Investing in turbulent times :: Business Line

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The year 2011 has been a year to forget but try as hard as you may, it is a year that will be etched in people's memories forever. Our children and their children in years to come, will go through case studies on 2011 — the year that personified the eye of the perfect storm, the year that defied all fundamental economic theories and gave rise to a new world order.

As we near the end of the calendar year, the “new normal” continues to be instability and uncertainty. Global market volatility is here to stay as we realise how nonsensically small and connected the world indeed is.

India's growth forecast has been cut from over eight per cent to 7.6 per cent. These statistics may be lower than originally expected but certainly not significant enough to be running to the wealth manager's and/or banks and cashing up to leave the money under the mattresses when the rest of the world (excluding China) are forecasting close to zero, even negative, growth.

India, however, has not covered itself in glory. Our economic growth has surprised everyone on the down-side: inflation has been unrelenting, far more than anticipated.

The rupee has been the worst performing currency in Asia. Government policy paralysis is impacting progress. There is a liquidity crunch in certain sectors and current account deficit is becoming an issue.

The news is undeniably bad and market volatility is here to stay. It might take years, perhaps even decades before the “glory days” of pre-2008 are here again. Despite the dire outlook and despite what appears to be an almost certainty that there is more bad news in the near-term, India will recover quicker and stronger than most other economies.

BOOM TIME STRATEGY

So how does one invest in these turbulent times? Exactly the way one invests in boom times — through a well diversified portfolio with an asset mix that takes into account the market environment dynamically.

But first things first… know the pitfalls to avoid

Know that there is no magic product or solution that will help recover any losses suffered

A single product led solution does not take into account other investment circumstances (risks, correlation, over exposure to one asset class)

Cashing out of one asset class (equities for example) and investing in cash or equivalent, in fact reduces your purchasing power parity when net returns are compared against inflation.

If it is too good to be true, it is too good to be true.

Most importantly, you need a trusted advisor able to assess investment products and solutions against your own individual needs and objectives to investing, growing, managing and preserving your wealth.

The “new normal” demands diversification.

BEYOND USUAL ASSETS

The now “new normal” calls for looking beyond traditional assets like protection (debt) and growth (direct equities, mutual funds, structured products, commodities, currency, PMS, Gold and like) to include appropriate asset allocation to other types of “aspirational” assets such as global hedge funds, Venture Capital Funds (VCFs)/ Private Equity Funds (PE) and co-investments in “real” assets (partnering with firms, whose focus is on acquiring these “next generational” assets i.e. food related, resources, environmental assets ).

These co-investment opportunities have historically only been available to large institutional investors such as investment banks, asset managers, pension funds, private equity or sovereign wealth funds. The “new normal” demands such appropriate diversification across the asset classes to ensure the underlying assets in the portfolio have little to no correlation with each other.

It is also simply not enough to only have an asset class diversification. Multi-jurisdictional and portfolio construction diversification are two additional critical layers. Multi-jurisdictional diversification introduces a world of opportunities while improving the risk/ return balance in a wealth portfolio.

It is important, however, to ensure that in a multi-jurisdictional diversification strategy, one is not exposed to assets that will move in the same direction as the domestic assets.

In other words, it does not make sense to invest in the US equities, for example, due to the high correlation between the US equity market and Sensex (despite the fact that the real economies of India and the US are not strongly related).

Portfolio construction diversification takes one's investment portfolio to the next level, to ensure investments within the same asset class have very little correlation with each other (a multi-sectorial equity exposure for example). With respect to the next generational real asset investments, it is important to ensure that the real assets are producing assets.

One must also ensure that any climatic risks have been accounted for — for example, investing in farm land in New Zealand as well as Brazil to ensure the opposite climatic exposures at different times of the year in both these countries are maximsed. Geo-political risks should also be taken into account to ensure that investments in next generational assets, including farmland and resources, are in more politically stable countries.

ADAPTABILITY

The key is “adaptability”.

Going forward, while there will invariably be enough and more reports emerging on the types of investment themes to focus, it is important to remember that the prevailing world of unpredictability, dynamic information, rapid capital movements and shorter reaction times, calls for adaptability.

This is commonly referred to as Dynamic Asset Allocation. This is the ability to make proactive adjustments to the investment portfolios as a result of emerging market condition shifts — the need for adaptability has never been greater as we embark on what invariably is going to be a volatile period through 2012.

Once you understand why it's important to diversify your portfolio by asset, style and geography, and take tactical calls to benefit from market movements, you're well on your way to grasping the timeless principles of investing irrespective of the market conditions. You'll know that diversified portfolios contain investments that behave quite differently from each other — and that, at any given point in time, some of them will do better than others.

You will accept the inevitable periods of negative returns in your portfolio, knowing that they will be more muted because outperformance in one asset will help balance underperformance in another. You'll understand that what really matters is the sum of parts, not the individual parts.