Many investors believe that spreading investments across stocks, bonds, and alternatives provides adequate diversification. But for sophisticated investors, traditional asset allocation models often fall short of addressing the complex risk landscape that UHNIs and HNIs face. This is particularly evident during periods of extreme market stress, when correlations between asset classes often converge, thereby reducing the effectiveness of conventional diversification.
While diversification across asset classes remains fundamental, a smarter way to build resilience into a portfolio is by organising capital into different categories, each tailored to absorb a specific risk. That is where a risk pool framework comes in. It involves intentional segmentation of capital based on risk type, not just asset class.
A risk pool framework accounts for all relevant factors that may impact long-term wealth management. This includes macroeconomic risks like inflation and interest rates, structural risks like currency depreciation, and unpredictable events such as geopolitical shocks or pandemics. In this framework, capital is organised across multiple pools. Where some pools may absorb market volatility, others preserve purchasing power, and a few are designed to remain liquid and ready when unexpected events occur.
By framing capital around risk exposure rather than just return potential, investors gain a deeper layer of strategic control and adaptability. Let's dive deeper into the components of the framework.
1. Currency stabilising pool: hedging against rupee depreciation
The Indian rupee has steadily weakened over the last decade, moving from around INR 63 to over INR 86 against the US dollar. For investors with global exposure, or those planning expenses like foreign education or travel, this can quietly erode overall portfolio value.
Allocating a portion of the portfolio to global assets such as international equities or USD-denominated bonds can help build the currency stabilising pool. According to HSBC’s Affluent Investor Snapshot 2024, one-third of affluent investors in major international wealth centers are keen to invest in other markets. As the world moves ahead, other currencies have also started gaining momentum. Just like their markets, currencies like CHF and Euro have drawn notable interest from investors.
Rather than attempting to "hedge" currency risk, this category acknowledges currency movements as a risk factor to be managed through diversification, not elimination.
2. Inflation resilient pool: staying ahead of price erosion
Even moderate inflation can chip away at wealth. At 5 percent inflation, the real value of one crore drops to around 60 lakh over a 10-year period.
To counter this, capital can be deployed into inflation-sensitive assets:
- Public listed Equities, which, despite being a volatile asset class, offers one of the best hedges against inflation because, often, listed companies are expected to grow at the minimum nominal GDP+ rate. (Choosing the right fund and fund manager as well as the type of instrument selection is paramount; it is important to discuss the final strategy with your investment advisors.)
- Gold, which has historically been seen as a store of value
- Other Commodities, accessed through ETFs
- Real estate and REITs, which tend to benefit from rising asset values and inflation-linked rents.
It should be noted that no single asset is a perfect inflation hedge. This bucket should be diversified and monitored based on macroeconomic shifts.
3. Tail risk absorption pool: protecting against market shocks
Events like the 2008 financial crisis or the recent tariff wars remind us that markets do not always behave as expected. These are tail risks, rare but severe events that can disturb investor portfolios.
Importantly, the instruments which offer protection against tail risk usually are a part of public listed market but the strategy here is set to behave differently during periods of stress. These could be absolute return strategies, government bonds, or structured products that provide downside protection. The goal is to create a group of investments to help keep the portfolio stable when it matters most.
4. Contingency pool: planning for the unknown
Not all shocks are domestic market led, some of them are a result of extreme globalisation of today’s world. For example a pandemic, a natural calamity impacting the supply chain of oil, or sudden geopolitical tension, like Russia-Ukraine War or Israel-Iran conflict. These events cannot be predicted, but their existence is a reality.
In such scenarios, investors should maintain a certain allocation in liquid assets that can be accessed quickly without major losses. Usually, families consider 3-5 years’ worth of their lifestyle expenses to be kept in this bucket. The kind of instruments considered for this category include:
1. Cash
2. Money market instruments
3. Short-term Debt Funds (falling on the shorter end of the yield curve)
4. Other instruments that can be converted into cash with minimal impact on value, like Government Bond, Commercial Paper (CP), Certificate of Deposit (CD), Short-term Fixed Deposit (FD), and so on.
Having a liquidity buffer allows investors to navigate turbulent periods more confidently and, in some cases, even make opportunistic allocations when valuations correct sharply.
Putting it together: a dynamic risk pool framework for long term wealth management
Instead of fixed allocation models like 60-40, the risk pool framework encourages investors to think in terms of exposure to specific risks. The structure is flexible: In times of rising inflation, the inflation pool might grow. If global tension increases, the currency bucket may need to expand. The key is that allocation decisions are driven by the risks investors want to manage, not just by market cycles.
The only exception to this rule is the Contingency Pool, which should always be maintained at the family-level based on their lifestyle and this should be reviewed regularly to avoid any omissions or miscalculations.
A Complementary Model
The framework does not replace traditional strategies like allocation models; in fact, this approach helps complement the overall portfolio. The framework's success depends on disciplined implementation, regular monitoring, and the recognition that this framework is intended to manage risk as effectively as possible, not eliminate it.
For investors with sufficient scale and sophistication, this approach offers a more nuanced path to building resilient, long-term wealth.
