In today’s environment of volatility and uncertainty, one of the changes in the Indian private banking space is an appreciation by investors of the concept of asset allocation. This has come as investors have started to better understand the merits of looking at their portfolios from a broader and longer-term perspective.
Date: May 8, 2012
Tags: India, Asset allocation, Equities, Fixed income, ETFs
In today’s environment of volatility and uncertainty, one of the changes in the Indian private banking space is an appreciation by investors of the concept of asset allocation. This has come as investors have started to better understand the merits of looking at their portfolios from a broader and longer-term perspective.
At the same time, however, the concept of portfolio diversification is difficult to execute in India because there are so few asset classes represented by the industry at the moment.
In turn, private bankers often find it difficult to provide adequate diversification at the right price to clients. And product manufacturers find it difficult to bring this to market because of the lack of scale.
These were among the thoughts shared by some of the leading asset management companies and other product manufacturers in the Indian wealth management market at a private roundtable discussion hosted by Hubbis in Mumbai in April 2012.
When it comes to individual product opportunities, participants explained that private banking clients are now chasing yield a bit more than before – in the form, for example, of fixed maturity plans, high-yield bonds backed by shares or real estate, or through certain structured products. ETFs are also in favour with some investors. Notably, there has been little appetite for putting money into direct equities, or into structures which track direct equities.
Product providers, therefore, said the key is to focus on simple and easy-to-understand products combined with the education to provide the foundations to be able to move to the next stage of development in the market over the next six to 12 months.
When it comes to setting and managing investors’ expectations on returns, product manufacturers said one of the challenges is that return maximisation is not the goal in most cases – instead it is risk mitigation which is the central feature of the product, not complexities.
Further, the definition of longer term is now being revisited, given that the deluge of information available today for investors has meant that they are generally becoming short term.
In terms of interactions with product gatekeepers, product providers said they should think about reviewing the filtering criteria they use to evaluate a product, given that some of their filters don’t make as much sense in today’s environment as they perhaps used to given changing market conditions and evolving client demand.
Chairperson
Hansi Mehrotra
Managing Director, India
Hubbis
Participants
Ajit Menon
Executive Vice President & Head of Sales
DSP BlackRock Investment Managers
Akhil Chaturvedi
Head, Retail Sales (West & South)
Daiwa Asset Management
Amit Gupta
Director, Investor Solutions
Barclays Capital
Arvind Bansal
Vice President & Head of Multi Manager Investments, India
ING Investment Management
Himanshu Pandya
Vice President & Head Product and Delivery Team
ICICI Prudential Asset Management
Irfan Khan
Senior Vice President
Motilal Oswal Asset Management
Sanjaykumar Singh
Head, Product Management Group
Reliance Capital Asset Management
Sayandev Chakravartti
Vice President, Investor Sales, South Asia
Citi Global Markets
Vikaas Sachdeva
Chief Executive Officer, Asset Management
Edelweiss Capital
Assessing investor appetite
Hansi Mehrotra: What are some of the trends in terms of risk appetite in the Indian private banking market among high net worth individuals (HNIs) at the moment?
Sayandev Chakravartti: One of the changes we have seen in the Indian private banking space is an appreciation by investors of the concept of asset allocation. Given the amount of volatility there has been in the last three to four years, investors have started to better understand the merits of looking at their portfolios from a broader perspective – allocating their assets with some sort of investment horizon in mind.
In fixed income, the general view has been bullish and yields seem to be peaking, investors have been expecting yields to ease off for quite some time now. However, the volatility that we have seen in the fixed income market off late, has been largely unprecedented, and hence investors remain cautious in playing for a directional view.
As a result, there is quite a bit of uncertainty at the longer end of the curve, and due to the liquidity in the system, the shorter end looks more interesting.
In equities, given that investors no longer have conviction in the same way as they did previously, the focus now is on more systemic investment opportunities, rather than on individual equity plays.
Amit Gupta: Private banking investors are now chasing yield. This can come in a few different formats – for example, in the form of fixed maturity plans (FMPs), high-yield bonds backed by shares or real estate, or through a structured product where the client is selling the index volatility or the stock volatility to get a return which is in some sense fixed in nature.
The chase for yield has driven investors to take on slightly higher risk, but via products which are well structured, including equity structured products. Investors are shying away from buying products which are more than three or five years in maturity, and which are more participative in nature.
A particular macro trend we have seen over the last two years is investors showing little appetite for putting money into direct equities, or into structures which track direct equities.
