Can gold offer more stability to your mutual fund portfolio?

The 60/40 investment portfolio comes with the promise of good returns and moderate volatility. But does this traditional strategy of allocating around 60% to equities and around 40% to fixed income work when it really counts? I’m not so sure. The returns of the Aggressive Hybrid category of mutual funds have plunged about 7.70% in the first six months of the year, as per data from Value Research. At the same time, the Multi Asset category, which invests in gold in addition to equities and fixed income, is down 4.10%. This brings us to an important question: is it time for investors to think beyond the conventional 60/40 investment strategy? Is gold the missing piece in your asset allocation? Well, the current global macroeconomic conditions seem to suggest so.

Let’s take stock of the situation. Global shocks to supply caused by the Covid-19 pandemic and Russia’s invasion of Ukraine meets robust demand fueled by historic stimulus packages and low interest rates. The result is multi-decade high inflation. Central banks are significantly behind the curve and are resorting to the most aggressive tightening of monetary policy since the 1980s to cool the economy down and ensure price stability. Possible result could be an economic slowdown or recession or at worst, a stagflation. This isn’t good news for equity and bond markets obviously. That’s where gold comes into the picture. While tighter financial conditions are fundamentally negative for the yellow metal too, inflation, risk aversion and a depreciating rupee are keeping gold relevant. Positive gold price movements are offsetting losses from equities and fixed income, smoothening out the ups and downs and limiting the portfolio’s downside.

This is now. But if you zoom out and see the bigger picture, it looks something like this:

In the years preceding a recession, global policy makers loosen financial conditions with low interest rates and excessive money printing. This spurs economic growth, but also pushes up inflation and causes unsustainable bubbles in financial markets. Public and private indebtedness swells. At some point, inflation gets out of hand. Central banks are rudely reminded of their primary objective of price stability. They pivot to tighten financial conditions. Interest rates go up and liquidity is sucked out of the system. Overvalued stock markets begin to falter, consumer confidence flounders, business margins contract. The result? An economic slowdown. To “save” the economy, central banks pivot again. Interest rates go down. Policy makers flood the economy with liquidity to spur economic activity. The economy bounces back thanks to all the easy money. And the cycle continues.

While all three asset classes move up in times of accommodative policies, equities and bonds tend to simultaneously suffer during a period of higher inflation and rising interest rates – equities because higher interest rates impact discretionary consumption, increase cost of capital for businesses and hurt their profitability. Fixed income because bond prices move in opposite directions to interest rates. Given the cycle of loose-tight-loose policy that the global economy seems to be stuck in, what good is a conventional 60/40 asset allocation if it doesn’t protect your portfolio every time the cycle turns? No doubt tighter policy puts downward pressure on gold too, but being a multi-faceted asset class, gold’s utility in times of inflation and economic uncertainty comes into play in this stage of the cycle, positively influencing its price.

It’s easy to guess where we are in the cycle currently. Equities represented by the BSE Sensex and bonds represented by the

Composite Bond Fund Index both are down 10% and 2% respectively as of June 2022. Domestic gold prices on the other hand are up 6%. Only time will tell how long this stage of the economic cycle will last. It will thus be prudent to add gold’s glitter to your diversified portfolio for this downcycle and the next. A DIY approach that allocates to equity, debt and gold or a Multi Asset fund that invests in all three asset classes could be a good choice for you – 3 is better than 2!