 "Avoid common mistakes when looking at exotic investments")
With persistently high inflation for some time now, many investors are being lured into investing in exotic high-yield investments and fixed arbitrage products that promise higher real returns. This past year, several such instruments, wrapped as structured products, real estate investment products, privately placed debentures and derivative arbitrage products, have been increasingly sold to investors with a promise of safety and higher returns.
It was these prospects of higher returns that made Nandkishore Bedekar, 45, invest a sizeable chunk of his savings in two capital-protected structured products two years ago. When he bought these products, he thought he would cash out of the product within a short time and pocket returns of around 13 per cent per annum. To his dismay, Nandkishore found out he couldn't exit his investments mid-way and his entire structure would not work. On the contrary, he could be hit with expenses as high as 30 per cent of his investments.
This is a scenario playing out across different products, and most investors are not aware of the possible conflict the products have with their financial needs. Says Amarendra Phatak, director, private wealth management, Ambit Capital: "Structured products come with a lock-in period and have differing pay-offs. If you don't understand the structure thoroughly, you should not get into these products. Exotic products imply higher risk."
According to wealth management firms, alternative investments such as structured products constitute about 12 per cent of investors' assets, while real estate investments are about 11 per cent. Investors don't take enough time to understand these products. Phatak also cautions that many a time, these products have a structure that is, say, in place for 24 months but the final pay-out happens only after 27 months. Investors are also not aware of the returns on these products. If a structured product has a return of 27 per cent, experts say one should look at the per annum returns of the product, not the total returns. Says Phatak: "The per-annum returns work out to just 11-12 per cent here and this does not compare well with other investments in the market." The risk is too high in this market. Explains Phatak: "The opportunity lost in terms of the higher risk is too high. There are many less risky products that offer almost similar yields."
Among the structures on offer are equity-linked debentures that offer 100 per cent Nifty participation; others offer a capped Nifty participation where the returns are capped, or a knockout participation where the returns are reduced if the underlying index crosses a pre-specified level. An issuer's rating also needs to be examined. A lower rated issuer could give higher returns but investors often tend to overlook it. All these structures work only if certain market conditions are fulfilled with varying degree of payouts to the investor. Says Shankar Raman, head investment products and advisory, Centrum Wealth: "People often don't look at the conditions under which these structures will or will not perform. Most investors don't pay much attention to detail. In these products, the devil is in the detail."
The best way to avoid a wrong investment is to look with scepticism at the returns if someone tries to sell you a high-yield product. Know also whether it forms a strategic fit with your portfolio, and avoid such products if the structure is too complex and does not have an easy exit option, say experts. Investors have to be extra careful on which financial institution is issuing such structured products, and its credit rating. Says Phatak: "One has to see the strength of the underwriter and all the terms and conditions on exit and other exemptions."
Investors are not only stuck sometimes with exotic structures but also with real estate investments. In the latter, investors are not aware of the inner workings of how the returns are calculated and what projects or annuities from real estate these funds are invested in. In the past few years, private real estate investment either through advances to builders or through private placements have been gaining currency. Typically, large investors park their money in a slew of projects through REITs (real estate investment trusts). Sebi recently released a draft paper on these. The products have been sold to high net worth individuals in the past.
In real estate investments, people don't know how much debt a real estate company has on its books, as no developer provides such numbers, say experts. For instance, real estate companies might borrow against a collateral of land but many times this is illiquid or embroiled in legal disputes. Some real estate investments promise returns of over 24 per cent but the transparency of such investments is far lower than other investment vehicles such as a mutual fund. Investors often do not know what the underlying projects are or when such projects will get executed, or how long they will have to stay invested. Says Sharma: "Real estate investments are better done through institutions that have a lot of experience in this sector and where their teams can assess the ground situation of different projects and evaluate their market value."
Other products that investors are being lured heavily into are high-yield non-convertible debentures that sometimes promise returns of around 18 per cent yearly. These are debentures typically issued by real estate companies that need working capital. Experts warn that such companies might have exhausted their credit line with banks and financial institutions. Investors should be wary of such issuers and look at the credentials closely, especially the credit rating of such paper. Alternative assets are also often handled by relationship managers that change very often and may not be able to resolve any problems that crop up. Experts advise that investors must look at the tried and tested alternatives of equity and debt before alternative structures. Says Sharma: "Only if you understand a product, can you evaluate if it's to your advantage."
