The New Year is around the corner and 2020 turned out to be good for investors despite the economic and financial havoc unleashed by the Coronavirus (COVID-19).
Equity, bonds and gold moved together
The benchmark BSE Sensex delivered double-digit return for the second consecutive year in 2020 — a rare feat for an asset class that is associated with volatility. The index is up around 12.6 percent year-to-date compared to 14.4 percent rise in 2019.
This was a good year for gold and bond investors as well. The spot gold prices are up 26 percent in US dollar terms during 2020 so far while it is up 32 percent when priced in rupee, according to data from the World Gold Council. This came on the back of an equally strong rally last year. The yellow metal had rallied by 18 percent in dollar terms in 2019 and was up 19 percent in the Indian market.
Also Read: How to invest in gold for maximum returns
The year of the pandemic also proved lucky for bond investors. The bond prices in the United States for 10-year US government bonds were up 40 percent in 2020 as US Federal Reserve pushed down the interest rate to record lows.
The yield or interest on 10-year government bond more than halved in the United States from 1.92 percent at the end of 2019 to 0.92 per cent now. There is an inverse relationship between bond prices and interest rates.
In India, bond prices are up around 12.5 percent in the current calendar year so far as Reserve Bank of India too pushed down interest rate post the pandemic. The yield on 10-year government bond has declined by around 60 basis points from 6.55 percent at the end of December 2019 to 5.95 percent currently.
In contrast, bond investors had suffered losses in 2019 both in India as well as the United States. Such a perfect alignment of stars in financial markets is rare when all asset classes do well simultaneously.
However, 2020 is not a typical year and the long-established relationship between various economic and financial variables was broken by the combined might of the pandemic and policy response by central banks and the governments.
It’s time to rebalance your portfolio
This means that you will have to rebalance your portfolio to maximise gains and minimise downside risks as we enter the New Year.
The asset allocation gets misaligned when different assets price moves at different speeds. This raises the weightage of assets that have outperformed and reduces the share of underperforming assets.
The investors not only need to rebalance across various assets but also within a specific asset class. In other words, you not only have to change the mix of equity, gold and bond in your portfolio but you also need to re-jig your equity portfolio.
The different industries and segment that comprise the equity market follow a cycle and one follows the other in leading the rally. Given this, one needs to reduce the weightage of outperformers and raise exposure to laggards to maintain an optimum level of risk to reward ratio in your equity portfolio.
Steps to rebalance your portfolio
1. Start with the broad division of your financial assets or portfolio into equity, bonds and gold. A typical portfolio is one with 50 percent equity, 30 percent bonds and 20 percent gold. If you had begun 2020 with a 50:30:20 ratio, it would now be misaligned in favour of gold as the yellow metal rallied the most this year. So you can book some profits in gold and move some of the money to equity.
2. Alternatively keep your investment in gold intact and put two-thirds (around 65 percent) of your incremental investments in equity and only 10-15 percent in gold. Rest can be invested in bond funds.
3. Bonds are also likely to underperform in 2021 as interest rates have begun to inch-up, which will weigh on bond prices. In the United States bond yields are up around 40 basis points from their lows and analysts expect a further rise in yields. The bond market could also face headwinds from rising inflation.
This is especially true in India where inflation is already at a seven-year high and looks stubborn. Higher inflation translates into a higher interest rate, which is negative for bond prices.
4. The biggest challenge in portfolio rebalance is to rejig one’s equity portfolio. Eleven out of 14 major sectoral equity indices in India are on course to give positive returns in 2020 and only three sectors are likely to end in the red – BSE Finance, BSE Oil & Gas and Bank Nifty. However, only three sectors managed to beat the Sensex this year – BSE Healthcare Index, BSE IT Index and Nifty Consumption index. Other indices underperformed the broader market even if they ended in the green.
5. Book profits in the stocks that belong to any of these 2020 champion sectors and use the proceeds to make incremental investments in laggards such as banks, non-banking finance companies, automobiles, metals & mining, oil & gas and real estate. But remember, this is not a call to completely exit the sectors that outperformed in 2020 but just book partial profits. As a rule of thumb, never book more than 25 percent profits in any of your stocks that have worked in the last one year.
This way you will reduce your downside risk and increase the probability of making superior returns in 2021.
Happy Investing in the New Year!
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).