Investors often struggle with finding the right asset allocation for their portfolios that can withstand different market cycles. Motilal Oswal Private Wealth recently conducted a comprehensive analysis spanning over three decades from 1990 to 2023 to evaluate the risk-reward of various portfolio combinations.
The analysis included Indian equity, US equity, long maturity debt, short maturity debt, and gold, all measured in rupee terms.
The portfolio combinations consisted of an equal weighted portfolio across all asset classes (25% equity: 75% debt, 50% equity: 50% debt, and 75% equity: 25% debt).
The analysis revealed that, on a pre-tax basis, the equal weighted portfolio had the best risk-reward, as measured by compounding return per unit of risk (standard deviation).
“However, the post-tax return from this combination may not be efficient in the future since the capital gains from all asset classes, except Indian Equity, would be taxed as short-term capital gains,” said Motilal Oswal Private Wealth.
A 50:50 equity-debt portfolio has the potential to generate significant wealth creation in the long term, as demonstrated by the analysis with a 12% CAGR for this combination. The 75-25% debt combination, with its higher exposure to equity, had the highest CAGR at 12.9%. However, it also had the highest volatility (standard deviation) among all portfolio combinations.
Based on a returns distribution analysis using 3-year rolling returns (monthly data), the equal weighted portfolio emerged as a superior alternative to traditional fixed income. This is because there were no negative returns observed for a minimum 3-year holding period, and 90% of observations generated higher returns than domestic CPI inflation (6% CAGR).
Based on this analysis, the investment management firm recommended a 50:50 equity-debt portfolio for moderate risk profile investors. The return distribution showed a low probability of negative returns, with around 54% of observations in the double-digit category.
Meanwhile, the 75-25% equity-debt portfolio was proposed to be suitable for aggressive investors who prefer higher long-term compounding while being able to tolerate relatively higher interim volatility.
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