Stock portfolio: in a weak market, diversify your portfolio to hedge downside and maximize your advantage

Extreme volatility has been observed across asset classes driven by frequent unknown events over a short time horizon. And the instability has spilled over from financial assets in capital markets to real assets as well.

Portfolio diversification could protect investors during those times while ensuring long-term goals are on track.

It is always prudent to focus on asset allocation based on investor profile and even more so given the current global uncertainty surrounding inflation, interest rates, geopolitics and the pandemic.

An investment plan that incorporates risk and return objectives, liquidity needs, time horizon, tax and legal requirements should be an ideal starting point.

This plan should highlight the optimal products for exposure to relevant asset classes such as equities, fixed income, gold, alternatives,

. as different assets would behave differently to different factors.

The goal is to protect the downside while positioning the portfolio to benefit from any potential upside.

Capital
Equities are the only asset class that provides a surefire way to build long-term wealth. But it is accompanied by volatility and a high risk of capital loss.

It tends to be positively correlated with low to moderate inflation and therefore can provide positive real returns in a rising price environment. But hyperinflation could have a negative impact on companies’ margins and profitability, especially when consumer confidence is weak and the recovery in demand is moderate.

Within stocks, an investor can allocate to different market capitalization segments depending on various factors such as valuation, risk sentiments, liquidity, earnings growth and technical indicators.

Strategic allocation to stocks can be built through a mix of products such as mutual funds, ETFs, PMS, IDAs, and direct stocks.

In addition, a small allocation to global stocks can also be made from a logical diversification perspective. Investing abroad provides exposure to multiple currencies and differentiated themes not available in domestic markets.

In addition, it also reduces the overall volatility of the portfolio. Investors should always have a strategic asset allocation towards international equities and take active tactical positions based on changing market (country) dynamics and fundamentals.

Fixed rent
Debt instruments provide investors with a fixed return on a constant basis over the term of the product until maturity.

The probability of principal loss is also relatively low on sovereign and AAA-rated bonds compared to equities, unless invested in high-yield credit.

Inflation affects fixed income investments the most due to its inverse relationship with interest rates. They are also subject to duration risk, which is a function of the yield curve and interest rate outlook.

At times, central banks might take action around monetary policy and systemic liquidity to manage interest rates or yields on debt products, but eventually the fundamentals would catch up.

Strategic debt allocation can be built through a mix of mutual funds, PMS, ETFs, and direct instruments like G-Secs, SDLs, corporate bonds, MLDs, PTCs, etc.

Inflation-protected securities are a category of bonds that adjust yields for inflation, which could be considered in times of rising inflation. Similarly, short duration bonds/funds could also be considered in times of rising interest rates.

Prayed

Gold has peculiar attributes that make it a valuable strategic asset in investment portfolios: ability to generate returns over long periods, great diversifier due to its low correlation with other asset classes both in periods of expansion and recession, which leads to better risk-adjusted returns, liquidity like other major financial assets, and no credit risk.

Investors also see gold as an ‘alternative currency’ or ‘currency of last resort’, especially in countries where the local currency is losing value.

It is also a good hedge against inflation, as it tends to protect portfolio values ​​in times of rising inflation, which is why it is also called a “premium store of value.”

A small allocation to gold will also provide portfolio protection against uncertainty and volatility. But if central banks sharply raise interest rates under inflationary pressure, then non-yielding assets like gold could become relatively unattractive to some investors.

Gold also has an inverse relationship with the dollar index and therefore a strengthening US dollar could put downward pressure on gold prices.

We believe that the above assets are essential in an investor’s portfolio to meet their various risk-return objectives. For a few risk-conscious investors, alternative asset classes made up of real estate (real estate funds, ETFs, REITs, InvITs), commodities (theme funds) and private market (PE, VC, direct investment) could also be considered.