In recent times, a leading business paper has been publishing a regular column in which it features well known people in the world of investing. The column provides an insight into the guest’s approach to personal finance including their personal asset allocation strategy. My reaction to the asset allocation strategies of people (not just those featured in the column) is exactly along the lines of the question posed by George Carlin! I find many to be excessively cautious and others to be much too aggressive for my comfort. Asset allocation is not just the means to an end - securing your financial goals; it is equally about what allows you to sleep well at night. And just as George Carlin’s aphorism goes, asset allocation is an intensely personal choice. What’s right for you may not be right for somebody else. And what is right for somebody else may not be right for you.

The purpose of asset allocation is diversification, reduction of portfolio volatility and improved risk adjusted returns. It is not to maximize returns by switching between asset classes to seize the moment when they are likely to perform the best. While it is a very short period, this is one of the years (2022) where asset allocation is not working the way you would wish it would. In India, equities and bonds (medium to long duration) are in negative territory year to date. Only Gold has managed to hold in positive territory and its gains are enhanced by the depreciation in the rupee. In the US context, the data is even more acute. The Bloomberg US aggregate bond index has delivered one of its worst ever performances to start a year dropping nearly 9% on a year-to-date (YTD) basis. The S&P 500 index is down over 13% YTD which means the classic balanced portfolios (equities and bonds) is facing sharp losses in both asset classes. The muted losses in India in comparison to that in the US is a reflection of the difference in the health of the macro parameters that the economies find themselves in, as well as the initial conditions.

In India, there is much handwringing about the significant FPI selling this year. I would instead suggest that investors should focus on earnings and valuations through a sound investment process. In the long-run stocks are slaves to earnings. I use the term earnings in all compassing sense - not just Earnings Per Share (EPS) but its many dimensions – Return on Capital Employed (RoCE), Operating Cash Flow, Free Cash Flow etc. The economic cycle and level of participation influences the valuation cycle; this makes stock returns more volatile than earnings. Valuations matter because they can either add to returns or detract from the returns that might accrue from the earnings cycle. I see the discussion over who is buying and who is selling as a distraction from the role of earnings and valuation in investing. People are drawn to the seductive attraction of a narrative, whereas an investment process is boring by design. The objective of an investment process is to guide decision making under the conditions of uncertainty; a future filled with surprises both good and bad. It has nothing to do with daily price fluctuations or the identity of the buyer and seller.

हमारा कानून अंधा है... (hamara kanoon andha hai…) Amitabh Bachchan in Chehre (2021)

In the typical Bollywood dialogue the phrase ‘andha kanoon’ has acquired a derisive tone and narrative. The image of the lady of justice with the balancing scales and sword is interpreted as ineffective because she wears a blindfold. The reality is that the blindfold symbolizes impartiality in dispensing justice without fear, favour or corruption or the status of the opposing sides appearing before the court. All that matters in delivering justice is how the scale of evidence tilts. Similarly, investors should be guided by how the scales of fundamentals, earnings and valuations tilt in making decisions about the attractiveness of an investment rather than the identity and status of the buyer and seller in the market.

As regards to valuations, the mid and small caps are now coming closer to joining the large caps in the comfort zone. This is a function of the much sharper decline in small caps with Nifty Smallcap 100 TRI down 19.07% YTD. A better measure of the decline in the small cap space is the peak (Jan ‘22) to trough (May ‘22) drawdown which now measures nearly 28%. In comparison the large cap Nifty 50 TRI is down 5.30% YTD with a peak (Oct ’21) to trough (March ’22) drawdown of a shade below 15%. Mind you, valuations are still above the long-term average and not yet attractive vs bonds but the recent cuts have now worked through a degree of the valuation excesses and narrative.

Last month, the world’s most renowned nonagenarian investors - Warren Buffett and Charlie Munger were in the limelight and as usual provided much food for thought. But I was more impacted by a non-celebrity nonagenarian individual in the extended family who has lived the good and simple life in aamchi Mumbai. In the course of our conversation where I explained what I did for a living, he left me with a difficult question. He said what do you plan to do for the next 40 years of your life? I must admit that question threw me off guard. Another 40 years would get me firmly into nonagenarian territory. I don’t know if I will make it there, but it was an abrupt reminder that the time horizons that we bring to the investing domain are quite misplaced. We think of bimonthly Monetary Policy Committee (MPC) meetings, quarterly earnings forecasts, and 5 years or more as long-term. In reality, our time horizon likely runs much longer. You need good health and sound financial planning to enjoy the long drive.

And on that note over to George Carlin again - Life is not measured by the number of breaths we take, but by the moments that take our breath away.