Asset classes one should consider while rebuilding portfolio

where to invest

The adage of the finance wizard has never been more true than it is today and if you are witnessing the current volatility in the market (specifically in asset classes such as equity, commodity), the chances are that you would concur with him. But which are these baskets in which you be keeping your money?

Before delving into various asset classes such as equity, fixed income, commodity (Crude oil futures), precious metals (gold, silver), real estate, etc., let’s discuss the portfolio building process. While rebuilding the portfolio, one can take a core-satellite approach.

Core portfolio

The part of the portfolio which would aim to provide steady & stable returns while keeping the volatility in check. Generally, the core portfolio comprises of benchmark tracking funds such as large-cap, multi-cap, large & mid cap equity mutual funds, high credit quality (>80% AAA & Eq.) fixed mutual funds, gold ETFs, etc.

Satellite portfolio

The part of the portfolio which aims to generate additional alpha (positive return) by taking some tactical bets. This portfolio comprises of Equity PMS/AIF, etc. Real estate AIF, private equity funds, etc. As a thumb rule, the core portfolio comprises 70-80% of the overall portfolio and the satellite portfolio comprises 20-30% of the total portfolio. But the final weights may vary, depending on the risk appetite (both financially and mentally) of the person. If one may ask, why not invest everything into one asset class? Well, let’s see how that plan pans out.

As one could notice, if one invests in 100% equity, though return will higher, the volatility in the portfolio would be very high and if one invests completely into fixed income, though the volatility would be much low, the return of the portfolio would be hampered.

Now, let’s get back to various asset classes in which one could look to invest:

Equity: In the equity asset class, there are two categories, listed space & unlisted space.

Listed Equity: On the basis of market capitalization, listed firms have been divided into large-cap, mid-cap & small-cap. Large Caps are considered as bluechip stocks that provide stable a return with less volatility, while mid & small-cap stocks exhibit higher volatility but deliver higher returns over a longer tenure.

Investors are generally recommended to invest through mutual funds and ETFs to reduce the concentration risk and liquidity risk. Through mutual funds, investors can get exposure to various strategies & sectors,. The risk-seeking investors can invest in PMSs/ AIFs.

Unlisted space: the unlisted space primarily consists of private firms, startups, etc. This space is generally meant for financial savvy investors where these investors take exposure through closed-ended private equity funds with a longer time horizon.

Fixed Income: In the fixed income space, the instruments available range from plain vanilla fixed deposits, GOI bonds, corporate bonds, debt mutual funds, etc. The major criteria that the investors must consider are the yield, credit rating profile, duration of the bond/ portfolio of bonds, etc. Fixed Income portfolio is generally meant to provide downside protection as well as regular income to the overall portfolio.

Precious Metals: Gold is not only the most traded precious metal but also considered as the haven by many investors. The precious metal generally acts as a hedge against turbulent times when all hell seems to break loose. The investors can take exposure through physical gold or
through ETFs/ mutual funds.

Real Estate: Categorized into residential & commercial, this asset class provides diversification & regular income to the portfolio but is fraught with some major risks such as liquidity risk, political risk, regulatory risk, etc.

The investors can invest directly into properties or can take
exposure through AIFs. Though there are various exotic asset classes and instruments available, before investing in any investment vehicle, the investor should be cognizant of various risk factors. Happy investing!!

(The writer is Head, Investment Advisers, HDFC Securities.)