Ultra high net-worth people typically have a significant percentage of their wealth invested in non-financial assets. First-generation entrepreneurs usually consider their own business not only as an engine for wealth generation, but also as the most lucrative avenue and first port for investment. Then comes real estate, the traditional haven of high-value investments in India. Adding jewellery to the mix, one is typically left with not more than one-third of the family’s wealth for investment in financial assets.

This is true to a lesser degree for those who have inherited wealth and who may invest larger portions of their money in financial assets—and time in wealth advisory—and for employed professionals with regular incomes. They too, however, may have a fair portfolio of their net worth in real estate, employee stock options, unlisted equity, etc.—investments on which they may or may not formally seek the advice of a wealth manager.

In the three segments listed above, the typical asset classes within financial assets—debt and equity—are the most preferred. Alternative investments such as private/unlisted equity, venture capital, real-estate funds, structured debt/equity, etc., typically comprise a very small percentage of the portfolio. This is because the financial portfolio is seen more as a wealth preserver than a wealth creator.

Individuals with irregular and lumpy income, such as actors, sports personalities, authors, typically have a different set of expectations. They receive lump-sum amounts on a sporadic basis, and therefore are likely to invest more time and effort in their financial investments. They are also more likely not only to be open to return-enhancing products within the two traditional asset classes i.e. debt and equity, but also keen to explore alternative investments as “alpha" generators in the portfolio.

For example, while the majority of the sporadic income would be invested in the typical avenues of retail investments—mutual funds, direct equity and bonds—significant emphasis is also likely to be given to a part of the portfolio which actively aims to generate a significant return, unrelated to the typical asset-class benchmarks. For this part of the portfolio, they are much more likely to be willing to take on a calculated but higher risk for the possibility of a supernormal return.

These individuals are likely to be much more oriented towards “risk-adjusted returns". For example, from a perspective of generating returns in line with equity and debt markets, they may invest about 60% of the portfolio in equity and debt mutual funds, stocks and bonds. For the balance, they may look at NCDs (non-convertible debentures) with higher coupons, AIF (alternative investment funds)/PMS (portfolio management services) schemes with specific themes, venture capital/private equity funds, etc. The level of their involvement in understanding the structure and specifics of these investments is typically much higher than the other segments discussed.

Within the debt portfolio, they may be keener to invest a certain part in income-generating investments such as bonds, in order to ensure a regular flow of income. This would be despite the fact that these instruments are typically not very tax-efficient (coupons being subjected to the marginal, which is most usually the highest income-tax slab rate).

They may also hold a higher than usual portion in ultra-short-term debt and short-term debt mutual funds with investment horizons of 15 days to six months. A debt mutual fund, when held for three years or more in the “growth" or “capital appreciation" option, qualifies for long-term capital gains with indexation benefits, which makes this the most tax-efficient way to invest in fixed income in India. These individuals may forgo that advantage and invest these short-term monies in the “dividend" mode, paying a higher dividend distribution tax of almost 28% as a price for any-time liquidity.

They may also be more open to what we call a “safety pot" approach—where a portion of the portfolio is carved out as non-risk capital at inception. This would typically consist of high credit quality and relatively risk-free assets with a varying degree of liquidity depending on the investor requirements and goals. The return objective for the safety pot portfolio would be to protect assets and generate regular interest income for the expenses/consumption on an inflation-adjusted basis. The residual portfolio can then be invested into growth assets (typically equity, real-estate oriented, and other alternative investments) with a relatively higher degree of volatility with the objective of generating returns through capital gains. In this case, the risk-appetite for each of these two buckets of the portfolio is clear, giving the investor the leeway to invest in higher risk avenues while protecting capital and future income. It also gives them the ability to look at longer investment horizons (especially in the case of real estate-/private equity-oriented investments)—this is usually a point of resistance owing to concerns on future liquidity.

Finally, they are well placed to benefit from an “asset allocation and rebalancing discipline" approach that we strongly endorse. Given the lumpy nature of their income, the temptation to invest large, sporadic tranches in higher-risk investment avenues that come along periodically can be strong, as can the inclination to try and optimize returns by rebalancing investments and asset classes in an ad-hoc manner based on market momentum/sentiment. While these, chosen after due diligence and an understanding of the risk-reward equation, definitely belong in an ultra high net-worth individual’s portfolio, they should be invested with an eye on product suitability, maximum caps on product/instrument exposures and other risk-management parameters which become even more important in cases where the income isn’t regular.

Disclaimer: The views expressed in the article are personal.

Rajesh Iyer is head—investment advisory services & family office, Kotak Wealth Management.

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