It was these prospects of higher returns that made Nandkishore Bedekar, 45, invest a sizeable chunk of his savings in two capital-protected structured products two years ago. When he bought these products, he thought he would cash out of the product within a short time and pocket returns of around 13 per cent per annum. To his dismay, Nandkishore found out he couldn't exit his investments mid-way and his entire structure would not work. On the contrary, he could be hit with expenses as high as 30 per cent of his investments.
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This is a scenario playing out across different products, and most investors are not aware of the possible conflict the products have with their financial needs. Says Amarendra Phatak, director, private wealth management, Ambit Capital: "Structured products come with a lock-in period and have differing pay-offs. If you don't understand the structure thoroughly, you should not get into these products. Exotic products imply higher risk."
According to wealth management firms, alternative investments such as structured products constitute about 12 per cent of investors' assets, while real estate investments are about 11 per cent. Investors don't take enough time to understand these products. Phatak also cautions that many a time, these products have a structure that is, say, in place for 24 months but the final pay-out happens only after 27 months. Investors are also not aware of the returns on these products. If a structured product has a return of 27 per cent, experts say one should look at the per annum returns of the product, not the total returns. Says Phatak: "The per-annum returns work out to just 11-12 per cent here and this does not compare well with other investments in the market." The risk is too high in this market. Explains Phatak: "The opportunity lost in terms of the higher risk is too high. There are many less risky products that offer almost similar yields."
Among the structures on offer are equity-linked debentures that offer 100 per cent Nifty participation; others offer a capped Nifty participation where the returns are capped, or a knockout participation where the returns are reduced if the underlying index crosses a pre-specified level. An issuer's rating also needs to be examined. A lower rated issuer could give higher returns but investors often tend to overlook it. All these structures work only if certain market conditions are fulfilled with varying degree of payouts to the investor. Says Shankar Raman, head investment products and advisory, Centrum Wealth: "People often don't look at the conditions under which these structures will or will not perform. Most investors don't pay much attention to detail. In these products, the devil is in the detail."
The best way to avoid a wrong investment is to look with scepticism at the returns if someone tries to sell you a high-yield product. Know also whether it forms a strategic fit with your portfolio, and avoid such products if the structure is too complex and does not have an easy exit option, say experts. Investors have to be extra careful on which financial institution is issuing such structured products, and its credit rating. Says Phatak: "One has to see the strength of the underwriter and all the terms and conditions on exit and other exemptions."
Investors are not only stuck sometimes with exotic structures but also with real estate investments. In the latter, investors are not aware of the inner workings of how the returns are calculated and what projects or annuities from real estate these funds are invested in. In the past few years, private real estate investment either through advances to builders or through private placements have been gaining currency. Typically, large investors park their money in a slew of projects through REITs (real estate investment trusts). Sebi recently released a draft paper on these. The products have been sold to high net worth individuals in the past.
In real estate investments, people don't know how much debt a real estate company has on its books, as no developer provides such numbers, say experts. For instance, real estate companies might borrow against a collateral of land but many times this is illiquid or embroiled in legal disputes. Some real estate investments promise returns of over 24 per cent but the transparency of such investments is far lower than other investment vehicles such as a mutual fund. Investors often do not know what the underlying projects are or when such projects will get executed, or how long they will have to stay invested. Says Sharma: "Real estate investments are better done through institutions that have a lot of experience in this sector and where their teams can assess the ground situation of different projects and evaluate their market value."
Other products that investors are being lured heavily into are high-yield non-convertible debentures that sometimes promise returns of around 18 per cent yearly. These are debentures typically issued by real estate companies that need working capital. Experts warn that such companies might have exhausted their credit line with banks and financial institutions. Investors should be wary of such issuers and look at the credentials closely, especially the credit rating of such paper. Alternative assets are also often handled by relationship managers that change very often and may not be able to resolve any problems that crop up. Experts advise that investors must look at the tried and tested alternatives of equity and debt before alternative structures. Says Sharma: "Only if you understand a product, can you evaluate if it's to your advantage."