Page 96 - BFSI CHRONICLE 10 th Issue (2nd Annual Issue ) .indd

BFSI Chronicle, 2 Annual Issue, 10 Edition July 2022
nd
th
Investment “B” goes up 0% the first year, and for two years would be 32.5%.
30% the second year.
Asset Allocation - Fixing the Right Invest-
If you invest in either A or B, you get a 30% ment Mix
return over two years. Your average volatility Asset allocation - getting the right balance
is 15%. Volatility is measured using Standard between different asset classes is the
Deviation; where cornerstone of a successful Financial Planning.
Blending of different assets (equities, bonds,

gold, real estate, overseas investments et al) can
produce a unique shade of risks and returns.
Interestingly, the risk-return profile of these

blended portfolios can be better than any of
their component assets independently (refer
above illustration).
σ = Standard Deviation
Investment research and empirical evidences
X = Terms Given in the Data have demonstrated that asset allocation of
μ = Mean an investment portfolio is by far the most
significant factor in determining long-term
n = Total number of Terms investment performance.
It seems no matter how you mix these two In fact, the asset allocation decision can be more
investments, you can't get more than a 30% important than the choice of individual stocks
return over two years. But you can. And you or asset classes themselves. This proposition,
can lower your volatility as well. even intuitively, makes sense because
individual stocks within a particular asset
Imagine a blended portfolio of half invested
in A and half invested in B. The first year you class (say, same sector or industry) may move
in tandem, i.e. they may be highly correlated.
would experience a 15% return, and the second
year a 15% return. Your volatility would be It is like “putting all eggs in the same basket”.
Asset allocation facilitates getting rid of this by
0%. Lower volatility means a more efficient
portfolio. diversifying the investments across different
assets.
You would have both lower volatility and
To understand the effects of blending different
higher returns. Compounding returns would
produce a total return over the two years of assets, MPT also entails knowing how much
the assets move in sync with one another. The
32.5%. You experience a higher return because
after half of your portfolio invested in A grows statistical tool used is “Correlation Coefficient”.
by 30% the first year, you “rebalance” your Two asset classes that move completely
together have a correlation coefficient of +1.0,
portfolio. So half of the growth from investment
A is rebalanced and put into investment B. Half and if they move completely opposite, their
correlation coefficient is -1.0. The lower the
the growth would experience another 30%
growth the second year when investment B did correlation, greater is the benefit of mixing two
better. Thus, your total return (compounded) asset classes. Using asset allocation strategies
to invest in inversely correlated (or lowly

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