Home / Opinion / Stay true to your goals, and not the product

It was tax time and like everyone, I was collecting all my investment information to file with the tax department. While compiling the information, I ended up with some interesting data on returns of some private equity (PE) investments that I had made in 2007 in the real estate space. So, a comparison with equity index Nifty followed. The results were an eye opener for me, both as an investor and as an adviser.

Real estate fund 1 has given a return of 10.8%, whereas the Nifty with similar cash flows would have given 10.2% in the same period. Real estate fund 2 is an investment that has gone completely wrong and its returns are similar to a savings bank account interest. Nifty, with similar cash flows, would have given 8% in the same period. This would have been even higher in the ‘Nifty-stay invested’ scenario (cash outflow is the same as in the PE fund but no cash inflows, so the investment remains intact). But instead of looking merely at returns, let us consider risk as well and see if the risk-adjusted returns of the PE funds justify the investment?

Considering the risk, the raison d’être of these funds is to generate alpha. Unfortunately, in one case, alpha eroded by the time it reached the client, and in the second case, there was huge underperformance. As a client, I would be quite concerned because I take the risk whereas the alpha returns, if any, do not accrue to me.

Keeping this in mind, there are some important factors that clients and product manufacturers of structured products and PE funds should consider.

For product manufacturers

 Ensure that the expected returns of a product are commensurate with the risk being borne by an investor.

 Design the fee structure in such a manner that it allows clients to enjoy part of the alpha. Ultimately, if a client gets returns (post-tax, and post-charges) that are similar to the equity market, then there is no extra return for the higher risk being taken.

 Consider the non-liquidity aspect of the instrument in the expected return.

 Show illustrations not based on the most optimistic scenario but rather a likely scenario. Consider taxes because interest is taxed at the slab rate and unlisted securities have indexation. Overall, in my experience, clients end up paying 20% tax on the gains made. In India, equity-oriented schemes and direct stocks do not incur any tax after one year where securities transaction tax (STT) is paid. So, tax implications do play an important part when comparing investments.

 Show overall compounded annual growth rate (CAGR) on an ongoing basis rather than showing it only for individual investments in the fund. For example, in the case mentioned above, the real estate fund 1 provided a transparent and good report but nowhere did it mention the overall CAGR. I had to do that calculation myself, especially considering tax deducted at source (TDS) so that there is proper accounting and an apples-to-apples comparison.

 Provide performance data and important information mandatorily in the public domain.

For clients

 Don’t get swayed by optimistic illustrations. Factor in administration fee, performance fee, statutory charges and taxes before arriving at expected returns.

 Consider your risk profile before investing in structured and PE products.

 Adhere to your long-term objectives and asset allocation. Evaluate the investment with those criteria in mind.

 Review the fund manager’s background, philosophy, strategy, outlook, approach and past performance. Have a discussion with her, if possible.

 Evaluate your liquidity requirements and ensure that you do not need the money. Most investments have clauses to increase the tenor by a couple of years and end up being locked for 5-7 years.

 If feasible, get independent and unbiased advice from a licensed investment adviser.

Ultimately, what matters for clients is being able to attain life goals with robust risk management. I am often reminded that investments are like a long drive on a highway to a destination hundreds of miles away.

If you drive too slow (for instance, by investing in debt and keeping cash in bank), you will take too long to arrive; if you drive too fast (invest only in equity and risky products), you may cause an accident.

Steady driving with the speed you are comfortable with (risk profile) will do the job for you. Of course, there will be some traffic and diversions (volatility) along the way, which you have to cope with. Often, the attractive feature of a fund is its exotic theme. For example, there have been structured products that invested in Bollywood movies, paintings and other sectors. Investors have lost money in such investments.

Remember, complexity and exoticness in products do not necessarily mean better returns or risk management. In the end, your commitment is not to a product but to your goals, which may be achieved by taking moderate risk. Look at structured and PE products if they are suitable for your journey.

Anup Bansal, managing director, Mitraz Financial Services Pvt. Ltd.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less

Recommended For You

Trending Stocks

Get alerts on WhatsApp
Set Preferences My ReadsWatchlistFeedbackRedeem a Gift CardLogout