Skip to main content

Asset Allocation – A Contrarian Approach

Background

There are mainly two approaches to asset allocation —
  • The Bandwagon Approach and
  • The Contrarian Approach.

In the bandwagon approach - one chases the best performing assets and broadly follows the crowd. In the contrarian approach one focuses more on core value and enters assets that may be out of favour.

The contrarian approach to asset allocation, if followed judiciously, can be rewarding. It combines a full range of fundamental and technical analysis, evaluating assets continuously — in the search for assets that are likely to reverse its past trend. It is not about just blindly doing the opposite of what the market is doing. It is about identifying assets that offer true value.

Rationale

One of the key reasons for using a contrarian approach to asset allocation is the cyclicality of asset classes. There are also some asset classes that are complementary to the others. For instance, when interest rates go up, it hurts the bottom line of companies and hence equities are impacted negatively. On account of a spike in inflation last year, interest rates went up sharply — this was one of the key leading indicators that triggered the initial fall in Indian markets.

Similarly, gold is globally used as a safe investment avenue. When the outlook turns negative on stocks, investors move to safer asset classes like gold. While the Sensex dropped from a close of 20,301 on January 1 2008 to 13,802 on July 8 2009, a whopping 50% drop, gold prices in the global markets yielded an absolute return of 11%. An investor who took advantage of this trend would have topped up the good stock market returns, with gains in gold commodity. Cycle trend anticipation is the backbone of the contrarian approach to asset allocation. Different asset classes perform well at different times and timing the market is always a challenge. A well-balanced portfolio helps achieve best risk-adjusted returns. The right way to get the best of every asset class is proper asset allocation keeping in mind one’s risk appetite, the market cycle of each asset class and the time period one intends to stay invested.

A practical approach

A key to the successful practice of the contrarian approach is that investors should avoid unnecessary risk by being sufficiently diversified. The contrarian approach to asset allocation not only helps reduce portfolio risk by including investments that are negatively correlated; but also enhance returns by timely rebalancing of assets.

While the traditional school of thought believes in keeping one’s asset allocation fixed, a contrarian would work on a variable asset allocation pattern, depending on the outlook to the asset classes. In the first situation, the market is low, while the future outlook of equity is positive. Hence, the higher equity allocations in the contrarian approach. When markets run up and are at a high and the outlook to equity becomes negative, then one realigns the asset allocation and increases the allocation to debt and gold as shown in the second scenario. This example is simplistic. In reality, the asset allocation would be changed in phases. The success of the investor would depend on whether one was able to make this transition prior to the change in market cycle.

Monitoring and re-balancing

Consistent monitoring is essential to ensure that best returns are achieved at the relevant risk level. When any asset class delivers very high returns, its composition in the portfolio automatically changes. However, rebalancing too quickly can have a negative impact. For example, the last bull cycle started when the BSE Sensex was around 3,000 points in April 2003 and hit a high of 20,869 on January 19, 2008. An investor who was happy with a good 100% returns would have missed most of the rally that followed.

A few TIPS:

  • A diversified approach across various asset classes is important to success. E.g. Equity, Debt, Gold, Commodities, Real Estate, etc.
  • An understanding of the correlation between asset classes is vital to the contrarian approach. Only use asset classes that you can track.
  • Study market cycles, lest you exit too early and miss a bigger market opportunity. Risk should be the basis of most switches.
  • Think long term - most asset classes deliver returns only in the long term. Contrarian style for a short term investor can be very damaging.
  • A phased approach to realigning the portfolio (switches in asset composition) can be used to reduce the dependence on 'timing the market'.
  • Keep your financial goals in mind while doing your asset allocation.
  • Do not get emotionally involved. "Fear and Greed" are two emotions that result in taking irrational actions that are not financially rewarding.

