Download Complexity of the global economy

Simplicity is the best policy
HNIs often fall prey to sophisticated financial products. But the real experts know the value of
keeping the portfolio simple.
Quantum physics, abstract paintings and rocket science are just a few things likely to bamboozle us
with their complexity. We might well add modern day finances to this list. Indeed, one might well
wonder how many people truly understand the global markets in all its complexity and splendour.
Complexity in modern day finances have three dimensions:
1. Complexity of the global economy
2. Complexity of investments
3. Complexity of multiple experts handling your money
Let’s look at each in turn.
Complexity of the global economy
At this very moment, the global economy is dealing with many complex occurrences. Like China’s
likely implosion, Brexit, the Fed’s burgeoning balance sheet, negative interest rates in Japan, the
collapse of commodities (oil in particular), the EU printing money while the US desisting from doing
so.
The global economy might well sound like the chatter of uncertain emotions in 500 languages. More
noise than sound.
Indian HNI investors might be more interested in a more proximate question: how does all this
impact investments in India? What are our prospects?
To India’s credit, the economy is growing at 7-8%. So theoretically, if foreign investors are willing to
take risk, a disproportionate amount will enter India’s promising markets. However, volatility
remains the theme of the hour and complexity is the mantra on the horizon.
While the largest HNI investor in the world will not reverse the complexity of the global economy, he
certainly has the power to eliminate complexity in his own investments. That’s a great personal
stride forward.
Complexity of investments
It’s natural for the ultra-wealthy to get attracted to innovative and new products which seem far
removed from the retail investments made by the salaried class. Therefore, they often shun
commonplace mutual funds, even if a particular mutual fund is the most transparent and wellconstructed investment.
Innovation is sophisticated. It is sexy. Perhaps so in other realms such as fashion, technology and
entertainment. In investments, there can be no substitute for simplicity (also read: Consolidation is
simplification). A simple portfolio can be navigated and de-mystified at will. At the same time, here
are a few instances of how innovation (you could also say sophistication or complexity) can hide
losses and risks:
1. A well-known Indian Wealth Manager ran a seemingly promising fixed-income product and
leveraged it to take 3 times the invested amount as loan from their own NBFC at the rate of 11.5
to 12%. The assumption that the interest rates will climb down never materialized. Meanwhile,
the investor paid a hefty commission and experienced a negative carry from day one.
2. Quant products are supposed to be based on algorithms that benefit from past trends and data.
However, new trends throw up new blind spots that are not accounted for in the algorithms,
rendering their innovativeness meaningless.
3. Certain investments are linked to market movements. If the market goes up, say, 15%, your
investment doubles. If it plummets 20%, it will be valued at zero. With multiple such variants
and the volatility of the global market, you can no longer forecast your revenue.
4. Nowadays, certain derivative products claim a high return such as 25%. However, when one
subtracts the 1-2% wealth manager fee, 2-4% carry and high level of taxation, the real net return
is significantly lower.
5. Another example is a balanced fund where more than 65% of the investment is in Equity and 2030% is in Debt might bleed more than it appears. The client thinks it gives the best of both
instruments. In reality, he pays more for the same investment. Because the classification and
payment of commissions is like equity, and since equity commissions are higher, more
commissions are doled out. It’s more effective to separate debt money from equity money.
6. Certain Real-estate funds indicate >20% p.a. return in the 7-10 year time-frame of investment.
On closer inspection, one finds no exit window in between. Moreover, after deducting
management fees, profit sharing fee and taxes the ROI on such funds would fetch returns similar
or lower than equity assets. The same can be invested into equity mutual funds which have
more liquidity, tax efficiency, transparency and may result in similar or superior returns.
7. Many High Risk Debt funds sound innovative, promising to wrap the risk of equity with the
solidity of debt funds. As it happens, these funds are half as risky as equity and offer only 1-2%
more returns than a standard debt fund. And if a client’s appetite for risk is higher, they might as
well venture into equity. And they would, if the innovation is seen for what it is.
8. Another mean strategy that seems innovative is repackaging and repositioning an existing fund
with hardly any assets under management by Wealth Managers. This offer will have higher pay
outs due to target committed by the Wealth Managers to the AMCs.
9. Positioning a fund to fit an investor’s asset allocation is a common innovation practice. We had
the experience of evaluating one such fund that was advised as an Alternate Asset fund to one
client, a High Risk Debt fund to a second and as a Real Estate fund to the third. Clients not
looking beyond reassuring labels miss the informative fine print.
10. Sometime back, the market saw a long tenor fixed-maturity plan linked to an inflation index.
The instrument promised a marginal return above the index return. Recent commodity crash has
pushed this index into negative territory, and as a result, clients are hardly getting any return in
this locked-in investment. So dastardly was this innovation that we circulated a note to our
clients warning them that index output was both volatile and ambiguous.
