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Asset allocation is like a game of cricket
Dr Sanjiv Mehta
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June 02, 2008
Asset allocation is the single most important tool when it comes to maximising wealth. Multiple research studies show that appropriate asset allocation determines more than 90 percent of a portfolio return, while individual security selection determines only a miniscule part.

Unfortunately, the time spent on each is inversely proportional to its relative contribution. In my conversations with numerous investors, I am always surprised by their fixation on getting hot tips on how a stock will fare, rather than on economic factors driving various asset classes.

I find maximising wealth to be uncannily similar to cricket. Winning in both results from building up a sensible innings, withstanding the tough times while taking advantage of opportune times. Both involve putting up a winning total while at the same time controlling risk. If one takes indiscriminate risks, one actually gets a smaller total by getting skittled out. At the same time, playing too cautiously also leads to a small total.

With the Sensex crossing various milestones in the past few years (there has been a significant correction lately), many investors are understandably delighted -- their preferred stocks have performed very well. However, many of them have much less than the optimal allocation to stocks as a part of their total portfolio. A large portion of the portfolio is in low-yielding bank deposits or saving schemes. This is exactly like showing flashes of brilliance in a few overs, but not focussing on holistic asset allocation to reach the winning target.

Many investors have a misconception that higher returns can be generated only by taking higher risks. Appropriate asset allocation is a remarkable tool that maximises returns at minimal risks -- it is an optimisation equation with the personal life cycle and business cycle stages as major variables. In cricketing terms, it helps you make the maximum number of runs possible, taking into account the pitch condition (business cycle) and the team condition (personal stage). Portfolio risk is reduced by diversification across asset classes, consistent with Markowitz's 1990 Nobel Prize-winning economic theory.

The current Indian business cycle is akin to a batsman-friendly pitch, where a good score is very much possible. Presently the economic growth rate is high and not likely to be affected too much by global woes. The corporate earnings growth rate is lower as compared to preceding years, but still impressive.

Inflation has picked up and is a bit similar to a bowler who is hostile but operating on a wicket, which is still good though. A bit of care is required in the short run with asset allocation being balanced between stocks and debt. Once this bowler's spell is over, a more aggressive approach with heavier allocation favouring attacking batsmen like stocks and real estate will be useful.

Summary: Appropriate asset allocation, like team selection in cricket, is the single most important factor determining whether somebody wins the wealth game.

Dr Sanjiv Mehta is the MD, Finance Doctor, a wealth management company and author of Winning The Wealth Game: Cricket Strategies For Financial Freedom.

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