generate better risk-adjusted returns.

How does a multi-asset fund like yours help investors with asset allocation?

Multi-asset funds act as a solution for investors by taking care of the decision-making when it comes to asset allocation. Most multi-assets funds invest in 3 asset classes – equity, debt and gold. Asset allocation decisions based on past performance or without considering valuations may lead to sub-optimal future returns. Multi-asset funds automate this process for investors by investing in different asset classes in a specified range and in accordance with the valuations, fundamentals and relative attractiveness of each asset class. Such funds make use of model-based asset allocation to inculcate discipline and eliminate personal biases in asset allocation.

How should an investor review and manage his/her diversified portfolio across different market cycles?

One of the reasons appropriate asset allocation works is because assets such as equity, debt and gold have low or negative correlation with one another. Thus if a particular asset class is not doing well, the other one may do well and lift the overall performance of a portfolio. Hence, each asset class has a role to play in an investor’s portfolio. In that context, as long as investors have diversified their portfolio amongst various asset classes and rebalance regularly, the portfolio will perform well in the long run.

How should investors look at asset allocation in today’s market situation?

If you look at the current scenario, equities are doing well, while gold is underperforming. Now if you look back at the time the covid pandemic first hit India, it was gold that was doing well and equities were underperforming. In that sense focusing on a single asset class or changing your asset allocation based on current trends or underperformance will not be appropriate. An investor should not be concerned with the underperformance of individual asset classes and should focus on the risk-adjusted return of the overall portfolio. It is important to remain invested in each of the asset classes for a long time and look at the combined returns of the entire portfolio.

You can listen to the entire interview here.

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