11. A few years ago, a debt fund with underlying FCCBs of Indian companies was sold overseas. It
has fizzled away causing anguish to investors. Sometimes, complexity is simply a geographical
matter.
To counter these complexities, we urge investors to follow these simple rules:
1. Allocate assets: Do this according to your risk appetite and target growth rate. The former
determines your instruments, the latter your exit point.
2. Consider the long-term:
a. Defining breakout and breakdown points is just one way to acquire a long-term
perspective of the market, where intra-day and intra-week pressures don’t matter to
you.
b. More importantly, sound investments always stand the test of time.
c. Also remember that fear at the bottom is far higher than greed at the top of the market.
But by regulating fear and greed, you can tide your way to handsome profits.
3. Reject lengthy lock-ins: The longer the lock-in, the more suspect the claim of the product. No
one can sacrifice liquidity in a volatile market. If you find an instrument with zero lock-in, we
urge you to study it with enthusiasm.
4. Avoid layered products: Management fee, carry, taxation and other costs must be ascertained
at the earliest to estimate the true rate of return.
5. Nurse a healthy scepticism: Every financial product needs to be treated with suspect till one has
had the opportunity to study it thoroughly. If it sounds too good to be true, it probably is. And if
the product is rather innovative, be rather watchful.
One of our clients, with a large corpus learnt this lesson the hard way. He invested in every
opportunity presented by anybody in his trusted circle. As it often happens, these trusted folks
had trusted somebody else while presenting the opportunities. What’s worse, the client had
signed a document accepting complete responsibility for the fate of these investments.
6. Consider products with negligible commissions: Plain AAA rated government-backed tax-free
bonds perform as good or better than most debt funds across time periods because debt funds
are at the mercy of interest rates. But nobody wants to sell these because the commissions are
negligible. That shouldn’t stop you from buying them!
7. Conduct a physical audit: We conduct a physical audit of our client’s portfolio as soon as we
begin the relationship. This is to help to ascertain and validate the accuracy of the MIS being
received from Wealth Managers.
We at Entrust Family Office confess to not understanding all products and domains. Ubiquitous
expertise is a myth in these market conditions. So we shy away from what we don’t understand. But
what we know, we know really well.
Bad market cycles have contributed to our greying hair, and we wear it proudly. We know that we
won’t be dazzled by freshly minted jargon or sophistication for its own sake. To impress us, Wealth
Managers will have to keep it simple.
As Einstein famously said, “If you can't explain it simply, you don't understand it well enough.”
That overarching mantra helps us safeguard our clients’ wealth. Which brings us to final dimension
of complexity.
Complexity of multiple experts
HNIs are constantly approached by wealth managers with promising proposals. This can lead to the
HNI having multiple wealth managers. In addition to consolidation woes (read: Consolidation is
simplification) and the fact that the wealth manager’s allegiance is to the employer (read: Buttering
the right side), multiple wealth managers can complicate the picture in many ways:
1. The basis of wealth management is continuity. That is not possible when none of the wealth
managers has either the visibility into the entire portfolio nor the stamina and wherewithal to
hold on to a client across job stints.
2. When the wealth manager moves to a new job, the client will have to either continue banking
with the same bank and be handled by a new Relationship person or/and switch to the wealth
manager’s new bank adding one more relationship. Both the options can be complicated by the
fact that the client has to make the new person understand about all the nuances of his / her
portfolio thus taking more time to settle down.
3. As briefly discussed in Investments and the time delusion, there is a dilution of trust. How much
of your most private matters will you reveal to your wealth managers? And to how many of
them? Take for instance a Chennai-based client of ours whose divorce hearings had been stalled
by the other party for 5 long years. The family owned 7 marquee properties in the name of our
client, and there was a valid fear of losing some of them. The family could not discuss the issue
with outsiders for fear of their image getting sullied or the creditors reacting in a kneejerk
manner. When they trusted us with the details of their situation, we suggested gifting and then
re-registering the properties in the name of the parents of the client. This was done. When the
other party asked for a list of assets of the client, they did not find the properties listed. Thus
properties were safeguarded.
4. Locked-in products offer more commissions to wealth managers. Therefore, if you have multiple
wealth managers, you are likely to be holding on to many static investments as well.
Summary
The global economy, sophisticated investment instruments and an array of wealth managers can
each add layers of complexity to your portfolio. The remedy is to keep it simple.
Having a confidante by your side, working only for you, being paid only by you, will most certainly
simplify your investments and your life. A confidante can hire an expert for a specific task. However,
an expert can’t hire a confidante. And a confidante who is also an expert (like a Family Office
Investment Advisor) is the rarest of rare wealth manager. But then, you need only one of them.