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Naive investors, risky products

Naive investors, risky products
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First Published: Mon, Jan 03 2011. 09 02 PM IST
Updated: Mon, Jan 03 2011. 09 02 PM IST
There is usually almost nothing in common between poor borrowers in the villages of Andhra Pradesh and high net-worth investors in urban India. However, their woes unexpectedly intersected in 2010 thanks to mis-selling of financial products. Aggressive lending practices by some microfinance institutions led to a backlash and regulatory overreach in Andhra Pradesh. The fraud at Citibank that came to light at the end of the year brought another type of financial aggression into focus.
It is still too early to tell what Shivraj Puri, the Citi relationship manager who was at the heart of the huge fraud on the bank and its customers, was really up to. But what seems quite clear is that many rich investors fell for the bait he offered them: guaranteed returns that were far higher than what was available through simple investment products such as fixed deposits or money market mutual funds. It is shocking that people who are more financially literate than most others should not have realized that high returns necessarily come with high risks.
Anecdotal evidence suggests that negative real interest rates over an extended period sent many investors on a hunt for higher yields to protect their wealth against the ravages of inflation. Many banks and other financial companies offered structured products to these investors. It seems that call and put options were an important part of these structured products and that many investors ended writing options rather than buying them, a strategy fraught with risks that need sophisticated minds to handle. Though there was no fraud, investors in a structured product sold by Aditya Birla Money collectively lost over Rs100 crore, according to reports. The Aditya Birla group had to step in to cover these losses.
There is nothing wrong in structured products sold to people with an appetite for higher risks and the ability to absorb losses. But regulators will have to ensure that these products are not sold to the wrong people, the risks are explained in a transparent manner and there are no promises of guaranteed returns. The financial industry should also discipline itself if it wants to escape the sort of regulatory sledgehammer that has hit the microfinance industry in Andhra Pradesh. But above all, investors need to be on the guard against products that seem to offer high returns for seemingly minor risks.
The why of risky choices: greed or lack of awareness? Tell us at views@livemint.com
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First Published: Mon, Jan 03 2011. 09 02 PM IST