Further, we are also seeing demand in recent months for quantitative products. This has been either in the form of, for example, high-frequency trading algorithms, and strategies around futures or options or which allocate money through a quantitative algorithm.
Arvind Bansal: Investors have become much smarter in recent years. For instance, they are now looking at reducing their risk and accepting a more reasonable return – rather than low risk and high returns.
In addition, they are now comparing pre-tax and post-tax returns, and looking at various instruments in this context. At the same time, investors are increasingly asking for much more documentation, as well as doing some basic due diligence cross-checking with several people before committing to any product, to ensure it is true-to-label. Further, there is much less interest today in complicated products, with more of a focus on liquid funds and products.
Himanshu Pandya: The concept of portfolio diversification, one of the fundamental aspects of wealth management, is very difficult to execute in India because there are so few asset classes represented by the industry at the moment.
We look at equities and fixed income, and to some extent gold and real estate. There is a dearth of innovation, and private bankers therefore find it difficult to provide adequate diversification at the right price to clients. Product manufacturers find it difficult to bring this to market because of the lack of the scale.
The challenge at the moment is to find the right balance between innovation and the price at which this is offered.
Sanjaykumar Singh: During the last four years, risk aversion has become commonplace among advisers and clients. This was seen by the demand for infrastructure bonds – rather than investors taking a little bit of risk by doing some due diligence on privately-held fixed income products. And in terms of equities and quant-related products, investors are looking at capital protected products. These use options to give some element of participation. As a result, manufacturers are trying to create simpler products.
However, over the last few months there has been some traction in the market in relation to more talk about equities as an opportunity again after four years of subdued returns. Recently, the earnings of the Sensex have increased substantially yet stock prices have not followed. At the same time, with investors now more educated than before, manufacturers need to create a structure to bring them out of the inertia they have created for themselves to provide an optimum return.
Irfan Khan: One of the things which surprised me when I came to the Indian market from offshore in 2008 was the level of innovation and risk appetite of most clients and advisers for structured products. But what was apparent was a significant lack of disclosure and understanding not only by clients but also those who were selling it. In addition, the after sales support networks and the concept of where they sat in the scheme of a portfolio became all the more apparent post-Lehman Brothers.
Now, the investor and adviser base is gaining the understanding they should have had before buying these products. It’s a necessary period, where an understanding of the basic elements and risks are needed in order for the market to move to the next level.
More recently, it has been interesting to see that while investors have recently been chasing yield, they haven’t been averse to chasing products they are familiar with – for example Gold. Look at the growth of Gold ETFs; this has happened because investors are moving back to things they understand and are comfortable with – which in India means gold, real estate and fixed deposits/income.
So as a product provider, they key is to focus on simple and easy-to-understand products combined with the education to provide the foundations to be able to move to the next stage of development in the market over the next six to 12 months.
Vikaas Sachdeva: If we look at the market in perspective, we can see a few ongoing trends. First, investors – whether they are HNIs or retail individuals – have tended to invest in products which which they are comfortable rather than being convinced. The fact that they are now asking for more documentation is because they are not as comfortable as they were a few years ago, and the desire for more information is actually a good thing.
Secondly, investors have always – whether subconsciously, or consciously in times of a crisis – looked at risk-adjusted returns depending on the market environment. A positive trend from the last few years is the fact that the crisis has put pressure on both manufacturers and distributors to try to innovate, which today means simplicity.
We run an asset management company targeting HNIs which is completely run on quant products, whether this is in commodities or equities, for example. The traction we are finding – despite being relatively young – proves that investors want comfort and to buy products they understand.
Akhil Chaturvedi: Over the last few years, the private banking sector has witnessed a significant amount of innovation across varied asset classes – structured products, Gold ETFs, ELDs, real estate funds, and fixed income. However, there is little to cheer about the returns as they have not been very attractive overall.
Going forward, I expect that products will be evaluated more thoroughly. For example, “gold” as an asset class has provided extremely good returns over the last 18 to 24 months, but at the current levels it may look adequately priced. So, whether this is the right asset for an investor going forward is the key consideration.
There seems to be a limited visibility across asset classes in terms of expected returns over a 12 to 18 months horizon. Currently, short-term funds / FMPs are the only category where there is some visibility of returns (9% to 10%) with relatively low risk and high liquidity. Investors can also look at other avenues of investments, but with a longer outlook – around five years and more.
Our strategy, as a relatively new mutual fund in India, is to be conventional and try to keep it simple. We would aim to launch products which are less complicated and have potential to provide consistent risk-adjusted returns.
Ajit Menon: Anecdotally, I constantly hear about the need in the private banking industry to cut costs as a result of the pressure for revenue – which is similar to other parts of the financial services sector.
