Multi-asset investing is like building a cricket team

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The performance of asset classes varies over time, making it difficult to predict winners and losers from year to year. The same asset classes will not always be on top. Our research shows, for example, that various asset classes / markets which were winners in some years were losers in subsequent periods, and vice versa. For example, Indian stocks outperformed in 2009 and 2010, but turned out to be the worst performers in 2011. When global stock markets experienced steep corrections in 2008, debt eclipsed. In 2013 and 2019, when Indian stocks performed poorly, international stock markets such as the United States and Europe outperformed. Based on a compound annual growth rate (CAGR), developed markets driven by U.S. equities have outperformed Indian equities since 2008.

Global winners and losers

Why does the performance of asset classes vary from period to period? Each asset class tends to have different economic or return drivers, resulting in varying performance over time. For example, Indian stocks provide exposure to Indian economic drivers and would perform well during positive cycles in the domestic economy and corporate earnings and underperform during an economic downturn (e.g. in 2008, 2018 and 2019 ). International equities provide exposure to global economic engines and hedge against the local currency. The depreciation of the Indian rupee improves the returns of Indian investors who invest in international markets. Interestingly, a multi-asset portfolio (40% Indian stocks, 10% global stocks, 45% Indian fixed income and 5% gold) has not been at the bottom of the chart for no year and has outperformed several assets over time, underscoring the essence of its portfolio diversification across asset classes and markets.

Reduces the risk

Indian stocks have performed well over time, but have seen steep declines at times and long periods of recovery. Drawdown is the maximum drop in the value of a security or index during market declines. And the payback period indicates the time taken to recover the original value of the investment. For example, if one had invested Rs100 in Indian stocks at the peak of the market in January 2008, its value fell 64% to Rs36 during the global financial crisis and it took about 86 months to recover the initial investment of Rs100!

Several asset classes experienced a drop in levies during times of crisis. Markets and asset classes behave differently, in terms of risk and return, due to a less than perfect or sometimes weak correlation of one asset to others. In other words, asset classes generally do not move to the same extent across market cycles. This means that a multi-asset portfolio would amortize the portfolio during declines compared to an equity portfolio only by reducing the risk of drawdown.

Why is it essential to reduce the risk of drawdown? As the drawdowns increase, the subsequent market performance required for the trade-in must be greater than the drawdown percentage. The table below shows the rise required to recover losses.

Potential to generate higher returns

Research highlights that the expected returns of asset classes vary over time in predictable ways, creating opportunities for investors to improve returns. An investment approach focused on opportunistically looking for assets that are priced to generate higher returns while keeping a long-term perspective is called valuation-oriented asset allocation.. Benjamin Graham, the grandfather of value investing, said: “In the short term the market is a voting machine, but in the long term it is a weighing machine. Simply put, markets measure short-term sentiment, but real value determines returns over time.

Understanding the difference between price and value is an important point for asset distributors. Over the very long term, stock returns are almost entirely determined by fundamentals as measured by total payout return (including dividend yield and stock buybacks) and earnings growth. This idea places the responsibility of long-term investing on a thorough understanding of the fundamentals. So, the goal of valuation-driven asset allocation today is to gain a deep understanding of the assets in which we invest.

In conclusion, a successful investment can be thought of as looking for assets that trade for less than their intrinsic value. It sounds simple, but it’s not easy. It requires a long-term mindset, a deep understanding of fundamentals, a repeatable decision-making framework, a willingness to go against the crowd, as well as an awareness of the cycle of capital.

Author is Director – Managed Portfolios, Morningstar Investment Adviser India

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