​​Portfolio Diversification​​ - Immunize Investment from COVID19

The Novel Coronavirus (Covid-19) is creating havoc on global economies. The upheaval has had a crippling effect on Indian equity markets as well, with the benchmark Nifty 50 index plunging 37% year-to-date (YTD) till March 23, 2020, almost in-line with global peers. But, while equities have been whiplashed, the other primary asset classes, viz, debt and gold, have stayed afloat, returning 2.35% and 7% over the period.

So, does this mean that investors should offload equities and move their investments to the other asset classes? Sure, stocks have cratered YTD. But, the answer is an emphatic ‘No’. Before rushing for the exit, investors should be aware that all asset classes are subject to pulls and pushes. Even debt, which is supposed to be a stable asset class, and gold, which a traditional investment vehicle, are not immune to volatility. Like for instance, in 2009, debt fell 6% while in 2013, gold lost 19%.

Hence, bouts of short-term volatility is not a clarion call for investors to shun equities. To be sure, equities have the ability to rebound on positive cues, as has been evident over several instances. Also, just as debt can lend balance to a portfolio, equities can provide the booster to returns.

So, do not rush to redeem or stop equity systematic investment plans or other equity investment vehicles. This volatile spell should not make investors allocate more to debt and gold. Because, while debt can act as a cushion against market volatility, it may not always be able to beat inflation. Further, gold has largely done well as a safe haven asset only during choppy times.

Hence, to get the best return, investors would do better by having a diversified portfolio.

Investment Diversification with equity, debt, and gold generated higher risk-adjusted returns

Historically, whenever the sentiment for equities strengthened, investors pulled out of safer assets, such as debt, and moved into stocks to capture the gains. And when equities pass through a bear phase, risk appetite takes a hit, and demand for safer assets and commodities, such as gold, rises.

Because of this inverse relationship between the asset classes, investing in a diversified portfolio of equity funds, debt funds and gold reduces the risk associated with investing in a single asset.

CRISIL Research analysed the performance of a diversified portfolio (equity, debt, and gold) as against standard diversification (equity and debt) and standalone asset classes. Our analysis shows that a combination of equity, debt, and gold in a portfolio generated higher risk-adjusted returns (Sharpe ratio) than other combination / standalone classes.

* Allocation between equity and debt assumed to be 50:50 ^ Allocation between equity, debt and gold assumed to be 45:45:10

Mutual funds, an able ally to help Portfolio Diversification

This is where mutual funds are able to support the investment strategy. Mutual funds offer a variety of investment options in each asset class, enabling investors to build a diversified portfolio. Investors can either choose hybrid funds (mix of debt and equity) or multi-asset allocation funds. Investors can also choose to spread their investment across mutual fund categories.

To sum up

In these challenging times, when markets are highly volatile, diversification is a prudent tool to lower risk. Mutual funds can help build a diversified portfolio, thereby mitigating risks and optimising returns. That being said, do not fall in the trap of over diversification, but stick to allocating as per goals.

Disclaimer:

Any comparison mentioned in this material is for general information only and not intended to be relied upon as investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Information and content herein have been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. Recipient are advised to seek independent professional advice before making any investments. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. SBI Mutual Fund / SBI Funds Management Private Limited is not guaranteeing or promising or forecasting any returns.