We have discussed a number of times in our blogs that asset allocation is one of the most important aspects of financial planning and investing. Asset allocation is the most significant attribution factor of your overall portfolio returns; selection of investments within a particular asset class is a secondary factor. We have discussed this is in details in our article, Asset Allocation is much more important than fund selection. Asset allocation is the percentage mix of different asset classes like debt, equity, gold and real estate in your total asset or investment portfolio. While, in its simplest form asset allocation often refers to the percentage split between debt and equity investment, gold is also a very important asset class, especially in the Indian context. There are a number of hybrid debt equity products in the market that offers various asset allocation mixes to investors. However, there are relatively very few asset allocation products that also include gold as an asset class. Peerless 3 in 1 Fund is a product that has around 20% investment in equity, 52% in debt / fixed income, 16% in gold and 12% in cash equivalents. As such, this asset allocation is a good investment option for conservative investors. The fund was launched in April 2011 and has a relatively small AUM base of
र 26 crores (as on October 31, 2015). The expense ratio of the fund is 2.18%.
Why is asset allocation especially important for even conservative investors
Conservative investors, especially retirees or people nearing retirement, rely almost entirely on fixed income investments. As such fixed deposits, small savings schemes, post office monthly income schemes etc are the most favoured investment options for conservative investors. However, risk free assured return schemes are more often than not, unable to provide sufficient income or returns to the investors, on an inflation adjusted basis. Fixed deposit interest rates range between 7 – 8% for most private and public sector banks for 3 to 5 year term deposits. If you are in the highest tax bracket, your effective post tax returns, for risk free assured return schemes will be around 6%. The chart below shows the historical Consumer Price Index (CPI) inflation rate.
We can see from the chart above the chart above that the CPI inflation is above 6% for the major part of the last decade. In fact, for urban consumers the relevant inflation figure may be even higher than what is constituted by the figures of the CPI basket. The returns from your risk free assured returns investment will simply, most likely, not be enough. This is especially true for retirees, given the longer retired lives these days. If you are a retiree, you need to invest in an asset class that will give you inflation beating returns otherwise your financial freedom is likely to be severely compromised. Let us see how much returns you would have got from your risk free fixed income investment over the last 10 years. The chart below shows the 10 year Government Bond yield over the last 10 years
The average 10 year Government Bond yield over this period was around 8%. Your average risk free interest during this period therefore, would also have been around 8%. Interest from most fixed income investments are taxable as per the income tax rate of the investor. If you are in the 30% tax bracket, your effective post tax return is 5.6%. This clearly is not enough to beat inflation.
Equity as an asset class has historically beaten inflation and grown the wealth of investors. The chart below shows the 10 year returns of BSE Sensex. Over the last 10 years the Sensex has given nearly 12% compounded annual returns, which is higher than the CPI Inflation rate.
However, equity is also associated with volatility, especially in the short term. Gold is another asset class which has beaten inflation in the long term.
In the last 10 years gold prices have increased at a compounded annual growth rate of nearly 14%, which is well above the average CPI inflation rate. It is true that over the last 2 to 3 years, gold prices have been on a declining trend, but going by historical trends, gold is an asset class that you should own in your portfolio to beat inflation in the long term. In fact, given the current decline in gold prices, this may be a good buying opportunity. In the short term, gold prices may see a further decline, due to the preference for US Treasury securities amongst global investors. But once risk preference returns to the market, we should see gold prices rising from the current low levels. In fact, for a prolonged period of time, a few years back, gold returns beat the returns of other asset classes.
Peerless 3 in 1 fund
The Peerless 3 in 1 fund has 35 to 40% allocations to equity and gold ETF. The fund also has around 12% in cash equivalents, which offers the fund manager the flexibility of capitalizing on good investment opportunities, as and when they arise. As such the fund is well suited for conservative investors looking to get the best returns from their investment portfolio. A fund like this enables the investors to get good returns across different market cycles. The fund has underperformed versus debt oriented hybrid funds over the last few years, because gold prices have been on the decline. But for the same reason, we may see this fund outperform hybrid debt oriented funds, when the reversal in the gold price trend takes place. Gold prices have been on a declining trend for a few years now. We cannot say for sure, if the current price represents the bottom. If and when the US Fed hikes interest rates, which they surely will, gold prices, may decline even further from their current levels. Having said, given the multi-year trend, many commodity experts believe that gold is available at attractive valuations from a long term perspective. From an equity perspective, while equity prices have been extremely volatile for the last 1 year or so, given the structural improvement in macro-economic fundamentals of our economy in India, one can expect good equity returns in the next 2 to 3 years. The equity portfolio of Peerless 3 in 1 fund has a bias towards, large cap growth oriented stocks. These stocks are likely to do well, once the capex and domestic consumption cycle revives in our economy. The debt portion of the fund portfolio has limited interest rate sensitivity. Credit quality is also very high with over 80% of the debt portfolio rated AAA. Since over 60% of the fund assets are invested in fixed income and cash equivalents the volatility risk is low.
From a medium to long term perspective, we are likely to see better returns from Peerless 3 in 1 fund, once we see a reversal in gold prices. As such, Peerless 3 in 1 Fund is a good investment option for conservative investors looking for stable returns. Equities over a sufficiently long time horizon can beat inflation. Gold as an asset class has proven its ability to beat inflation. A combination of debt, equity and gold can enable the investors to earn inflation beating returns in the long term, while ensuring a degree of capital safety, that conservative investors need. You should consult with your financial advisor if Peerless 3 in 1 fund is suited for your investment portfolio.