BackWhy do we prefer physical assets over financial assets?
It is believed that immediate past performance is a reason for marked preference of physical assets.
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Indians seem to be creating a barbell in their portfolio by investing in “risky" assets such as gold and real estate and “safe" assets such as bank deposits and insurance. On the other hand, ownership of Indians, excluding promoters, in Indian companies (equities and mutual funds or MFs) has steadily declined over the last two decades. Here are some factors that explain why Indians prefer physical assets over financial assets.
Recent outperformance
In the last few years, gold and real estate have outperformed equities and MFs. Many believe that immediate past performance is one of the causes for the marked preference for physical assets. At the same time, lower real returns on bank deposits seem to be getting negated by the safety aspect.
If returns drive investor preference, then how does one explain consistent selling by Indians in equity markets, including blue-chip stocks that have delivered substantially superior returns than what gold and real estate have returned over the last two decades. The fact that Indians are selling a superior performing asset class and buying an inferior performing asset class shows that returns are not the only driver for investment decisions.
Distribution edge
The distribution mechanism of banks, insurance companies and jewellers is far superior than that of equities and MFs. Even the number of intermediaries involved in selling real estate, gold and insurance is far higher than those selling equities. On the equity side, though there are several stock broking outfits, many of them facilitate trading rather than investing.
Perception of safety
While Indians perceive banks and insurance companies as safe due to the implicit guarantee of the government of India, gold and real estate are important because of the social and cultural needs and aspirations. On the other hand, equities and MFs are perceived to be risky. But this risk can be mitigated by investing in equities systematically over the long term. It may be noted here that investment in this manner works for retirement planning. However, equity investment by pension funds has remained on paper.
Havens of unaccounted money vs transparent assets
Often, lack of adequate detection (presumptive buying of under reported real estate) and severe punishment allows savings to be deployed in physical assets to save on taxes. Equities have not caught the fancy of investors even though long-term capital gains are tax-exempt.
Infrastructure, which is on a par with global standards, has inadvertently resulted in entry barriers for retail investors. Rapidly changing requirements on know-your-client (KYC) norms, account opening and operating process and anti-money laundering provisions have dissuaded Indians from investing in financial assets. When an average housewife can buy equity shares like gold, we will surely see more allocation to equities than gold.
Financial regulators have taken many steps for the protection of investors. Since voluntary compliance is limited and the judicial process is time consuming, regulations have been made for the lowest common denomination. This has put severe constraints on equities and MFs versus real estate and gold in terms of reaching out to investors.
The difference in the advertisements and marketing of various asset classes has moulded varied risk perceptions and resulted into higher allocations towards physical assets. Lack of sophistication among Indian investors has allowed higher investment in gold (despite high impact cost of buying in small denomination or jewellery form, quality issue, limited liquidity) and real estate (despite issues related to pricing, delivery, high impact cost of transaction and liquidity). Transparency of equities and MFs is actually deterring Indian investors from investing in financial assets.
Leverage opportunities
Availability of in-built leverage in real estate, especially during the construction and pre-launch phases and easy and quick loan against gold are making them more attractive. Loan against equity and MFs remain out of bounds for most investors.
Compensation for intermediaries
Intermediaries of real estate and gold get higher compensation as compared with those selling equities and MFs. Intermediaries have no obligation in terms of examination, regulatory supervision or penalty for breach of fiduciary duty in selling physical assets as compared with financial assets. There is an exodus of intermediaries from selling financial assets to physical assets due to these reasons, which gets reflected in increased allocation towards physical assets. Slow traction in an excellent product like the New Pension System highlights the need for giving the right incentives to build an investor base.
Nilesh Shah is director, Axis Direct.
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