How to do proper asset allocation in your portfolio?

Financial Planning | admin | September 3, 2011 at 8:51 am

It's been grilled into our head that asset allocation is a must if we want our investment plan to succeed. However, when it comes to drawing up an allocation plan, many people fumble or falter. It's not an easy exercise for many. For instance, the first thing that you have to set is your life goals.

Next, you have to decide on the instrument (or asset class) that will help you reach the goal. Again, there is the tedious process of reviewing the investment portfolio and rebalancing it — if there is a need — in case there the investment landscape undergoes a change. No wonder, many people pay only lip service to asset allocation plan. Actually, most of them end up investing in disparate avenues without a proper allocation plan.

If you are curious to see how asset allocation works, you can check out the asset allocation schemes from mutual funds. There are five fund houses with asset allocation schemes in the market. These funds will help you in allocating money across different asset classes, depending on your investment goals and risk-taking ability.

An asset allocation fund is an open-ended fund of funds that seeks to generate superior risk-adjusted returns to investors in line with their asset allocation. Put simply, the fund first defines an asset allocation and then identifies a basket of the funds in which it will invest to achieve the pre-defined asset allocation.

"Asset allocation funds are a good option for investors looking for expert handholding to invest based on asset allocation," says Chaitanya Pande, head-fixed income, ICICI Prudential AMC.

Most of the funds are built around risk profiles – conservative, moderate and aggressive — in which most of retail investors fit in. "It is the risk profile of the investor and the life stage that the investor is in that will decide which of these options he or she should choose," says Satyabrata Mohanty, head of multi-asset investments, Birla Sunlife AMC.

To make life simpler, Franklin Templeton AMC has come out with plans based on life stages, which will help investors to decide on a plan that will suit his age profile. For example, a 25-year-old person can choose to invest in FT India Life Stage Fund 20's plan. This fund has defined the asset allocation as 80% for equity and 20% for debt. Money is invested in Franklin India Bluechip Fund (50%), Franklin India Prima Fund (15%), Templeton India Growth Fund (15%), Templeton India Income Builder Fund (10%) and Templeton India Income Fund (10%).

"A life stage fund can provide investors a single-stop solution for their needs. This makes the investment process much easier for investors and the inbuilt rebalancing feature helps in maintaining the target asset allocation, which could go awry due to market movements," says Jaya Prakash K, head-products, Franklin Templeton Investments, India.

The best part of investing in an asset allocation fund is that you will get access to a basket of funds with different investment styles that will invest according to your asset allocation plan. It saves the time needed for investing in multiple schemes and tracking them.

But asset allocation — the key to wealth creation — is bereft of meaning without rebalancing. Asset allocation helps you to invest across asset classes and garner good risk-adjusted returns. Asset rebalancing helps you further by timely profit-booking. In a volatile market, asset prices move and profit-booking becomes a must.

For example, let's suppose you started with a 60% investment in equity and 40% in debt. Over a year, your equity investment doubled whereas the debt part generated 10% returns. At the end of the year, you have a debt-equity ratio at 73:27.

In that case, it is better to sell equities and transfer those holdings to debt instruments and bring the balance back to 60:40. This process of asset rebalancing at regular intervals ensures that money moves from one asset class to another in a disciplined manner without getting the investor emotionally involved.

Asset allocation funds just do that at stipulated intervals, say every six months. So, you, as an investor, need not worry about entering into or exiting from a fund. And, more importantly, this is done keeping decision makers' emotions at bay.

The funds can really work as a proxy portfolio for those who are not too keen on devoting much time on selecting funds and do not want to be involved in the demanding exercise of rebalancing assets. "Asset allocation funds are one of the best options for investors with a long-term horizon in mind, starting with at least three years," says Maju Nair, head-distribution, Sharekhan.

One can look at these funds with a much longer perspective, provided you can track the schemes at regular intervals. To curb the short-term traffic, most of these funds have exit loads if you decide to exit in short period of time. With a minimum investment of Rs 5,000, they are rather accessible.

To own them, you are charged at the most 75 basis points towards charges each year. Given the fund of funds structure, you have to borne the charges of individual schemes also, leading to higher costs compared to individual schemes.

Tax treatment is an area which investors should be careful about. If you do asset rebalancing in individual schemes every six months, you will be taxed for short-term capital gains. If you use the shelter of asset allocator funds, asset rebalancing is done in a tax-efficient way. The funds enjoy the tax treatment of a debt fund and you can avail of indexation benefit while paying taxes on long-term capital gains. For long-term capital gains with indexation benefits, you will have to pay tax at 20.6%, without indexation you will pay the

tax at 10.3%.

Of course, not everyone is a fan of these funds. "These fund, by and large, have been gross underperformers when compared to the returns generated by their top three-five scheme holdings. It makes little sense to invest, considering the additional effort and expenses one will have to incur besides the higher risk, for tracking so many underlying schemes when the underlying scheme itself generates better returns and is easier to track," says Devangi Bhuta, vice-president, Lotus Knowlwealth.

Then there is another school that prefers to keep things simple — provided the investors are willing to put in some efforts. "It makes sense to identify one's financial needs and invest in individual schemes than going for readymade solutions," says Amar Pandit of My Financial Advisor.

Source: Economic Times