How to reach the optimum asset allocation - Kotak Bank
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The Indian economy is undergoing some radical changes in recent times. FY 2016 saw demonetization,
while 2017 witnessed implementation of GST. With introduction of such major elements in the economy, it is difficult for analysts to predict the markets on a day to day basis. Though around 45% of new currency was circulated in the markets as early as 17th December 2016, the equity markets, considered high return options, grew at an average of 4.81%, while the debt market grew at an average of 9.7%. Hence, for an investor to safeguard his capital, at the same time gain good returns, it is important to allocate his/her investments wisely.

What is Asset Allocation?

Asset allocation is a strategy which allows you to diversify your investment portfolio among
variousvehicles. The allocation of assets is said to be at its optimum level when it successfully minimizes risks and yields maximum returns.

However, asset allocation is determined taking into account variousfactors which govern an investor's investment in the market.

Capital Available: 
The amount of capital at an investor's disposal determines whether he can invest in the market for a short duration or long. An investor with low liquidity may not be willing to invest in long term risky assets and vice versa.

Time Horizon: 
Whether an investor is looking for short term gains or long term gains determines the type of assets that he will be looking forward to invest into.

Investment Objective: 
Whether an investor's objective is to earn higher returns or safeguard his hard earned money also determines the asset base that he may choose in his portfolio.

Risk Tolerance:
Investors with a high risk tolerance certainly prefer risky assets like equities over corporate bonds. Likewise, low risk tolerant investors would include assets like government treasuries which have a government backing to keep their capital safe.

Asset Base: 
Different assets have different levels of risks and are affected by market fluctuations in different manner. A good asset allocation protects its investor’s entire portfolio from the ups and downs of a particular asset or market condition.

Investment portfolio is mainly distributed amongst assets like equity, bonds and cash (money market securities) depending on the above mentioned factors. This asset base is further divided into subclasses. The subclasses popularly invested into are large, mid and small cap securities, International securities, emerging markets, fixed income securities, money markets and real estate investment trusts. Amount invested in these subclasses again depends on the risk taking ability of an investor.

An investor saving for short term may like to invest in the cash markets, certificate of deposits and short term bonds in desired proportions. While an investor who is looking to invest in the market for a long term or till retirement may look into the equity market. He may then invest in different proportions in large, mid and small cap securities based on his risk taking ability.

Choosing the correct Asset Allocation Strategies

There are different types of asset allocations based on an investor's age, risk appetite and his or her investment objectives. It is the responsibility of a portfolio manager to provide a well managed asset allocation to his/her customers. However, these strategies are not exhaustive. Changes can be made in the strategies based on the model portfolio. The model portfolio can be anywhere in between a very aggressive portfolio to a conservative portfolio. You can optimize your portfolio taking one of the below mentioned approaches while allocating your investment in different assets.

Strategic Asset Allocation: 
This approach works on the principle of ‘Base Policy Mix’, wherein the portfolio manager, with the consent of the investor, allots fixed proportions to each asset class based on the rate of return it yields. This rate of return is then averaged depending on the percentage it holds in order to reach the desired rate of return for the investor.

For example – Supposed Equity A is expected to give 30% return and Bond B is expected to give 8% returns. If the investor’s expected rate of return is 19%, then 50% of capital will be invested in Asset A and 50% in Asset B.

Constant Weighting Asset Allocation: 
Here, the percentage of capital to be invested in each chosen asset class is finalized at the start. Then according to the fluctuation in prices of the asset in the market, the holdings of that particular asset is changed to get the asset mix back to the original weightage allotted in the portfolio. In this allocation, you have to keep rebalancing your portfolio continuously.

For example - The portfolio manager and investor come to a consensus of investing 33% of the capital in equity, 33% in bonds and 33% in government treasury of Rs. 100 each. In case of the equity prices going up
to Rs. 120, the investor will either sell equity worth Rs. 20 booking a profit or purchase bnds and government equity worth Rs. 20 each to rebalance the portfolio.

Tactical Asset Allocation: 
This approach is best suited for investors who are willing to take more risk for higher returns. Under this approach, the portfolio manager is on a constant lookout for short term opportunities and makes small changes in the asset mix for a short duration in order to take advantage of that particular short term opportunity that yields high returns.

For example - A strong company raised a new IPO whose price is believed to increase at a faster rate. In such case the investor will purchase the new shares and sell it once he desired price is reached.

Dynamic Asset Allocation
- Dynamic asset allocation is for those investors who like to engage actively in the all activities related to their investment. Here the portfolio manager keeps on making adjustments in the asset mix in order to take maximum advantage of the prevailing market conditions. This is one of the most common approach used by investors today.

For example - Here, an investor engages in short term purchase and sale of equity or bonds based on his knowledge and future predictions. If share price of X company goes up to Rs. 120 from 100, an investor will sell and as soon as the price comes dwn to Rs. 80 the investor will again buy the shares to profit from the fluctuating prices in the share market.

Insured Asset Allocation: 
Under the insured asset allocation, the portfolio manager and the investor settle on a minimum base return rate, which if not fulfilled,they choose not to invest the capital. Incase the allocated portfolio mix does not yield the minimum rate of return, changes are made in the asset mix in order to bring the overall portfolio returnsto the determined percentage.

For example
– Asset allocation in assets A,B and C are expected to yield a minimum return of 12%. Till the time the portfolio yields a return of more than 12%, capital will be invested if not so the investor will divest his capital from the portfolio.

Integrated Asset Allocation: 
Integrated asset allocation is more of a custom-made strategy which combines more than one of the above mentioned approaches to design a portfolio that fulfills the investor's requirements to the fullest.

Even after one devices a well calculated strategic portfolio, it is not guaranteed that the investor will earn the desired return. Market volatility and other external factors play a big role in determining an asset's performance. Periodic portfolio reviews are required in order to ensure that the investment is generating the desired results. An efficient portfolio manager helps his investor undertake the rebalancing process,courtesy of which, the investor brings his portfolio back to a profitable position. During the rebalancing of one’s asset mix, one can sell the assets that have increased significantly and use the money generated to purchase units of those assets which have either declined or increased but by a minimal amount.

A portfolio manager does a lot of research and puts in a lot of effort to maximize the investor’s capital to the fullest. Go ahead and invest your hard earned money in equity. All you need to do is trust the experts who have their best interest in your growth.

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Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.