 |
Ask a financial planner for advice on mutual fund investing and he is likely to give you a lecture on asset allocation and diversification. This confuses people and they tend to interchange diversification and asset allocation. By design, mutual funds offer diversification, but for asset allocation one needs to invest across different types and categories of funds.
To define it simply, asset allocation is the process of adjusting the relative proportion of different asset classes in an investment portfolio. It is based on the fact that both the probable return and probable volatility of each asset class are different. By combining asset classes in different proportions, it is possible to modify a portfolio’s overall volatility and return.
The three major asset classes are cash, stocks and fixed income. The amount you choose to invest in each category depends on your risk tolerance, investment horizon and financial goals. Mutual funds are a convenient option to park some or all your assets in. For instance, if you are 35 years old and have allocated 70% of your portfolio to stocks, 20% to fixed income and 10% to cash, you can easily achieve this proportion by buying mutual funds.
Mutual funds manage portfolio risk through diversification, be it across asset classes, sectors, scrips, market capitalisation, geographies or time. A significant advantage of diversification is that it allows the portfolio to benefit from the general momentum of the market without risking too much due to the peculiarity of a single scrip. One mutual fund unit represents a proportionate portfolio.
Mutual funds expect people to be aware of their investment objectives and to invest according to their risk appetites. So a risk-averse investor putting his money in an equity-oriented fund is as inappropriate as a risk-loving investor doing so in a debt fund. Despite the portfolio diversification of funds, their asset class profile places them at different levels of the riskreturn matrix. So a debt fund with its low-risk, low-return profile is at the lower end of the risk spectrum, while an equity fund, with its high-risk, highreturn profile, is at the higher end.
Risk-averse people should invest prominently in liquid and debt funds, and risk-loving investors should have a high exposure to thematic/ opportunistic funds. On the other hand, an investor with a moderate risk appetite can balance his investment portfolio with a prudent mix of equities and debt funds.
However, it is important to remember that it is the rationale of investment, time horizon and realistic risk-return expectations that help one achieve the desired results.
Sandesh Kirkire, CEO, Kotak Mahindra Asset Management Company
