Do you believe in working with an asset allocation approach in your portfolio?

Do you rebalance your portfolio at regular intervals?

Is there a merit in dividing our portfolio in assets with low correlation?

In this post, let us construct a multi-asset portfolio combining domestic equity, international equity, and gold and see if delivers superior performance compared to a Buy-and-hold Nifty 50 portfolio. Superior performance could mean better returns, or lower volatility, or simply better risk-adjusted returns. We compare the performance of this multi-asset portfolio over the last 9 years.

You may argue that international equity is not really a different asset and is still equity. Fair enough but let us play along. I could have added a Fixed income asset (say a liquid fund) and diversify the portfolio even further. However, I have not included a fixed income asset in the portfolio.

Over the past few months, we have tested various investment strategies or ideas and compared the performance against the Buy-and-Hold Nifty 50 portfolio. In some of the previous posts, we have:

1. Compared the performance of Nifty Next 50 against Nifty 50 over the last two decades.
2. Compared for the performance of Nifty 50 Equal-Weight vs Nifty 50 vs Nifty 50 over the last 20 years.
3. Considered the data for the past 20 years to see if the Price-Earnings (PE) multiple tells us anything about the prospective returns. It does or at least has in the past.
4. Tested a momentum strategy to shift between Nifty 50 and a liquid fund and compared the performance against a simple 50:50 annual rebalanced portfolio of Nifty index fund and liquid fund.
5. Used a Simple Moving Average Based Market Entry and Exit Strategy and compared the performance against Buy-and-Hold Nifty 50 over the last two decades.
6. Compared the performance of 2 popular balanced funds against a simple combination of an index fund and a liquid fund.

The Funds and the Asset Allocation

I have used the following three instruments for this analysis.

1. Nifty 50 TRI (for domestic equity)
2. Motilal Oswal Nasdaq 100 ETF (as proxy for international equity fund)
3. Nippon Gold Savings (for gold)

We use the data for the above 3 from April 1, 2011 until July 22, 2020. Before that, there were no passive investment options for the international equity fund.

With respect to asset allocation, we have many options. We can divide the money equally between the 3 funds. Or since you are based in India, you can give a higher allocation to Nifty 50. I would prefer a higher allocation to domestic equity (Nifty 50) because that’s what we compare our portfolio performance against consciously or sub-consciously.

I use the following allocation:

1. 50% to Nifty 50 TRI
2. 25% to Motilal Nasdaq 100 ETF
3. 25% to Nippon Gold Savings Fund

The portfolio is rebalanced annually on April 1.

The Results

Let us begin with point-2-point returns.

Motilal Nasdaq 100 ETF is outright winner with CAGR of 24.24% p.a. over the 9 odd years. The multi-asset portfolio (mix of Nifty, Nasdaq 100 ETF and Gold Savings Fund) is second with CAGR of 13.17% p.a. Nifty 100 TRI and the Gold Fund return 8.56% p.a. and 8.07% p.a. respectively.

Here is the performance in each calendar year.

While Nifty 50 TRI has given negative returns in 3 calendar years, the multi-asset portfolio has not given negative returns for any calendar year under consideration. This alone is a huge positive. The multi-asset portfolio has beaten the Nifty 50 TRI in 7 out of 10 years.

How about rolling returns?

You can see that the performance of the multi-asset portfolio is much more consistent. You would expect that too when you add assets with a low correlation to the portfolio.

Downside protection is a major source of excess returns. Let us see how the multi-asset portfolio has performed in managing drawdowns.

The multi-asset portfolio does very well.

What about the rolling risk?

The multi-asset portfolio has been a super performer in this aspect.

So, the multi-asset portfolio (for the period under consideration) gives much better returns than the Nifty 50 TRI with lower volatility and much lower drawdowns.

What else can you ask for?

The benefits of diversification, asset allocation, and regular portfolio rebalancing in full glory.

The Usual Caveats

1. Past performance may not repeat.
2. Rebalancing on a regular basis will involve transaction costs and can result in tax liability. I have not accounted for the impact of taxes.
3. The tenure is noticeably short, just over 9 years. Not smart to arrive at far-reaching conclusions.
4. I am saying all this in hindsight. Nasdaq 100 has been a superb performer over this last decade. Add to this the rupee depreciation from ~40/USD to ~75/USD in this decade. Nasdaq simply shines through. In fact, for the period under discussion, the ETF NAV has gone by over 754%. On the other hand, Reliance Gold Fund NAV and Nifty 50 TRI have gone up by just over 200%. So, exposure to Nasdaq 100 in any portfolio will add value.
5. I chose Nasdaq 100 ETF because that was the only option available since March 2011. No other passive fund option before that.
6. Motilal Nasdaq 100 ETF is an ETF. I have taken the day-end NAV for this exercise. In real life, you will have to purchase ETF on the stock exchange. Hence, your acquisition price can be quite different from the day-end NAV. In fact, the purchase price can be different from real-time NAV. That’s how ETFs work. Motilal Oswal Nasdaq 100 FoF (that invests in the ETF) was launched only in the year 2018.
7. Why Nasdaq 100 fund and not S&P 500 fund? I have no explanation. S&P 500 looks better diversified on paper. Nasdaq 100 consists of primarily tech companies in the US. In 2011, given a choice, I might have picked up an S&P 500 index fund.
8. Why not a Global Equity Index Fund? If you are looking for diversification, a global equity index might be a better choice than a US-only index? Again, the lack of options.
9. I have used Nippon India Gold Savings Fund. We could have used physical gold. Could have used Sovereign Gold Bonds (SGBs) after 2016. SGBs have an additional advantage of interest income of 2.5% p.a. (or 2.75% p.a. earlier). However, rebalancing portfolios using Sovereign Gold Bonds will be quite difficult.

Eliminating Nasdaq from the choice

We know that the Nasdaq 100 ETF has been a primary driver of returns in the multi-asset portfolio discussed above.  What if we had combined just gold and Nifty 50?

Let us discard Nasdaq 100 from the choice of investment options. Let us see how various mixes of Gold Fund and Nifty TRI would have performed.

As you can see, even without Nasdaq 100, gold has added value to the pure equity portfolio. You can see, a mix of an annually rebalanced portfolio of gold and Nifty has given better returns than both 100% gold and 100% Nifty. This means the combination portfolio has given better returns than the two underlying assets it is composed of.  I have not checked the volatility of the combination portfolio, but I expect it to lower than a pure equity portfolio.

That’s the power of portfolio rebalancing. Do note rebalancing may not always give higher returns than individual assets but is quite likely to reduce portfolio volatility.

What should you do?

While there is no guarantee that the past will repeat, there is merit in adding different assets to your portfolio. While the percentage allocation to various assets will change depending on your comfort and risk appetite, adding low correlation assets to your portfolio will likely add value over the long term, either in terms of higher returns or lower volatility or both.

I have not added a fixed income (debt) product to this portfolio. Adding fixed income products will make this portfolio even more robust.

What do you think?

Source/Additional Links

ValueResearchOnline

NiftyIndices