Article

How to Create an All-weather Portfolio?

04 Jul 2019

What exactly do we understand by an all-weather portfolio? Obviously, portfolios are supposed to be dynamic and keep changing with the times. But there is a larger approach which is called the all-weather approach. In this approach you take a long term view where the portfolio is designed and constructed in such a way as to have in-built defences against the vagaries of the markets and the cycles in macroeconomic variables. Such all-weather approach to your portfolio can yield much better results in the long run in terms of risk-adjusted returns. Here are 5 steps to help you create an all-weather portfolio.

Step 1: All weather portfolios are about risk and diversification

Investing in any asset class entails risk to some degree or the other. For example, equity has market risk, debt has interest rate risk and commodities have price risk. In addition, macro factors like inflation, higher interest rates and slowing GDP growth creates risk for all asset classes - be it equity, debt or commodities. Creating an all weather portfolio, therefore, begins with an understanding of the risk profiles of each of the asset classes before allocating.

Step 2: Look at diversification based on correlations

There is genuine merit in diversification. For example, debt can help you diversify the volatility of equity. Similarly, gold can help you diversify the macro risk of an economic slowdown, which typically impacts all classes other than gold negatively. The key to creating an all-weather portfolio is to diversify your risk across a variety of asset classes based on low or negative correlations. What do we understand by asset correlations? They show how closely asset returns are correlated to each other. In this step you must mix assets that have low correlations or even negative correlations; if that is practically possible.

Step 3: Look for a solutions based approach, if possible

Take the case of balanced funds. These funds are hybrids that mix debt and equity to give a combined flavour of wealth creation and stable income. Therefore, balanced funds automatically have an all-weather flavour to them. Even within the balanced funds category, there are options available which makes it a lot more flexible - like you have balanced funds with a predominance of equities or debt. If you are looking to take on a slightly higher risk, you can even look at a dynamic approach which helps you make the best of market movements.

Step 4: Adopt a phased approach, rather than rushing into assets

Nothing helps you create an all-weather portfolio more effectively than a phased and systematic approach. We have heard of the SIP approach to investing quite often, and one of the best ways to create an all-weather portfolio is to adopt a phased approach to investing. But, how exactly does a phased approach help you in creating an all-weather portfolio? The answer is quite simple. When you adopt a phased approach, the rupee cost averaging automatically works in your favour. This is helpful in all types of market conditions and for all asset classes, especially if you evaluate it over a longer time frame. A phased approach gives you a lower average price of entry and a higher average price of exit.

Step 5: Use gold, commodities and other assets to hedge

One of the best ways to create an all-weather portfolio is to allocate 10-15% of your portfolio to gold. Don’t go about 15% but tweak your allocation between 10% and 15% based on your take on geopolitical risk. You should ideally hold gold in the form of gold bonds or gold ETFs; which is less cumbersome but mirror the price of gold equally well. The advantage with gold is that it automatically outperforms in turbulent times. Traditionally, gold has been uncorrelated with assets like equity and that makes it a genuine piece in creating an all weather portfolio. You can also look at other commodities like silver, industrial metals and agri commodities, but they are yet to evolve as genuine asset class options in India.

The key to creating an all-weather portfolio can be summed up in three points. Firstly, get your asset class mix right and build diversification into it. Secondly, adopt a more dynamic approach to asset allocation wherever possible but only with the relevant degree of expertise. Lastly, the phased approach always works best in volatile markets, as you don’t need to worry about the timing aspect. The result is an all-weather portfolio!

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How to Create an All-weather Portfolio?

04 Jul 2019

What exactly do we understand by an all-weather portfolio? Obviously, portfolios are supposed to be dynamic and keep changing with the times. But there is a larger approach which is called the all-weather approach. In this approach you take a long term view where the portfolio is designed and constructed in such a way as to have in-built defences against the vagaries of the markets and the cycles in macroeconomic variables. Such all-weather approach to your portfolio can yield much better results in the long run in terms of risk-adjusted returns. Here are 5 steps to help you create an all-weather portfolio.

Step 1: All weather portfolios are about risk and diversification

Investing in any asset class entails risk to some degree or the other. For example, equity has market risk, debt has interest rate risk and commodities have price risk. In addition, macro factors like inflation, higher interest rates and slowing GDP growth creates risk for all asset classes - be it equity, debt or commodities. Creating an all weather portfolio, therefore, begins with an understanding of the risk profiles of each of the asset classes before allocating.

Step 2: Look at diversification based on correlations

There is genuine merit in diversification. For example, debt can help you diversify the volatility of equity. Similarly, gold can help you diversify the macro risk of an economic slowdown, which typically impacts all classes other than gold negatively. The key to creating an all-weather portfolio is to diversify your risk across a variety of asset classes based on low or negative correlations. What do we understand by asset correlations? They show how closely asset returns are correlated to each other. In this step you must mix assets that have low correlations or even negative correlations; if that is practically possible.

Step 3: Look for a solutions based approach, if possible

Take the case of balanced funds. These funds are hybrids that mix debt and equity to give a combined flavour of wealth creation and stable income. Therefore, balanced funds automatically have an all-weather flavour to them. Even within the balanced funds category, there are options available which makes it a lot more flexible - like you have balanced funds with a predominance of equities or debt. If you are looking to take on a slightly higher risk, you can even look at a dynamic approach which helps you make the best of market movements.

Step 4: Adopt a phased approach, rather than rushing into assets

Nothing helps you create an all-weather portfolio more effectively than a phased and systematic approach. We have heard of the SIP approach to investing quite often, and one of the best ways to create an all-weather portfolio is to adopt a phased approach to investing. But, how exactly does a phased approach help you in creating an all-weather portfolio? The answer is quite simple. When you adopt a phased approach, the rupee cost averaging automatically works in your favour. This is helpful in all types of market conditions and for all asset classes, especially if you evaluate it over a longer time frame. A phased approach gives you a lower average price of entry and a higher average price of exit.

Step 5: Use gold, commodities and other assets to hedge

One of the best ways to create an all-weather portfolio is to allocate 10-15% of your portfolio to gold. Don’t go about 15% but tweak your allocation between 10% and 15% based on your take on geopolitical risk. You should ideally hold gold in the form of gold bonds or gold ETFs; which is less cumbersome but mirror the price of gold equally well. The advantage with gold is that it automatically outperforms in turbulent times. Traditionally, gold has been uncorrelated with assets like equity and that makes it a genuine piece in creating an all weather portfolio. You can also look at other commodities like silver, industrial metals and agri commodities, but they are yet to evolve as genuine asset class options in India.

The key to creating an all-weather portfolio can be summed up in three points. Firstly, get your asset class mix right and build diversification into it. Secondly, adopt a more dynamic approach to asset allocation wherever possible but only with the relevant degree of expertise. Lastly, the phased approach always works best in volatile markets, as you don’t need to worry about the timing aspect. The result is an all-weather portfolio!