Asset Allocation Matched to the Market Cycle Creates Outsized Returns

2023 was a very good year for equity as an asset class in India. The NIFTY 50 TRI, which represents large caps, saw a 21.4% increase, while the NIFTY Midcap 150 TRI and NIFTY Smallcap 250 TRI, which represent broader markets, saw increases of 45% and 49% respectively. At different market periods, different asset classes perform differently. The returns quilt below demonstrates this point showing how the market cycle changes the return-risk profile over time. 

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No one asset class is the best investment at all times.

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For example, of the past ten years, small caps have performed the best in five years and the worst in three. While gold reported returns of 15% in 2023, it has been the top performing asset class only in two of the past ten years.

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Past variations in the timing of returns from different asset classes highlight the importance of diversifying portfolios across a variety of assets according to risk tolerance and expected returns. Equity may be the best performing asset in the long run but not all your goals are for the long term. Moreover, we may not be comfortable with the volatility that comes with investing in equities. So, what assets should you chase?

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Our 70:20:10 portfolio outperforms for long term risk-adjusted returns.

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The most common asset allocation, the 60:40 equity:debt ratio seems to be losing its edge. It works better with a touch of gold. Gold, considered as a safe haven, not only acts as a buoyant when equity markets dip but also hedges against inflation.

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An investment of Rs.10,000 in the beginning of 2017 with a 70:20:10 allocation across equities, debt, and gold yielded a remarkable compound annual growth rate of 15.7% over the seven years to Rs.27,800 by 2023. 

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This diversified portfolio creates higher returns with lower volatility than large cap equity indexes, despite having a smaller equity allocation in the portfolio. 

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Of course, individual risk tolerance, investment goals, and time horizons should guide portfolio construction. 2024 promises a number of exciting events in India, including the general elections, a possible rebound in private capital expenditure, and reinforcement of India’s position as the fastest-growing major economy. 

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By embracing diversification, rethinking traditional allocation models, and seeking professional guidance, investors can make informed decisions and capitalise on the promising opportunities presented by the Indian investment landscape in 2024.