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Asset Allocation Plan should not be disturbed despite high interest Rates


   The stock market has been volatile for a while now. At the same time, the interest rates have been moving up, making debt instruments more attractive. The recent Reserve Bank of India(RBI)policy review also under scores that the interest rates are likely to remain high for a while. So, is it time to rejig your portfolio and make fresh allocations to debt as many investors are tempted to do?
You should not deviate from your target asset allocation. Move money from equity to debt only if you have decided to rejig your asset allocation on a strategic basis and not merely as a tactical measure.


If the equity markets are weak, reflecting lower valuations, the proportion of debt in your portfolio would have proportionately increased. Therefore, a further increase in debt allocation may not always be optimal. However, one could tactically look at a modest increase in debt allocation to capture the current high rates. One should also evaluate the quality, duration and yield of one's existing debt portfolio to see if the current rates provide an additional opportunity to lock in investments in instruments offering higher yields.


Simply put, you don't change your asset allocation plan due to changes in the stock market or in the interest rate regime. In fact, the fall in market already presents you an opportunity to increase your allocation into (no, you guessed it wrong – it is not debt) equity. This is because the recent fall in stock prices may have skewed your asset allocation towards debt.


Now, you should add to the equity component to rebalance the portfolio. According to experts, such rebalancing can be done once a year or every time there is a material change either in your life's circumstances or your financial goals.


As for your existing debt portfolio, you can consider parking a portion of your corpus in fixed maturity plans (FMPs) since they are offering good rates now. But, while doing so, ensure that you do not go overboard and lock the funds meant to meet your short term liquidity requirements. In other words, maintain a balance between your hunger for yield and liquidity.


If there is a strong desire on the part of clients to migrate to a certain asset class merely because it is making the headlines owing to its strong outperformance, I usually try to dissuade them saying they should actually increase their allocation in the underperforming asset class so as to redress the balance rather than aggravate it. Sometimes, I suggest a compromise solution by utilising around 5% of the client's corpus for such tactical shifts. This is usually not large enough to cause any material impact and it assuages the client, too.

DEBT TO EQUITY RATIO

In fact, investors should better pay attention to their overall asset allocation rather than fret about the debt to equity ratio of their portfolio. This is because there is no "ideal" ratio for all investors. It is a combination of several factors like your investment objective, your risk-taking ability, your financial advisors' take on the asset class and so on.


There is a thumb rule that states that the percentage of equity allocation should be 100 minus your age, but I often quote the John Bogle version of it which states '80 - your age'.

FACTORS THAT DETERMINE THE CHANGE

Ideally, an investor should consider rebalancing a portfolio only once a year. This period is neither too frequent nor infrequent.


Investment objectives and time horizon should be the primary determinant for any change in the portfolio, though it is a good idea to review and rebalance during any significant market event that may cause volatility.


You may, however, require an interim review under two circumstances. One, there is an adverse event – it could be either internal, such as a family issue, or external like, say, a dramatic change in the investment climate. For example, the implementation of the impending direct taxes code or the 'small savings' committee report may force you to alter your investment plan.


The second scenario that would warrant a change in your asset allocation is if there is a sudden change in the timing of a financial goal.


For example, a couple living in a rented house has decided to purchase a house within a year instead of the earlier target of three years.


Typically, profits could be booked based on relative performance of an investment. That is, if there is a better investment opportunity than the one being reviewed, or when an objective has been achieved, or when a portfolio needs to be rebalanced in favour of another asset class. One must be cautious against booking profits too often, since there may be unnecessary transaction costs or taxation consideration with every transaction.
 

 

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