Popular posts from this blog

Rs 14,000 Crore worth of tax free bonds coming soon from NHAI , PFC

  NHAI, PFC file prospectuses, coupon rate not yet decided MORE debt investment options have opened up for investors with AAA rated tax-free bonds worth over Rs 14,000 crore lined up. The National Highway Authority of India ( NHAI ) and Power Finance Corporation ( PFC ) are offering Rs 10,000 crore and Rs 4,033.13 crore worth of tax-free bonds, respectively, as per prospectuses filed with the Securities and Exchange Board of India (Sebi). Of a Rs 5,000 crore issue by PFC, Rs 966.87 crore has already been raised through private placement on September 28 and November 1. Tax-free bonds give investors tax-free return on any amount invested. In another kind of bonds, the long-term infrastructure bonds, investments up to Rs 20,000 are tax exempt, that is this cap amount can be deducted from the taxable income. Accordingly, the NHAI prospectus has clarified that only the amount of interest from -and not the actual investment on -its new bonds will be tax-free. "NHAI's publ...

Change in Fund Manager for some of HSBC Mutual Fund Schemes

Buy Gold Mutual Funds Invest Mutual Funds Online Download Mutual Fund Application Forms Call 0 94 8300 8300 (India) However, this facility is only available to Unit holders who have been assigned a folio number by the AMC.   HSBC Mutual Fund has announced that the below mentioned schemes shall be managed by the new fund managers as stated in the table. The effective date will be July 02, 2012.   Amaresh Mishra 's will be Vice President and Assistant Fund Manager. Having done a Post graduate diploma in Business Management and Bachelor of Chemical Engineering, he has over seven years of experience in Equities and Sales.   Mr. Piyush Harlalka's designation shall be Vice President- Fixed Income. Qualified as a C.A., C.S. and holding M.B.A.( Finance degree), he has over six years of experience in Fund management and ...

How EEE and EET Tax affect Retirement Investments

  An important factor while choosing a financial product is its taxation , and for retirement savings, this is even more important as the sums involved are usually life-long savings. Here's a look at the current tax treatment of three major long-term retirement planning products, which are - Employees' Provident Fund (EPF), Public Provident Fund (PPF) and National Pension System (NPS). EPF The tax treatment is EEE, which means your money is exempt from taxes at the time of investment, accumulation and withdrawal. At the time of investment, the tax deduction is under the limit of section 80C of the Income-tax Act , which is currently Rs 1.5 lakh. Partial withdrawals are also tax-free if made after 5 years of continuous service. If withdrawals are made before 5 years of service, 10% tax will be deducted at source. Exceptions have also been provided for transfer of amount and conditions wherein the subscriber is unemployed for more than 2 months or the loss of job was beyond th...

Personal Finance: You can insure your wedding

But luck may not always be on your side. With the frequency of such attacks, as also other risks and unforeseen accidents growing, a wedding insurance is something you may want to look at if a marriage is being planned in the family. Event insurance plans like this is still in its nascent stages due to low awareness. And given the sacred nature of the ritual, nobody wants to discuss or think negative. But as wedding spends and risks grow, it makes sense to cover the potential monetary loss. The policy in those countries even covers the loss of the wedding ring, the wedding gown not reaching on time and even the expenses/loss due to late or non-appearance of the photographer which may mean staging the event once again for the photograph. In India, most insurance companies — including ICICI Lombard General Insurance, Oriental Insurance, Bajaj Allianz and National Insurance — offer wedding insurance. The policy is tailor made to individual requirements and needs. The sum insur...

DSP BlackRock MidCap Fund

Best SIP Funds Online   HOW HAS DSP BlackRock Small & Mid Cap Fund PERFORMED? With a 10-year return of 14.61%, the fund has outperformed both the category average (12.34%) and the benchmark (10%) by a good margin. Should you invest in DSP BlackRock Small & Mid Cap Fund? This fund invests predominantly in mid-cap stocks but takes a sizeable exposure in small-caps as well. The focus is on nascent companies with high growth potential. The fund manager places emphasis on quality and avoids inferior businesses even if these look tempting from a valuation perspective. Over the past year, the fund portfolio has grown, having added to some of the underperforming sectors like chemicals and healthcare. Its portfolio churn has come down significantly. The heavily diversified portfolio is run completely agnostic of its benchmark index— most bets are from outside the index—which can at times lead to bouts of underperformance as seen in the recent years....
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now