Instead of compromising on returns, HNIs should manage their portfolios better

By Uma Shashikant

There is one well-kept secret in the personal finance space. The portfolios of wealthy investors (high net worth individuals or HNIs) have more poorly constructed than they care to admit. HNIs, except for a small minority, are actually not well-informed or are unorganised when it comes to their money. Many simply pile on a range of products from a range of advisers, hoping something will work. Large sums of money need a more strategic approach than that.

The market for HNI wealth is deeply segmented. Not all HNIs are inheritors. In modern times, there are entrepreneurs who build their businesses from scratch and make huge amounts of wealth through strategic sales or public offers. There are employees who hold stock options that translate into crores of rupees. There are professionals, such as doctors, lawyers and architects, whose fee income has increased steeply from increasing opportunities. Then there are crony capitalists, politicians and their supporters, and local mafia, who have made a fortune, but mostly in cash. To this list if we add successful sportspersons and film industry professionals, we are looking at a large diverse group that has become wealthy through various means.

A look at their portfolios, however, shows that politicians and film stars have invested in property and bank deposits, while CEOs have concentrated portfolios in their own company stocks. There is little about a typical HNI portfolio that is inspiring and exemplary. Worse, not many of them have put in place a succession plan to secure their wealth.

The HNIs who do not understand the math of money end up with wasteful insurance products. They think that choosing a product from an established name with a set of defined future cash flow is somehow securing their wealth. They tend to sign up for large premiums if a suave relationship manager of a bank offers the product. What they do not like to admit is that they have not taken the time to check the calculation. They end up with products that earn small single-digit returns. By the time they realise that their investments have dropped significantly due to front-loaded costs, it is too late. They fret about the losses, but are unwilling to admit that they signed up without asking for proper calculations.

The HNIs who come with a sense of entitlement about returns buy into exotic products. Being used to business class and exclusive lounges, many believe that financial markets also offer them such special places to park their wealth. There is a class of salesmen that will take a product to an HNI showcasing its ‘exclusivity’, saying that only a few chosen investors can participate. Many who bought into structured products have been dismayed to receive the original investment amount with zero return on maturity. There has been no capital protection whatsoever. Many investors in high-cost PMS are trapped in low-return products that they loathe, but can’t explain why they bought them in the first place. The use of jargon makes some HNIs feel superior.

It is important to separate emotion from investing and sellers know very well which emotion to tap. There are HNIs who understand that they could be targeted. If they have been top professionals in their work of choice, they can identify operators in the financial markets. These type of investors listen to sales pitches with suspicion and do not decide quickly. However, many do not simply have the time to manage the loads of money they make. They then end up compromising their portfolio because they cannot trust anyone. They choose to leave their money in the bank, with state-owned insurance, or in government schemes. They choose gold and real estate since it is easy to make bulk investments with the view that these assets are safe. Their suspicion about equity markets and anything that is risky and complex translates into sub-optimal returns. Many of them have idling cash piles too.

Since they earn and save a lot of money, they think that the compromise on returns is something they can live with. This probably explains why the disclosed wealth of our MPs is mostly in bank deposits. Then there are those who see the world of finance as a world of opportunity. They are willing speculators in stocks, derivatives, commodities and currencies.

However, they like to see a firm return on investment and a quick control of any loss to capital. They always push their advisers and can be insistent about earning higherthan-average returns. They are ruthless operators. They make a lot of money when the going is good, but can end up with sharp losses due to the poor quality of deals. Many who lost money in the NSEL scam were aware that they were betting on an opportunity that may not last, but wanted to be there as long as there was money to be made. From unfinished real estate to distress sale of property, they are present like vultures. Illegal betting on sport is funded by such HNIs who are willing to cross the line to make a few more bucks. When they lose, they have nowhere to go. Some HNIs who have earned a disproportionately high personal income, want to use that power to earn high returns on their investments.

A preference for angel funding, venture capital, private equity or exotic structures that require big-ticket investment comes from their ability to bear risks and seek better returns. These calls are taken by a small subset of HNIs, who know firsthand what it takes to build a business. The formal family office structure, which engages specialists to manage their wealth, is a choice a small subset of HNIs makes. They may represent the minority that has formalised its wealth management by using specialists working to specific goals.

A very small subset works with private bankers and insists on formal processes. The rest lean on a mix of chartered accountants, friends, relatives, private bankers and financial advisers. Without a strategy for portfolio construction and accountability for performance, HNIs have mostly been engaging at a ‘transactional’ level, dealing with multiple agencies and piling on products that may or may not work. This segment has the power to set the rules of the game by demanding professional services and offering to pay for it. However, HNIs may be too busy to bother or too shy to admit that they have been gypped.

(The author is Managing Director, Centre for Investment Education and Learning.)