How to build an All-Weather Portfolio

The last few years witnessed some of the most unpredictable market movements. While the Sensex dipped to 25,000 points in 2020, it soon crossed 60,000 in 2021. Markets are volatile, and over the long run, the losses are likely to even out. 

What is an All-weather Portfolio?

To cushion your portfolio and money against such volatile movements, you can create an all-weather portfolio. It is essentially a mix of assets with varying risk levels and in line with your risk appetite.

An all-weather portfolio helps you adapt to the market volatility, adjust to different conditions of the market, minimize downside risks and give you risk-adjusted return over the long term.

Let’s explore the parameters you need to consider when building your all-weather portfolio.

• Accept That There is No Winning Asset Class

Different asset classes perform differently across various times. There is no winning asset class, as assets are cyclical. Sometimes equity performs better, while other times, so will debt or gold. In 2020, while equity markets were at record lows, gold prices were soaring. But none of us can predict this.

Investing in just one asset class could hamper one’s financial goals. Hence, it becomes important to have an asset allocation strategy by diversifying across asset classes such as equities, debt and gold to generate risk-adjusted returns.

So now that you have accepted that there is no winning asset class, how do you build an all-weather portfolio that can continue to perform under various market conditions?

• Determine Asset Mix

The asset mix is nothing but the relation between any two assets. To develop a diversified portfolio, you should endeavour to build a portfolio of imperfectly or negatively correlated asset classes.

For instance, during the onset of Covid, those who invested in equities alone saw their portfolio returns diminish considerably. However, if you were among the investors that diversified across equity and gold, you would be in a better position to achieve a balanced return or risk-adjusted return.

Gold generally has a negative correlation with equity assets and is one of the key reasons why it forms a preferred portfolio diversifier during periods of macroeconomic uncertainty. It’s similar to building a diverse team that has skilled professionals belonging to different functions and expertise.

• Pick the Right Asset Mix

The key to creating an all-weather portfolio is to diversify across asset classes. There are two approaches to diversification. One is where you do-it-yourself. This involves following an asset allocation strategy.

The second is investing in readymade or dynamic asset allocation solutions like mutual funds. You can also have a mix of stocks, bonds and equity/debt mutual funds.

In the first DIY approach to asset allocation, you need three building blocks to form a robust asset allocation strategy. 

These are:

Emergency Block – This is your go-to financial backup for emergencies when you are in urgent need of money. Experts suggest setting aside money equivalent to 6-12 months of expenses in low-risk highly liquid investment options or your bank account. Low risk options are those that have the least chances of a capital loss when you withdraw in an emergency.

- Portfolio Diversifying Block 

- Earnings (Growth Block)

The next 2 blocks define most of your portfolio. Growth block is the block where you park your high risk investments that give the edge to your overall portfolio while the portfolio diversifying block balances out the risk. Depending on your risk appetite, you can allocate your funds accordingly.

• Achieve Readymade Allocation With a Dynamic Allocation

Some investors are unable to improvise their portfolios due to time constraints. Under these circumstances, one can use a readymade asset allocation offered by a Multi Asset Fund of funds. Such funds work as a hybrid fund and have underlying investments in more than one asset class, thereby achieving diversification in a single portfolio.

The advantages of a Multi-Asset Fund of Funds are built-in diversification, professional research and management, etc.