Let us start with a famous quote by Harry Markowitz “To reduce Risk, it is necessary to avoid a portfolio whose securities are all highly correlated with each other.”

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Asset correlation is a measure of how asset classes move in relation to one another over a period of time. The correlation coefficient, a statistical measure of the correlation between two variables can range from -1 to +1. When assets move in the same direction at the same time, they are considered to be positively correlated (refer chart 1). When one asset tends to move up when the other goes down, the two assets are considered to be negatively correlated (refer chart 2). Zero Correlation means that two asset classes are unrelated to each other (refer chart 3)

Chart 1

Chart 2

Chart 3

Theoretically, a perfectly negative correlation (-1) between asset classes is ideal for any portfolio. But, in the real world, there aren’t any perfectly negatively correlated assets.

In India, Asset Classes like Equity, Debt and Gold have a low negative correlation.

Source: Bloomberg Data for last 20 years. April 98 to March 21

Date used for asset classes: Equity – Nifty 50, Debt: Nifty 10 year Benchmark G Sec, Gold: Gold Spot Rate INR/10Grams

Developing a portfolio with a low correlation between asset classes s will help investors in reducing risk through diversification and may offer benefits of optimal returns over time.

Here is why an investor should consider asset allocator fund in these volatile market times and the benefits of investing in such funds:

Asset class winners change over a period of time. Even within a particular asset class such as equities sometimes large caps do well whereas there are times when midcaps and small caps outperform. Different asset classes also have different risk profiles and exhibit different levels of volatility.

Historical data indicates that by combining asset classes with low/negative correlation we can improve the risk-adjusted returns for investors.

Hence it’s important for investors to consider asset allocation as a part of their investment plan especially during these times of higher volatility.

However, an investor who is considering asset allocation faces the following questions:

How much to allocate to Equity, Gold and Debt?

• Within Equity – how much to allocate to Large Cap, Midcap and Small Cap

• What should be the frequency of rebalancing the portfolio

• Whether asset allocation can be tax-efficient

A simple solution to all these investors' needs is a systematic and process-driven asset allocation approach.

An Asset Allocation Fund is nothing but a one-stop solution that aims to address all the investor needs right from allocating assets towards equities, Debt and Gold but also appropriate allocation towards large-cap, midcaps and small caps based on a systematic process.

The strategies investors must adapt to realign their portfolio in the current volatile market backdrop.

While many things change in the markets, volatility has been a constant factor, especially in equities. In other words, we cannot expect equities to behave in a stable manner as compared to debt. Given this, it is crucial for an investor to have his or her investments allocated across various asset classes. This reduces dependency on a single asset class to generate returns and mitigates volatility of overall portfolio returns. So, how can an investor do this? There are two options:

1. Follow these steps:

a. Determine financial goals

b. Ascertain risk appetite

c. Determine optimal asset allocation

d. Invest in different asset classes directly and rebalance portfolio periodically

Since the above method is easier said than done, the investor can consider a much simpler second option, i.e to invest in an Asset Allocation Mutual Fund.

The writer, Rajiv Maniar, is Executive Vice President and Co-Head - Sales and Distribution at HDFC Asset Management Co. Ltd. The views expressed are personal