It is heartening to see, however, that while there are products which can offer investors higher revenue, even in the mutual funds space, private bankers shy away from structured products that may have higher expenses or don't which don't suit their client base. This is because they are much more alert now to underlyings and how certain offerings compare with others in the market.
The biggest challenge for private bankers in India relates to the [limited] choice of products and ideas which they can bring to clients.
However, given that correlations between asset classes are increasing during times of stress, advisers in the private banking space need to branch out into multiple asset classes. Risk diversification and risk allocation should take priority in the years to come.
Further, as a mutual fund manufacturer, some private bankers I have spoken to say that some of their largest clients – who have always preferred to trade equities – have become disillusioned with the markets, so now want to park money in a standard, diversified equity fund or a large-cap fund. This is because there is evidence that a large number of equity fund managers have done well over periods of time, so they don’t want to continue to take stock calls themselves.
Akhil Chaturvedi: Over the last decade or so, India has witnessed variety of innovative themes in the equity mutual fund space – mid-cap, small-cap, large-cap, infrastructure, offshore equity, and other sectoral funds).
It has been observed that over a medium to long-term horizon, for example five years more, diversified equity funds (meaning funds following no particular theme) have provided returns more consistently than thematic funds, which tend to perform in cycles.
Irfan Khan: We have four unique ETFs – which cover equities, both domestic and international, and a Gold ETF, plus a PMS side of the business, so we can compare the success of both styles of investing.
We have seen that investors’ acceptance of ETFs in general is a work in progress in terms of education and understanding the role they play in their investment plans. Where ETFs work best is providing low cost, easy access to sectors which may be ordinarily too time-consuming or volatile to invest in. A good example of this the mid-cap space, where advisers and investors don't necessarily have the requisite skills or time to be able to pick these stocks themselves but can use an Index ETF like our MOSt Mid Cap100 to get exposure to the real India growth story.
In terms of the PMS, where we focus on highly-researched, high-conviction, with a small number of stock holdings, this has been a successful formula which we have been running with, for over nine years, with investors buying into the idea of value investing in Indian stocks.
While these PMS portfolios seem to be more popular than passive ETF investing, the returns actually show that the passive approach can be surprisingly good especially in periods of market uncertainty.
Vikaas Sachdeva: In addition to there being investors who are used to products from a certain set of manufacturers, via a certain set of private bankers, largely driven by comfort, beneath the surface there is now a completely difficult segment of products which is coming in and helping to expand the market.
For example, where does an investor go if they want a product which captures 80% of the upside but not more than 20% of the downside? This will mean they need to start looking at names which they probably haven’t seen nor heard of before. This can enable them to manage the volatility in the Gold ETFs they hold. Volatility control is one of the latent desires given the focus on risk-adjusted returns. This is at a testing stage at the moment in the Indian market, to offer HNIs who have already tested a certain strategy to move beyond conventional products.
Sanjaykumar Singh: Investors are also increasingly asking about what returns they will lose out on if they invest in a certain product compared with another. For example, if they invest in a concentrated portfolio, their expectation now is they will get higher returns than if they invest in a diversified or structured product.
Returns expectations
Hansi Mehrotra: What role do you play as product manufacturers in terms of setting and managing investors’ expectations on returns, to ensure that it isn’t unreasonably high?
Arvind Bansal: The challenge is in understanding the transaction. For example, when an investor puts money into a real estate FMP or a real estate fund, they assume that the default risk is transferred to the mutual fund – but they are taking on credit risk.
This creates a challenge because the product gatekeeper sees this as taking a brand risk by selling this fund, so this transaction doesn’t come onto the radar. Yet they are willing to sell individual real estate deals.
Himanshu Pandya: Investors are no longer asking for the best-case scenario, and are in fact more interested in the worst-case scenario. As a result, return maximisation is not the goal in most cases – instead it is risk mitigation which is the central feature of the product, not complexities.
Ajit Menon: It’s about how to set expectations. As a pure mutual fund manufacturer, performance is in the public domain. Underlying earnings of Indian corporates have traditionally been around 18% to 20%, and while this has been tempered to an extent as many companies and sectors have matured, earnings are still in the 15% to 20% band. So from a client’s perspective, it isn’t wrong for them to expect their underlying equity funds to deliver that over a longer period of time.
However, the question now is: what is the definition of longer term? Anecdotal evidence which BlackRock, for example, has been seeing internationally is that the deluge of information available today for investors has meant that they are generally becoming short term. This is one of the bigger challenges.
