Factor in macros while investing

Your financial adviser has hopefully told you of the seminal research in investment theory done in the Western world about 30 years ago, which proved that most of the returns (70-90%) from your investment depends on your selection of asset classes and sub-classes—equity, fixed income, gold or real estate. Only some portion of the returns (5-15%) depends on the exact instrument or security that you choose within these asset classes. And another small, final portion (5-15%) on the timing of your investments.

In turn, which asset classes you choose to invest in depends on your specific financial goals and your risk-taking ability. This is what is called your ideal asset allocation.

But we have had a different on-the-ground experience in the Indian investment environment in the first decade of the new millennium—both through the boom of the first half and the crisis of the second half. While the twin concepts of asset allocation and financial planning still remain the overarching principles of investing, today’s investment decision-making process involves a higher degree of understanding of the macro factors—both Indian and global—which have been influencing, rather dictating the performance of entire asset classes.

Impact of macro variables

We believe that today, macro factors have become integral to the decision-making process and one has to diligently go through each of them before one can claim to have made a “decently informed” investment decision. These factors include the Indian macroeconomic variables, Indian political stability, global macroeconomic factors such as quantitative easing and finally the global polity such as impact of war in West Asia.

To test the rising significance of these factors, we asked 25 of our senior advisers to rate the above four factors on significance of each in today’s investment environment, after adding the three original steps—asset class, sub-asset class and product selection.

The advisers collectively believed that 43% of the decision-making for investments today should come from an understanding of the four macro variables (57% to come from the original three factors). Of this 43%, 15% significance was given to Indian macroeconomy, 11% to global macroeconomy, 10% to Indian polity and 7% to global polity.

Questions to be asked

To make the decision process more real, here are some illustrative questions under each factor that you can ask your adviser before taking a decision.

Indian macroeconomy: How fast will gross domestic product (GDP) grow in the near future? Which components of GDP will grow faster than others? Will interest rates reduce or increase in the short term? How will inflation behave? What is the impact of all of this on the asset class we want to invest in?

Indian polity: Which party will come to power in the 2014 elections? Will the United Progressive Alliance become even more subsidy-oriented if it gets re-elected? Will the National Democratic Alliance be able to carry out more aggressive reforms if it has to rely on a disparate bunch of coalition partners? Will Aam Aadmi Party type of political parties take us “lefter than the left”, as far as economy is concerned? What is the impact of all this on our economy and on the asset class we are considering to invest in?

Global economy: Is the European Union’s (EU) economic condition improving? Is China still slowing down? What will be the full impact of the slowdown in quantitative easing? What is the impact of all these on Indian markets?

Global polity: Is Angela Merkel’s re-election in Germany improving EU conditions ? Have chances of war in West Asia subsided, and will this affect oil prices and hence current account deficit, and the Indian rupee? What is impact of all this on our markets in India?

So, here’s what one should do.

• Try to understand the factors above yourself.

• Ask your adviser questions related to different scenarios possible in the macroeconomy and polity, and what impact will such scenarios have on the performance of the products being recommended. Test your adviser’s view on probability of occurrence of different scenarios in economy and polity on one or two others. Try to develop your own view also.

• Get an adviser who understands the above framework of decision-making and who involves you in your own investment decisions.

After all, you owe it to yourself and to your family to invest wisely and based on the best information available.

Advisers should try to keep things simple. Explaining macro variables to clients in simple terms will educate clients and help them co-own decisions. As Leonardo da Vinci remarked: “Simplicity is the ultimate sophistication”.

Sunil Mishra is chief executive officer, Karvy Private Wealth.