Outsource asset allocation to a fund

Raising equity allocation when the market is down and reducing it when it is soaring is difficult. Let dynamic asset allocation funds do it for you

My friend Anand called me a few days ago. He sounded crestfallen. He had kept in touch with me through the pandemic-fuelled crazy ride in the stock markets. Back in March 2020, when the Nifty had fallen to around 7,600 and fear was at its peak, I had coaxed him to stay invested in his existing equity mutual funds as his goal was due only 10 years later. I convinced him to look at his asset allocation, which was well below his target.

Although I could not convince him to increase his investment in equity funds, at least he stuck to his existing investments. He was extremely happy with that decision as the markets improved within a couple of months. 

He decided to redeem his equity mutual fund holdings in August 2020 after the markets had climbed back to their pre-pandemic levels. His equity funds had performed even better than the index and he was understandably happy. He called me afterwards to thank me. I asked him if his equity holding percentage was higher than his target allocation, and by how much. He mentioned it was slightly higher than his targeted allocation towards equity. “Why not redeem just that excess portion?” I asked. But the deed had already been done and he told me that the “irrational exuberance” driving the market would soon die out and the market would provide an opportunity to invest again. That’s where the matter rested till a few weeks ago. 

The markets scaled an all-time high. Anand was besides himself. He feared he would lose out by staying on the sidelines. This was the worst case of FOMO (Fear of missing out) I had seen in a while. 

My advice to him was simple. Do not invest based on emotions. Have a target allocation to equity based on your risk profile, availability of resources, and when the desired objective is due. If you are already fully invested, keep reviewing the allocation and rebalancing it up and down periodically (say, once or twice a year) unless the deviation is huge, as happened in March 2020. This sounds simple but all of us know it is difficult to operationalise in practice. It takes nerves of steel to be able to increase equity exposure when the market is down in the dumps. 

Hence, for some portion of your investments, it is a good idea to outsource the asset allocation decision to the fund house itself. A category of funds called dynamic asset allocation decides the allocation between equity and debt exposure depending on a pre-fixed formula. While the formula would be different for each fund house, all have one thing in common. The emotional element of deciding the allocation between debt and equity is taken out of the equation to a great extent. This allows the fund manager the ability to increase equity exposure when the market is low (based on their formula) and reduce equity exposure when the market is high (again based on their formula). 

I advised Anand to consult his investment adviser and spread his investments over 6-12 instalments in such dynamic asset allocation fun­ds. These funds would have a reasonable exposure to equity currently and would hence benefit from a further rise in the market. At the same time, the debt allocation would provide protection in case of a sharp correction. Also spacing out the investment over 6-12 months would ensure rupee cost averaging. 

This combination of rupee cost averaging and dynamic asset allocation is the best vaccine against FOMO.

The writer heads Fee Only Investment Advisers LLP, a Sebi-registered investment adviser