Preparing A Portfolio for Trying Times

At the onset, let’s hope that India’s vaccination drive gathers pace and there is no third wave. We have been here before when cases were down and lockdowns lifted. Hopefully this time, through higher personal discipline and vaccinations, the restart will stick.

Despite the devastating on-the-ground impact of the pandemic, the markets seem largely sanguine. This could be the impact of loose monetary policies around the globe, or expectations that the pandemic’s economic effects will be short lived. 

However, supply-side shortages, near-zero interest rates, and generous fiscal stimulus are all tailwinds that could lead to a sustained surge in inflation. This could force the Federal Reserve and ECB to taper their QE (Quantitative Easing) programs faster, which will hamper liquidity and induce volatility in global markets like the ‘Taper Tantrum’ in 2013. Irrespective, I believe that age-old principles of portfolio allocation will hold you in good stead. 

Depending on your demographic profile, a healthy equity allocation (as much as 75 per cent of savings for some cohorts) is always recommended. In my view, for a retail non-professional investor, this should mean a large allocation to passives like ETFs or index funds and some active strategies like mutual funds or portfolios recommended by professional financial advisors. 

The trend of the pandemic so far has been increased direct retail participation in individual stocks, but I think this is dangerous if it becomes a large part of portfolios. In my opinion, a non-professional investor should view individual stock or crypto trading as nights out at a casino. Investors should only dabble with small sums that they are willing to lose in their entirety without causing a material impact on their net worth. One should expect to only derive some entertainment or at best educational value, not a steady stream of income.

Some clichés are true and the key to equity investing remains, as always,“time in the market, not timing the market.’ It’s important to not let well documented human impulses like herd mentality or loss aversion take over – especially if there is to be volatility in the short to medium term due to pandemic related or other factors. 

If inflation is expected, gold and other commodities are a natural hedge. While it is difficult for retail investors to seek direct exposure to most commodities, there are ample options for gold. The best, in my view,  is the periodic Sovereign Gold Bond (SGB) issued by the RBI on behalf of the Government of India. 

SGBs are government securities denominated in grams of gold and are direct substitutes for holding physical gold. Investors have to pay the issue price in cash and the bonds will be redeemed in cash on maturity. In addition to capital gains exemption (if held to maturity) on gold price appreciation, the bonds also pay 2.5 per cent p.a. as interest on the initial investment. More information can be found on RBI’s website. 

There are limited options on the fixed income side in India, however, it is tough to argue against regular contributions to some national saving schemes like PPF, that offer attractive practically risk-free interest rates with unbeatable tax benefits. Corporate bonds or debt mutual funds are also viable options. However, there is no free lunch, if an instrument is offering you higher than FD interest rates it carries more risk. So, tread carefully, like loss of principal is a very real possibility here, especially in these uncertain times.

Low risk fixed income instruments like fixed deposits and liquid funds may not seem attractive at the moment due to negative real interest rates. However, they are an important part of anyone’s portfolio to park funds for medical emergencies and other contingencies. Equities or corporate bonds or other types of higher yield products are poor substitutes due to both interest rate risk and credit risk.

Finally, a small direct exposure to large cryptocurrencies like Bitcoin, Ethereum, among others may also help diversify your portfolio by adding an uncorrelated (theoretically) asset class. However, beware of extreme volatility, potential legal issues, and a high probability of capital loss.

Sticking to a well-researched systematic plan is hard and for the most part, boring, but it is a near guaranteed path to wealth.

The author is the Co-Founder - Upside AI

DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.