Pay heed to asset allocation to deal with growing turbulence in equity markets

Volatility within the equity market has increased.

- Sudipta Mitu

If you are thinking about the changes you should make to your portfolio so that it is able to negotiate the likely turbulence in the markets in the near future, the answer lies in following the mantra of diversification and asset allocation.

A large number of new investors have entered the equity markets over the past year and a half. These investors have only experienced a market that has been going up. Many of them may also have invested only in equities, and no other asset class, because they have heard that equities give the best returns over the long term. They may be reluctant at this stage to diversify into fixed-income and gold, whose returns have been poor in the recent past. However, there are many reasons why they should diversify.

The first factor is that equities have done extremely well in the recent past. Sooner or later, mean reversion is bound to happen in the markets. Mean reversion means that an asset class that has done well in the recent past is likely to stop performing in the near future, and vice versa. If a novice investor is allocated to equities alone, and they give poor returns for two-three years, such investors’ moods may switch from overly optimistic to overly pessimistic. They may find it difficult to hold on to equities and may exit at a loss.