How to know which asset classes to avoid investing in.

Typically it has been observed over a period of time that as an asset class becomes very popular it is typically a time to avoid that asset class. There are several examples of the same which have come over the last few years.

Subprime and mortgage linked assets and their derivatives became very popular since the beginning of the decade and we have seen what havoc they have caused in the financial system as well as the real economy over the last two years. Large institutions as well as economies of the West are in doldrums due to the mispricing of such assets over a period of years. Equities became very popular specially between 2006 and 2007 and most investors shunned away from fixed income assets during the boom years and as it turned out moving into debt would have been the best option at the time of extreme euphoria at the end of 2007.

Subsequently we saw that structured products and Fixed Maturity Plans became very popular and then due to the bust up of most of the writers of structured products and the debt market crisis that followed after the Lehman Brothers Collapse in the USA in October there was a crisis related to these products and subsequently these became unpopular.

There was also a huge inflow into commodity hedge funds in 2007 and first half of 2008 where despite the entire world economy collapsing the commodities kept on rising and made a big bubble. Crude oil specifically moved up on speculation and as it touched levels of USD 140 most experts predicted USD 200 per barrel, on the other hand over the next three to four months it collapsed to USD 35. Similar was the movement in a large number of other commodities like steel, copper, coal and other agri and non agri commodities. A majority of commodities have now fallen to 25-40% of their peak prices.

The current flavours of the market are Income Funds of Mutual Funds and Gold linked products. The holdings of the largest Gold ETF are now at record levels and the actual consumption of gold has come down drastically. The biggest gold ETF, SPDR Gold Shares has seen its holdings double since the end of 2007 from 500 tonnes to over a 1000 tonnes today. The total consumption of gold in the year 2008 is expected to have fallen by over 4% and Indian consumption is expected to have fallen 15%. However investment demand has been very strong. In fact we see that most people ( in India) are looking to sell gold rather than buy gold. I would not bet on investing in gold at this point of time as the fear factor driving investors towards gold will ultimately lead to a crash, which if not similar to what has happened in crude oil will also be drastic. Similarly on the debt side, Income Funds of Mutual Funds have become very popular. Such products are a doubtful proposition at least over the next few months due to a slowing economy and downgrades in rating of corporates. There will be a time for such products, but a few months later.
So, where does the fault lie, is it with the advisor to the investor who pushes popular products that are easy to sell or is it with the investors who want to invest in the asset which has done well in the immediately preceding period. I guess it is both as advisers find it difficult to advise offbeat products that are currently not the flavour of the market as it takes too much convincing to the investor for the same. Similarly investors also believe that what has done well in the past will continue to do well irrespective of the fundamentals of the same. As such it is important to have an open mind while making asset allocations as asset classes will always outperform each other cyclically.

As such the right way to invest is not in the products which are currently popular but which will become popular over the next few months. Will talk about such products later.

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