Year 2021 should focus more on asset allocation

Year 2021 starts on the back of a tumultuous 2020. The Indian economy is struggling to recoup its growth mojo. Here is how various asset classes look in 2021.

Jan 06, 2021 09:01 IST India Infoline News Service

Year 2020 has been a tempestuous journey for markets. Equities gave attractive returns annually but they gave phenomenal returns from the lows of March 2020. Longer term bonds did well on the back of falling yields but short term yields are almost unattractive. Gold was the star of the last 18 months and even scaled life-time highs. Above all, international equities also did extremely well and diversified risk.

How to approach various asset classes in 2021?

Year 2021 starts on the back of a tumultuous 2020. The Indian economy is struggling to recoup its growth mojo. Here is how various asset classes look in 2021.

a) In 2021, equity will not just be an option but it will be inevitable. How else do you play an economy that is poised to recover from -23.6% growth contraction to positive growth of 11% by next quarter? It has to be equities. For 2021, equities should still be your predominant asset class. Volatility will be part of the game so adopt a more phased approach; like what a SIP does. Equities are your principal asset class for 2021.

b) G-Sec funds did extremely well in 2020 giving returns of 10-11%. But with 10-year yield sat 5.85% and inflation above 6%, the room to cut rates is limited. That means, short term liquid funds and arbitrage funds will give you sub-par returns and G-Sec funds will limit capital appreciation. Keep allocation to debt to the minimum required.

c) What about real estate? This could be the surprise asset class of 2020 with a sharp recovery likely in residential demand. A surer game would be commercial realty. WFH is going to happen but it won’t end office space demand. You should look at tax efficient and diversified structures like REITs to participate in property.

d) Is gold a good idea for 2021? There are two points to remember. Firstly, gold has rallied 70% in the last 18 months. The gold rally was understandable in the midst of the pandemic, but now there is a lot more economic certainty and growth returning. Gold still makes sense to diversify, but don’t stretch your allocation beyond 10-12%.

e) The real global action could be in specific stocks. Look at how the FAANG stocks and Tesla have rallied. However, if you don’t have the expertise, a global index ETF is good enough. Again, global equities gave great returns in last 5 years but it is still a good diversification tool.

Answer to the 2021 puzzle lies in asset allocation

The asset outlook may be elegant but leaves us with a pertinent question. What is the action plan? The answer lies in asset allocation. We will come back to the idea of asset allocation and the reasons in greater detail, but first check out this chart.

Data Source: Financial Analyst Journal
What does the above graphic tell you? Over 91% of your portfolio returns are determined by your asset allocation. So, if you thought that portfolio skills were all about picking the right stock or the right bond or entering at the right time or exiting at the right time; then you’re are grossly mistaken. All these factors matter, but they only matter for less than 10% of your portfolio returns. The rest is about asset allocation, so that should be your focus. This is all the more applicable in 2021.

What is asset allocation and it is so critical in 2021?

Asset allocation is about creating a principle to allocate your money across different asset classes like equities, bonds, liquid assets, realty, gold and global assets. There were two things about 2020. Alpha was a lot easier as opportunities were literally thrown at investors and fund managers. Secondly, this resulted in active fund managers doing better than passive and even hedge funds did better than quants. That kind of an alpha overdose is unlikely to sustain in 2021.

The focus, therefore, shifts to asset allocation. You decide on an allocation range for each asset class based on your risk appetite and select assets based on liquidity needs and tax status. Once that is done, let asset allocation take over. If equities rally and the share of equities in the overall portfolios crosses a threshold, then the money is automatically allocated to other underpriced asset class. That is how asset allocation will work.

How will it help in 2021? It will help in 3 ways. Firstly, when Alpha is going to be hard to come by; there is no point fretting too much over stock selection and market timing. As we have seen, it is asset allocation that explains 91% of your portfolio returns. Secondly, asset allocation is an auto-liquidity generator. You create liquidity at highs and are fully invested at lows. Lastly, asset allocation is a market-agnostic approach. Just focus about being in the right place at the right time. That is the message for 2021!

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