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Explained: How new age investment options help in diversifying portfolio better?

Explained: How new age investment options help in diversifying portfolio better?

Explained: How new age investment options help in diversifying portfolio better?
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By CNBCTV18.com Contributor Apr 22, 2021 3:31:20 PM IST (Updated)

Diversification as a tool can help you manage risks, which along with returns are two sides of the same coin.

"Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing." – Warren Buffett

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“Diversification is an established tenant of conservative investing” – The Intelligent Investor
For the long-term health of your portfolio, it is important that you grasp that unless you are an experienced full-time investment professional, you should consider yourself to be ignorant.
Diversification as a tool can help you manage risks, which along with returns are two sides of the same coin. We often tend to focus only on the latter.
A key underlying assumption in this piece is that most Indians have outsized exposure to real estate and gold, hence, this article shall focus on other asset classes.
Traditional options here include mutual funds, PMSs/advisory services, and direct investing by buying stocks on the exchange. However, over the last 3-5 years traditional mutual funds have been unable to outperform the benchmark – this has translated to significant outflows from these mutual funds over the last year.
Many broking platforms internationally and in India have made direct investing much more accessible to retail investors. However, investing in stocks directly is fraught with risk for non-professional investors.
A better bet would be exploring ETFs (Exchange Traded Funds). ETFs as a concept originated only about 25 years ago and were initially promoted as a low-cost, index-investing option vis-à-vis mutual funds. Most ETFs allow an investor to mimic a popular index i.e., Sensex, Nifty 50 etc. Index investing itself is an age-old concept, made popular in the 1970s by John Bogle, the founder of Vanguard Group. Today, just the top 3 ETFs that track the S&P 500 manage over $730 billion. One of the key reasons ETFs have become so popular in the US is that hedge funds and active managers have generally underperformed the S&P 500, especially over the last market cycle of 5-10 years. It looks like the same story is playing out in India too. As mentioned earlier, performance data shows that the top five AMCs in India (that account for over 50% of AUM in mutual funds) have been unable to generate alpha over the index in the last 5 years.
Platform like Smallcase is another option; Smallcase allows you to invest in a basket of stocks constructed by professional managers, which are usually only accessible to high-net-worth individuals. Our portfolios are also offered on Smallcase helping individuals seamlessly invest online. In addition, one can also buy thematic portfolios, for example – there is one that buys a basket of companies that benefit from transition to electric vehicles, another that focuses on increasing rural consumption.
In addition, there are now also options to invest in overseas markets. Through platforms like Stockal and Vested once invest in the ever-popular FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks or even get exposure to Tesla. However, again this is a fairly risky option and, in my opinion, not recommended for retail investors. An interesting play could again be ETFs in the US. The number of ETFs in the US today are comparable to the number of individual stocks! Although the top 30 ETFs control over 40% of the total AUM, there is a slew of thematic and “active” ETF products available to the US investor. For example, there are ETFs that focus on ESG (environmental, social and governance) factors, or on the EV/Lithium industry, or even one that focuses only on the pet care industry.
On the debt side, besides traditional options like deposits and mutual funds, there are new-age platforms that offer direct exposure to various debt securities at attractive interest rates. Again, the risk tolerance for a prospective investor should be high to invest in these products.
This article would not be complete without addressing the proverbial elephant in the room. Cryptocurrencies or NFTs (non-fungible tokens) have become very popular worldwide. There are numerous crypto trading platforms to gain exposure to crypto assets. Personally, I think there are some robust arguments one can make in favor of these asset classes. However, I don’t think it is a viable option for Indian investors in the near term. The reason is the uncertain regulatory environment – it would be prudent to wait for concrete guidance from the Government, given the rumors of an impending ban. In any case, any investments in these assets should not be more than 2-3% of a typical retail portfolio.
Besides using these tech platforms to invest, it is prudent to diversify away from human managers and invest in products that use underlying tech to drive investing decisions. There was actually a study done by Nobel Prize winner Daniel Kahneman, which says “the evidence from more than 50 years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. At least two out of every three mutual funds underperform the overall market in any given year.” I believe that technology will make better investing decisions than humans over the long term. This is because machines are unbiased, unemotional and unaffected by market euphoria and panic.
The writer, Atanuu Agarrwal, is Co-founder at Upside AI, a Portfolio Management Services Company. The views expressed are personal
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