By Prabhat Ranjan & Vijay Chauhan
Misconceived by the notion that volatility is unfortunate is regrettable. It is nothing but a mere measure of the dispersion of returns often quantified by variance from the designate, which in itself is not static but a variable. Standard deviation, the popular metric that constitutes volatility is affected by both the inconvenience and the perks Come from Sports betting site VPbet . However, perks are rudimentary for investors, and investing in anticipation of it is justifiable. Conclusively, volatility in its entirety is not a drawback but just a fragment of it is. This fragment typically represented by the left side of the distribution, is an opportunity for the contrarian investor that disguises itself as a stumbling block for the pessimists.
For the risk-averse, diversification across asset classes, across geographies and within equities across market caps aids in balancing the risk for the returns anticipated.
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A series of observations about the behaviour of different asset types throughout previous cycles and analysing the historical range of returns for Gold, bonds, and stocks over holding periods ranging from 1 to 15 years, we have noticed that asset classes with the potential for higher returns experience a wider distribution of outcomes and require long periods to mitigate the risks. Uncertainties, crises, and pullbacks are inevitable and unpredictable in their timing, but through portfolio management over time, outcomes will be desirable.
Gold is globally considered a haven, so investors start investing in it when there is uncertainty in the economy and when the outlook turns bearish for equity markets.
In Exhibit 1, we have conducted a study on returns between gold and Sensex and have dissected the results into four quadrants, the first quadrant, Equity UP & Gold UP, implying returns were both positive during the year; the second one, Equity Down & Gold Up representing the returns were negative for equities whereas positive for gold, the third quadrant, Equity Down & Gold Down and the fourth Equity Up & Gold Down.
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Concluding the second and fourth quadrants, the plots highlighted in red imply that we can utilise the lower correlation between asset classes to improve the performance of portfolios during downside volatility in equity markets.
Exhibit 1: Sensex & Gold Returns
NOTE: Gold prices considered were averages for the years
Source: Ace-Equity & Bankbazaar
Exhibit 2(A) & 2(B): Index & Hybrid Fund Return & Volatility
From Exhibit 2(A&B), investors can see that even a vanilla Hybrid fund can mitigate volatility and maximise return. The reason is that asset classes barring a few exceptions are influenced abnormally by macroeconomic events.
Investors are exposed to unwarranted risk if investors misallocate the proportion of capital towards assets. For illustration, if an investor were to invest 100 per cent of the capital in equity would be exposed to undue volatility. However, optimal asset allocation will integrate capital market expectations with the investor’s desired level of risk and constraints, focusing on the long-term to compound wealth. Allocation is based on the quantifiable systemic risk of each asset class to generate maximum returns for the risk an investor can take on. In other words, investors must factor in the risks that can be tolerated and allocate capital in proportion to the desired level of risk.
In March 2020, before the announcement of the lockdown due to the COVID-19 pandemic, valuation models signalled prices higher than historical averages, so to de-risk flagship scheme RH Flexicap, we added gold and defensives like pharma due to lower valuation. Later the markets declined up to thirty-eight per cent, and as the markets turned bullish, the scheme significantly outperformed relative to the benchmark.
Post covid and the ongoing Russia-Ukraine war led to inflation spiking across economies. To control the raging inflation, most Central banks of major economies around the globe raised interest rates in unison, impacting the equity markets unfavourably. Unlike previous events, asset classes were affected differently this time. In response, we diversified across sub-asset categories focusing on sensitive sectors and positively impacted by raising interest rate scenarios. Investors can manage portfolios across market cycles through allocation across asset classes as per the desired level of risk and skew in favour of assets when outperformance is certain during a bull rally and vice versa.
Rather than being encapsulated with returns focusing on risk-adjusted returns, mitigating risks by managing portfolios through diversifying and investing over a longer horizon tends to smoothen the curves of the volatility of the portfolio and effectively reward investors.
(Prabhat Ranjan and Vijay Chauhan are Co-Fund Managers at Right Horizons, PMS. Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.)