Vikaas Sachdeva: Setting expectations is also a question of realising perceptions. For example, there is a completely different perception among Indian investors – compared with investors in other parts of the world – about real estate and gold. Investors equate these assets with debt in the sense that they don’t think they will lose money in real estate or gold.
I cannot see this changing for probably the next 10 years. As and when real estate starts being evaluated on a daily NAV basis, and people get affected by the volatility, investors will start asking questions and get more information – which is when perceptions may start changing.
Sanjaykumar Singh: In terms of equities, in 2006 and 2007, expectations in the Indian market were between 50% and 100% per year. I think that 20% over the long term is the right expectation.
Product development
Hansi Mehrotra: Which types of products can the industry launch, given the difficulty in changing the perception on real estate and gold? And at the same time appeal to the segment of the investor base which wants to invest some of the portfolio in more “interesting” products and strategies?
Sayandev Chakravartti: There has been appetite from investors for products which offer a pseudo-hedge to inflation. Increasingly they are coming to the viewpoint that hedging inflation through fixed income instruments might not be the best approach. We are seeing increasing investor interest to hedge inflation through systemic equity investments.
Himanshu Pandya: There are specific areas where we believe that as an industry we need to do a lot more. For instance, this includes providing meaningful diversification to clients, whether it is providing exposure to commodities, to offshore investments, or to systematic quantitative ideas.
Sanjaykumar Singh: On the mutual fund side of our business, we are looking at offering multi-country diversification for our clients. There are also other products which give participation over three years.
However, demand for a lot of new types of products is only from a certain segment and a limited number of advisers. For advised money, I foresee the focus being on simpler products than anything else.
Akhil Chaturvedi: Buy-in from private bankers is the most critical challenge that an asset manager faces while creating an innovative product. If a private banker finds an idea suitable, there would be another who might not be interested in it. This creates challenges for asset managers to launch products successfully.
Ajit Menon: In terms of new opportunities, once the AIF regulations and the taxation become clearer, then mutual funds can use this as a platform to see which products are possible to create.
Hansi Mehrotra: What can the industry do to ensure it has dialogue with the regulator to ensure proper understanding of the issues when approving or denying a product?
Vikaas Sachdeva: My sense is that the regulatory understanding is there. Even if it doesn’t increase the pace of certain products, this might be because it might not be comfortable with the way the industry is developing, or it might not think the industry has the maturity to handle a certain set of regulations or products. I don’t think that the understanding of products is related to regulations.
In addition, the regulatory approach is different today than from a few years ago – as the regulator has told market players to go by the spirit of the law, rather than just the letter.
For example, in the mutual funds industry, a series of guidelines are now starting to come in to create a mark-to-market valuation, which is being introduced to remove some of the risks the regulator sees.
Dealing with gatekeepers
Hansi Mehrotra: How would you like your interactions with product gatekeepers to develop or evolve going forward?
Sanjaykumar Singh: Distributors need to advise their HNI clients for the long term. While trading gains might lead to some inflows of client assets for a limited amount of time, diversification and asset allocation is important over the longer term.
Advisers will have to help their clients understand risk – meaning how much risk they should take, the relevance of risk and how they can use the understanding of this risk-return paradigm to build efficient portfolios to generate optimum returns using the concepts of asset allocation.
We focus on creating simple products, to help advisers recommend them in a way so that they can fit into any asset allocation, to help investors know how much risk they are taking on.
Irfan Khan: For most private bankers, they feel that bespoke products help differentiate their offering. However, I think they tend to forget that product manufactures are now less likely to do 50 variations with 50 different clients, given the changed deal size, new documentation and disclosure norms and the move by most banks to reduce their exotic risk appetite.
So it is also a question of managing the expectations of private banking distributors as to what product manufactures can and cannot do, which then flows down to the end investor.
Vikaas Sachdeva: In general, gatekeepers do a lot of due diligence to analyse products from every angle to ensure they only let the right ones through. But I think they need to review the filtering criteria they use to evaluate a product, and keep an open mind, because some of their filters don’t make as much sense in today’s environment as they perhaps used to given changing market conditions and evolving client demand.
For example, if they look at the AUM or track record of a product manufacturer which is just coming in, they might miss out out on a smart idea from a younger manufacturer.
Sayandev Chakravartti: It’s important to keep the target return concept in mind. Quite a few products are designed with a target return in mind. Yet sometimes, if there’s outperformance in a particular investment, in that euphoria, the target return can be forgotten, and the communication [to the investor] to then book profit or re-allocate to diversify gets lost.
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