It
is the very trait of the securities markets to move backward
and forward from one end to the other depending on the
popular frame of mind and in such times, those who can part
reason from sentiment can mark opening.
Well, there is a response in one of the proven portfolio
investment line of attack - Asset Allocation/portfolio
management. What is asset allocation? How does it work? How
does it help an investor to invest opposing to the stock
market?
Portfolio Management is the scientific process of separating
all your money across various non-correlated asset classes.
In simple terms, if your money is allocated between, bonds
and, you have taken the first step.
One may consider various other investment options like
property or gold but as they don’t have an direct impact on
stock exchange, therefore, we would not discuss that at
present in this article.
The second stride is to know how much money should be
allocated in which of the options. Now this is a function of
two things, the investment alternative has certain traits or
uniqueness and the investor has certain financial objective
as well as certain risk hunger.
This risk appetite is again a function of one's needs as
well as mental ability to handle the unexpected. The science
of asset allocation tries to put together a portfolio that
matches the traits of the assets with the requirements of
the investor.
There is a mixture of approaches to take on by different
advisors to build portfolios for their clients largely
keeping the clients' needs in mind. We will not get into the
discussion of the same here since the result would be
different for different investors since their requirements
would be poles apart from one another.
Let us come back to the argument of what asset allocation
can do and how it can help investors. We will try to keep it
very easy only for the rationale of understanding. The
actual portfolios or the realistic approach cannot be so
straightforward.
Let us assume that after evaluating the needs of one of the
customers, the consultant recommends investment of 700% of
the assets in an equity mutual fund and 30% in a money
market mutual fund.
The shareholder and the consultant then make a decision to
appraise the performance of the portfolio every six months.
The review process is also very simple. The objective would
be to maintain the allocation between equity fund and money
market fund at 70:30.
Given that the stock prices are volatile over shorter terms
and move in line with the profits of the company over longer
phase, we are likely to see the value of the equity mutual
fund go up and down over time. When that takes place, the
asset allocation would stray from the 70:30 that was set in
the beginning.
When the equity prices move up faster than the debt prices,
the allocation will get skewed in favor of equity and our
review process would restore it back to 70:30 by shifting
some money from equity fund to debt fund. In the other case,
when the equity prices move adversely, the balance would get
skewed towards debt and the balance can be restored by
shifting from debt fund to equity funds.
In realism, the shareholder may get inflows, which require
to be invested in the portfolio or have a need to take some
money out of the investments. In such cases, at the time of
investment or redemption, the investor has to look at the
current market value of the equity fund and debt fund and
rebalance the portfolio to 70:30.
