Basis of your investment decisions, product choice

The basis of portfolio allocation decision is financial goals, risk tolerance, investment horizon, etc. Here, we will scratch the surface on the multiple investment products crying for attention.

Underlying for product

Any investment product invests in the underlying market. Conventionally, underlying markets are equity stocks, bonds, and gold. There are also new concepts such as real estate where you can invest via Real Estate Investment Trusts (REITs) and infrastructure via Infrastructure Investment Trusts (InvITs). Potentially, there could be other investment assets like commodities (other than gold or silver), but these are yet to emerge as popular ones via investment vehicles. For HNIs, there are things like art but these are not available in the retail space.

The staple investment base is equity stocks and bonds, also known as fixed income or debt. Equity represents part ownership of the firm whose stock you are buying. As the firm grows, and new investors come in, the value improves and price increases. This leads to returns from investments in equity. Bonds represent ‘I owe you’ or loans given by the investor to the issuing entity. There is a defined interest payable on a defined date and maturity of bond or debenture is defined as well. The typical aspect is equity has given relatively higher returns than debt but has been relatively more volatile as prices fluctuate more. Gold is known as a ‘portfolio diversifier;’ with some allocation to gold, the volatility-adjusted return of a portfolio is better.

At the bottom of the pyramid, there are bank term deposits where there is a defined rate of interest and maturity. The interest rate is not dependent on any market condition. Bank FDs are not transferable. At the higher end of the pyramid, there are derivatives where the base is equity/government bonds/ commodities, which are more risky.

Investment vehicles

You can invest directly. You can buy equity stocks from the exchange via stock broker. These days there are multiple apps where you can do KYC online and start buying/selling stocks. For buying bonds online, there is Reserve Bank of India’s platform called Direct Gilt, where you can buy government instruments. For buying corporate bonds, there are Online Bond Provider platforms (OBPPs). You can invest in gold via Exchange Traded Funds (ETFs) or Electronic Gold Receipts (EGRs).

However, to manage a fund of equities and/or bonds, you need a professional. Therein comes the concept of investment vehicle: a fund management entity which will run a fund and will charge a fee.

The most popular investment vehicle is a mutual fund (MF), where you can buy units of a professionally-managed fund and liquidity is high. There are portfolio management services (PMS) with a minimum ticket size of ₹50 lakh and alternative investment funds (AIF) with a minimum ticket of ₹1 crore. Insurers offer Unit Linked Insurance Plans (ULIPs).

Choosing a product

The investment vehicles mentioned earlier, known as product manufacturers, offer a plethora of products, which are a combination of the base mentioned earlier with packaging.

You have to look at:

1. The risk in the underlying base: equity is more volatile than debt; within equity small cap or sectoral/thematic funds are relatively more volatile. In debt, higher rated bonds carry less credit risk.

2. Required investment horizon: historic performance of any asset i.e. equity or debt, gives an idea how volatile it has been, hence how long you should be in the product at the minimum.

Every investment product will have an investment objective, portfolio disclosure and track record unless it is a newly launched product. There is a concept called drawdown, which shows in the worst phase of performance, what was the return from that product. You need a horizon longer than the drawdown and recovery phase.

3. Liquidity: you may need cash flow at any time for an eventuality. You need to be aware upfront on product liquidity. Some products are not liquid by definition e.g. RBI Floating Rate Bonds. Equity is liquid but it is a function of the market level at that point of time. If the market is correcting you may redeem the fund subject to exit load but you would be taking home less.

While liquidity is desirable, it is not compulsory everything in portfolio should be liquid. There would be a certain liquid component, say 10% and a major ‘saleable’ or ‘if required’ component.

(Joydeep Sen is a corporate trainer (financial markets) and author)