Debunking the Myth: Is Asset Allocation Over-Diversification?

There’s a common belief in the investment world that mixing assets leads to over-diversification, diluting returns and complicating portfolios unnecessarily. Many argue for sticking solely to equities or a mix of equities and debt. However, the data from a DSP newsletter reveals a completely different picture, showing how multi-asset allocation has consistently outperformed in different geographies over the last two decades.

Performance of Multi-Asset Portfolios Across Markets
The analysis compares returns of equities, debt, international equity, gold, and multi-asset portfolios (a mix of 50% equity, 20% debt, 15% international equity, and 15% gold) over the last 20 years. In emerging markets, equities returned 3.5%, debt 5.5%, international equity 5.6%, gold 9.3%, while a multi-asset portfolio delivered 5.7% with much lower volatility.

In India, the story is even stronger. Equities returned 12.9%, debt 7.4%, international equity 9.2%, and gold a stellar 13.1%. The multi-asset portfolio, however, achieved 12.4% CAGR, nearly matching equities but with much lower volatility (standard deviation of 11.3%) compared to 21.3% for equities alone.

Even in the US, where debt (2.6%) and international equities (5.6%) delivered lower returns, a multi-asset portfolio still achieved a respectable 7% CAGR, smoothing out volatility significantly.

Why Multi-Asset Portfolios Work
One of the key reasons multi-asset allocation outshines individual asset classes over the long term is cyclicality. No asset class performs well consistently. For instance, equities may thrive during bull markets, but gold provides a hedge during economic uncertainty. International equity offers exposure to global growth trends, while debt can stabilize portfolios during downturns. By rebalancing annually, multi-asset portfolios ensure you’re always positioned to benefit from different cycles without being overly exposed to any single asset class.

Gold as a Crucial Asset
The analysis highlights gold’s vital role in a portfolio, particularly in emerging markets like India. Over the last 20 years, gold delivered 13.1% CAGR in India, outperforming even equities. This challenges the common notion that gold is a “dead asset.” Gold not only preserves purchasing power but also acts as a hedge during equity market downturns. In a world where debt returns may remain subdued due to changing interest rate cycles, gold and equities together can provide robust returns.

Volatility: The Silent Portfolio Killer
The standard deviation, a measure of volatility, underscores the value of diversification. In India, the standard deviation for equities was 21.3%, but it dropped to 11.3% in a multi-asset portfolio. This smoothing effect ensures that investors experience fewer sharp portfolio drawdowns, making it easier to stay invested for the long term.

What This Means for Investors
The data dismantles the myth that diversifying beyond equities and debt is unnecessary. Instead, it proves that multi-asset portfolios are essential for long-term wealth creation, especially in markets like India where cyclicality is pronounced. A strategic mix of equities, gold, international equity, and debt ensures balanced returns while reducing portfolio volatility.

Given the current macroeconomic scenario, with rising interest rates and uncertain debt performance, a higher allocation to equities and gold may be prudent. International equity also provides diversification benefits and exposure to global growth stories, rounding out a robust portfolio strategy.

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