How Multi-Asset Allocation Funds May Help You Cushion the Downside Risk in 2023

December 15, 2022 Mutual Fund

The Indian economy in 2022 has witnessed a roller coaster ride of events from the Russia-Ukraine war with its effect on global supply chains to skyrocketing inflation which has led to rising interest rates; all this has also had a significant impact on the Indian markets. The prevailing year has not been easy for investors, with volatility and uncertainty affecting the market performance.

Many investors are experiencing different economic and market phenomena this year that they have never encountered before. In addition to the existing geopolitical concerns, any further escalation between China & Taiwan could add to the market volatility. There is also a possibility of recession rearing its head in several developed economies like the US. Even if a global recession were to play out, the impact on India is likely to be minimal.

While there are uncertainty concerns due to macroeconomic fluctuations, there is still hope for investors. The sentiments in the market have turned bullish recently due to sustained purchasing by FPIs. After pulling out funds from Indian equities in the past 2 months, FPIs made a strong comeback in November. This was the third month in this year after July and August when FPIs witnessed net inflows. This may be because India is perceived to have good growth prospects. Besides this, the abating of crude oil prices and the easing of inflation rates are some of the other factors that have further aided the positive outlook of the market in the coming year.

The year 2023 may become a year of stabilisation and growth for your investment portfolio. According to the experts, inflation is expected to normalise as some of the drivers disperse, such as the supply chain issues, are being resolved. This would allow central banks to take a pause from the aggressive interest rate hikes. The RBI policy rates are anticipated to reach their peaks in the first quarter of 2023 and stay at that higher level for a long period. The geopolitical crisis, the trajectory of inflation, and the Federal Reserve’s monetary policy will likely be the major influencers of financial markets in 2023. It is unclear how they will turn out and their effect on the economy, however, high market volatility is one outcome that is, nevertheless, obvious in such scenario.

How investors can tide over uncertain economic conditions and volatile markets?

Although easing inflation and better interest rate stability takes some pressure off central banks and financial markets, we still need to be cautious about the 2023 outlook due to recessionary risks and the threat these pose to corporate earnings.

One needs to learn how to be resilient in the face of such unsettling events and not shatter under pressure. This would mean choosing investments that can potentially help you benefit from volatility in the long run. Currently, tactical asset allocation across asset classes is the key to protecting against the downside risk that may affect your portfolio.

Notably, not all asset classes always move in the same direction, and there are periods when one underperforms the other. If you recall, amidst the pandemic, the equity indices plunged sharply, and the debt market was grappling with liquidity concerns; gold as an asset class soared to new highs and acted as an effective portfolio diversifier, a hedge, a safe haven, and commanded a store of value.

Graph: Performance of different asset classes vary over the years
(Past 10 years historical data)

Data as of December 14, 2022
(Source: ACE MF, PersonalFN Research) 

As you can see from the above graph, in the year 2014, 2017 and 2021 equities outperform debt and gold, whereas in the years 2016, 2018, 2019, and 2020 (the outbreak of COVID-19 in India) gold and debt fared better. You see, generally, equity and gold share an inverse relationship –they do not move in the same direction always.

Given these circumstances, it is better for investors to stick to a tactical allocation of assets across classes and continue with their investments systematically, as markets are likely to remain volatile. Hence, diversifying investments across asset classes, viz., equity, debt, gold, and even holding optimal cash, is necessary to tide over the uncertain economic conditions and volatile markets. And what better way to diversify investments than Mutual Funds.

Multi-Asset Allocation strategy in mutual funds with a dynamic asset allocation to equity, debt, and gold offers a far better balance and optimises the risk-returns ratio. This strategy comes in handy as a way of dealing with market volatility and economic uncertainty.

What are Multi-Asset Allocation Funds?

As the name suggests, Multi-Asset Allocation Funds aim to invest in multiple assets. As mandated by SEBI, these funds invest in at least three asset classes with a minimum allocation of at least 10% in each. Muti-Asset Funds aim to generate modest capital appreciation while reducing overall risk to the portfolio from a combined portfolio of low-correlation assets (primarily equity, debt, and gold). Hence, it offers better downside risk protection and improves your portfolio’s return potential.

Fund managers of multi-asset allocation funds have the flexibility to dynamically allocate investments in different asset classes by looking at a variety of factors, such as:

• Valuations relative to historical averages
• Interest rate outlook
• Macroeconomic factors prevailing in India and globally
• The quality and growth potential of securities (equity, debt, gold, etc.)

The low correlation among assets enables multi-asset allocation funds to protect the downside risk during uncertain economic conditions and volatile markets. As we approach the peak in rates, we expect the correlation between government bonds and risk assets to weaken, allowing the former to regain their diversifying characteristics in multi-asset portfolios.

Benefits of investing in Multi-Asset Allocation Funds:

• Optimum diversification with exposure to equity, debt, and gold with a single fund
• It helps mitigate the downside risk and optimise gains
• Timely portfolio rebalancing, based on the performance and the outlook of each underlying asset by a professional fund manager
• It allows you to focus on your financial goals rather than trying to time the market.
• Low cost of investing, since you invest in a single fund and not in different schemes of each asset class.

Multi-Asset Allocation Funds can help navigate uncertainty with the right mix of assets per market trends. In case the equity markets are highly volatile during uncertain times, debt allocation in your portfolio may provide a source of stability and income to your portfolio. On the other hand, gold as an asset class may help limit the downside risk.

Who should invest in Multi-Asset Allocation Funds?

Multi-Asset Allocation Funds are dynamically managed hybrid funds. They are suitable for investors seeking long-term capital appreciation with a moderately high-risk profile and an investment horizon of at least 3-5 years. This is an ideal option for investors who are willing to diversify their portfolio across sectors but want to avoid the hassle of investing and tracking different schemes.

Thus, if you are a first-time investor looking for capital appreciation at a low risk as compared to pure equity funds, you can consider investing worthy multi-asset allocation fund. The category is suitable for investors who find it difficult to rebalance their portfolio on their own depending on the changing market conditions.

To conclude…

Given the headwinds in play, the year 2023 is the anticipated to be the year of multi-asset investing by industry experts. The Multi-Asset Allocation strategy will provide a cushion for your investment portfolio against the downside risk. When an asset allocation is wisely defined and followed as per the market outlook, it serves as an investment strategy that balances the risk-reward ratio.

Though the equity market could be highly volatile in the near term, given the headwinds in play, it has the potential to outperform other asset classes in the long term. Debt is one category which is likely to do well. Post the structural failings in cryptocurrencies combined with global central banks tapering makes commodities like gold and silver interesting. One of the tactical ways to allocate to gold is via a multi-asset fund where the fund manager will allocate investments across equity, debt, gold, and any other asset classes. In this manner, an investor can have a calibrated exposure to gold.

Moreover, suitable allocation to debt and gold in your portfolio will continue to protect against rising inflation and support growth amidst uncertainties if the equity market turns volatile again.

This article first appeared on PersonalFN here