Trading Guide: How to construct a portfolio to insulate from crises like Russia-Ukraine war?

Victor Prather is revered as one of the first American Space heroes. He was a part of project RAM to develop a new age space suit.

To test the spacesuit, he ascended to an altitude of almost 35,000 meters in a special balloon and the suit worked well perfectly.

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While descending once the balloon reached an altitude where he could breathe on his own, Victor opened the faceplate of his helmet and due to a mishap, Victor fell in the water.

In a normal scenario, it wouldn’t have been fatal as the spacesuit is watertight but since the faceplate of his helmet was open, water found a way to gush into the suit and Victor drowned in minutes.

NASA had done so much planning for this test flight, scenarios were simulated on computers, rehearsals were done and yet a tiny act became the reason for a tragedy.

Your investments could meet a similar fate if you do not insulate it from potential crisis. 

We spoke to Rahul Bhutoria, Director – Valtrust Capital on what should be the asset allocation strategy amid the Russia-Ukraine war to insulate from volatility:

On Thursday due to Russia’s military actions, markets fell worldwide and when I noticed that Russian Markets were down by 50% during the day, I recalled reading about Victor sometime back in a blog and got a reminder of this quote by Arthur Conan Doyle’s Sherlock Holmes: “The world is full of obvious things which nobody by any chance ever observes.” Geopolitical risk is one such kind of thing.

Two weeks back, the worries for investors mainly were a possible increase in US Interest rates and Supply chain issues. Suddenly the focus has changed.

Imagine being a Russian investor who has most of his wealth invested in Russian equity markets and the value is eroded to half in a few hours’ time.

That’s the impact a Geopolitical risk brings to portfolios. While India is a far more stable country, we are not insulated from geopolitical risks.

Geopolitics is about power rivalry amongst great military and economic powers. This translates into a risk for the portfolio which is external in nature.

Geopolitical risks are not only about War but also include incidents of cyber-attacks, government clamping down against companies, or technology decoupling.

Being external in nature, these cannot be controlled and so they create sharp drawdowns in the markets.

Therefore, the portfolio ought to be so robust that it reduces the drawdowns and has a shorter recovery period. A judicious mix of asset classes helps in accomplishing it.  

Investing is fraught with risks, but Asset Allocation is the key. Asset classes have different characteristics and a correlation with other asset classes.

Hence a portfolio should be diversified to have low correlated asset classes so that the recovery period of the portfolio after the drawdowns is shorter.

It is paramount to always maintain some cash levels in the portfolio as cash works as a hedge against market falls. In times of volatility that cash can be used as a tactical strategy to make investments.

Many asset classes have a low correlation to equities, like Litigation finance, Specialised funds which acquire & trade Insurance Policies, Venture Capital.

These are not as volatile as equities are. Unfortunately, many such opportunities are still not available in India to invest. There are ETFs available in the US through which one can take a Sell position on markets to hedge the portfolio.

Financial markets behave differently to the same event. After Russia’s action Indian markets were down by almost 5%, but the US Indices ended in the green.

All these validate a need to have a portfolio diversified across currencies, markets & themes. Evidently, it has become pertinent to have a portfolio diversified through international investments.

While on a humane side all of us wish that such events creating geopolitical ripples don’t occur, we have to keep our portfolios ready if it happens. The need of the hour is to have:

● Investments in asset classes have a low correlation with each other with an orientation toward risk-adjusted returns.

● Repositioning of the portfolio in case of exposure to investments that have an impending geopolitical risk hanging.

● If cash is available then use it tactically to make investments in the next 2-6 weeks.

Risk is an inevitable part of the process of investing, but we cannot eliminate it completely. The objective of investing is to make consistent returns over the long term with a very low probability of capital erosion.

A prudent allocation in different asset classes at the global level is the way to go about it.

(Disclaimer: The views/suggestions/advices expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)