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Portfolio allocation models for Indian investors

This article shows how different asset allocation models for Indian stock and bonds have performed over the years.

Portfolio allocation models for Indian investors


Posted on 03 Feb 2024
Author: Sayan Sircar
8 mins read
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This article shows how different asset allocation models for Indian stock and bonds have performed over the years.

Portfolio allocation models for Indian investors

Disclaimer: This article replicates a methodology similar to Vanguard’s model portfolios found at https://investor.vanguard.com/investor-resources-education/education/model-portfolio-allocation. This article does not mention or recommend any investments.

📚 Topics covered:

Introduction

The purpose of this article to give a high level overview of the return vs. risk trade-off in various equity vs. debt asset allocation models in the Indian stock and bond markets. We understand that this article is a deviation from our usual “easy to digest” content style but serious investors will benefit considerably from understanding the results of the analysis.

Methodology

We are using data for the SENSEX TRI (Total Return Index which includes dividends) for equity and the CCIL All Sovereign Bonds Index for the bond allocation. The data is from 1998 till date and uses month-end index values for a lump sum investment. We rebalance once a year. Returns are calculated using the Geometric average of the annual returns. The Sharpe ratio calculation uses 7% as the risk-free rate.

Taxes and trading costs have not been considered in these calculations and will reduce portfolio returns. Depending on the implementation, there might be taxes due to dividends and interest income that will further reduce returns.

Investors must complete a risk profiling exercise, using a tool like the Arthgyaan risk-profiling tool, before investing in any portfolio from the list below.

None of the portfolios below are suitable for short-term goals (less than or equal to five years) since the debt component has long-term bonds with considerable duration risk: Gilt funds do not always go up in value. Should you invest in gilt funds?

Since we are using indices these portfolios are not investible directly. Tax-efficient investment options for these portfolios do exist and can be implemented appropriately under professional guidance.

To understand how these model portfolios can help you:

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Income model portfolios

These portfolios are suitable for investors looking for regular income from their portfolios. We can see below that having a lot more bonds than stocks in the portfolio does reduce risk considerably., However, since the investment has long-term bonds, there is a considerable amount of duration risk which means that the portfolios with a highest amount of bonds do not necessarily give more number of years of positive returns. Investors looking for such portfolios should consider implementing them via bucket theory: How to construct buckets for your retirement portfolio?.

0% stocks / 100% bonds

Model portfolio of 0% stocks and 100% bonds in India

  • Average annual return: 8.3%
  • Best year (2001): 26.9%
  • Worst year (2009): -6.3%
  • Standard deviation: 8.1%
  • Sharpe Ratio: 16.3%
  • Years with a loss: 2 of 25

10% stocks / 90% bonds

Model portfolio of 10% stocks and 90% bonds in India

  • Average annual return: 9.4%
  • Best year (2001): 22.6%
  • Worst year (2004): -2.0%
  • Standard deviation: 6.8%
  • Sharpe Ratio: 35.9%
  • Years with a loss: 1 of 25

20% stocks / 80% bonds

Model portfolio of 20% stocks and 80% bonds in India

  • Average annual return: 10.4%
  • Best year (2003): 25.0%
  • Worst year (2011): -1.8%
  • Standard deviation: 7.1%
  • Sharpe Ratio: 48.6%
  • Years with a loss: 2 of 25

30% stocks / 70% bonds

Model portfolio of 30% stocks and 70% bonds in India

  • Average annual return: 11.3%
  • Best year (2003): 31.5%
  • Worst year (2011): -4.5%
  • Standard deviation: 8.9%
  • Sharpe Ratio: 49.1%
  • Years with a loss: 1 of 25

Balanced model portfolios

Balanced portfolios do not show a strong bias to either equity or debt and are suitable for investors focusing on long-term portfolio growth without taking on an excessive amount of risk. These portfolios are suitable for the accumulation phase of an investor with a stable source of income. Investors in retirement should move on to income portfolios as described here: How much equity should you have in your retirement portfolio?.

40% stocks / 60% bonds

Model portfolio of 40% stocks and 60% bonds in India

  • Average annual return: 12.2%
  • Best year (2003): 38.0%
  • Worst year (2011): -7.2%
  • Standard deviation: 11.5%
  • Sharpe Ratio: 45.0%
  • Years with a loss: 3 of 25

50% stocks / 50% bonds

Model portfolio of 50% stocks and 50% bonds in India

  • Average annual return: 12.9%
  • Best year (2003): 44.5%
  • Worst year (2008): -13.7%
  • Standard deviation: 14.4%
  • Sharpe Ratio: 40.6%
  • Years with a loss: 3 of 25

60% stocks / 40% bonds

Model portfolio of 60% stocks and 40% bonds in India

  • Average annual return: 13.5%
  • Best year (2003): 51.0%
  • Worst year (2008): -21.3%
  • Standard deviation: 17.6%
  • Sharpe Ratio: 36.7%
  • Years with a loss: 3 of 25

Growth model portfolios

Growth portfolios are suitable for investors looking only for wealth maximisation along with the potential for larger drawdowns during stress periods like the 2008 Global Financial Crisis. As the proportion of equity increases in the portfolio, the risk increases fairly quickly.

70% stocks / 30% bonds

Model portfolio of 70% stocks and 30% bonds in India

  • Average annual return: 13.9%
  • Best year (2003): 57.5%
  • Worst year (2008): -28.9%
  • Standard deviation: 20.9%
  • Sharpe Ratio: 33.3%
  • Years with a loss: 5 of 25

80% stocks / 20% bonds

Model portfolio of 80% stocks and 20% bonds in India

  • Average annual return: 14.3%
  • Best year (2009): 65.4%
  • Worst year (2008): -36.5%
  • Standard deviation: 24.2%
  • Sharpe Ratio: 30.2%
  • Years with a loss: 5 of 25

90% stocks / 10% bonds

Model portfolio of 90% stocks and 10% bonds in India

  • Average annual return: 14.5%
  • Best year (2009): 74.3%
  • Worst year (2008): -44.2%
  • Standard deviation: 27.5%
  • Sharpe Ratio: 27.4%
  • Years with a loss: 5 of 25

100% stocks / 0% bonds

Model portfolio of 100% stocks and 0% bonds in India

  • Average annual return: 14.6%
  • Best year (2009): 83.3%
  • Worst year (2008): -51.8%
  • Standard deviation: 30.9%
  • Sharpe Ratio: 24.7%
  • Years with a loss: 5 of 25

What do we learn from such historical data?

  • Diversification Impact - The data indicates that as the percentage of stocks increases, so does the average return. However, this comes with higher volatility, as seen in the increasing risk and wider range between best and worst years.
  • Risk-Return Trade-off - There is a clear correlation between risk and return. Portfolios with higher stock allocations show both higher average returns and increased volatility. This aligns with the fundamental principle of the risk-return trade-off in investing.
  • Best and Worst Years - Examining the best and worst years for each allocation provides insight into the potential extreme outcomes. For instance, portfolios with higher stock percentages experienced their worst years during the 2008 financial crisis.
  • Sharpe Ratio - The Sharpe ratio, a measure of risk-adjusted return, shows that portfolios with higher stock allocations generally have higher Sharpe ratios. This suggests that, despite increased risk, these portfolios may provide a better risk-adjusted return compared to those with higher bond allocations.
  • Market Conditions Impact - The performance during specific years, such as 2001, 2003, and 2008, reflects the influence of major market events. Understanding the historical context of these years can provide additional insights into the impact of external factors on portfolio performance.

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This post titled Portfolio allocation models for Indian investors first appeared on 03 Feb 2024 at https://arthgyaan.com


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