Diversification can save you from poor performance in a narrow set of investments
13-Sep-2013 •Research Desk
The most basic type of asset allocation -- and yet one that is often ignored -- is that of the fundamental asset type. Investors mark themselves out as equity investors or fixed income investors and then stick only to that. Even worse, they have an idea that asset allocation is a good idea and even work out that they should have x per cent of equity and x per cent of debt and then forget all about it while choosing and tracking their funds.
Like other types of diversification, one can stick to the plan only if it's an ongoing process. However, if the continuing fund investment does not stick to the menu, then deviation from the original intent is very likely.
Moreover, keeping one's asset allocation in tune is simultaneously more difficult and more rewarding than other diversifications. For one, equity and fixed income are inherently divergent. When interest rates are high and fixed income investments offer good returns, equities don't do well because businesses are paying too much for debt. When interest rates are low, businesses do well. The time of transition between the two conditions may be an exception but otherwise, this relationship holds.
This means that left to their own devices, the equity and fixed income portion of your portfolio will necessarily diverge from what you intended. They will need constant attention to make them stick to the straight and narrow path. But then, there's a great advantage in doing so.
When equity is growing faster than fixed income you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored. When equity starts lagging, you periodically sell some of your fixed income and move it into equity. This implements beautifully the basic idea of booking profits and investing in the beaten down asset. There are a variety of ways of doing this but the best is probably to utilise the services of a balanced fund, about which we have written often. As to the question of how one should detect that one's assets are out of balance, the ValueResearchOnline.com Portfolio Manager comes to your help. On the 'Analysis' view of the 'My Portfolio' section, the first graph on the top is 'Portfolio Asset Allocation'. It's a simple display and tells you the whole story in an instant.