Where Do Millionaires Invest? Three Key Factors Aiding Growth Of International Investing

R. Saluja: Our clients are high-net-worth individuals and ultra HNIs.

HNI is someone who has got a million dollars plus, of investable assets outside his business. Ultra HNI is someone with more than $25 million of investable assets.

That's the client segment that we are focused on.

You are right, they have created wealth on their own. Many of our clients, I would say 75-80% are promoters and 20% are professionals. So, these 75-80% of our clients who created wealth have expertise in their own business. But when it comes to managing their financial investments, for looking at opportunities outside their own business, they need expertise. That's why they come to us.

There has been a dramatic change. Earlier, a large portion of these clients would invest in real estate. But over the last five-seven years, many of these clients are creating financial portfolios, and this is where our expertise comes.

R. Saluja: It's customised for each client depending on his age, his wealth. There are lots of factors that come into play. As a wealth manager, our idea is to create customised solutions. But frankly, since they are taking a lot of risk in their own business, they are not giving us the mandate to take excessive risks. So, the first core objective is preservation of wealth. Post which, there is growth and creation of wealth. That's how we really build the portfolio.

S. Mukherjee: That's very bespoke and customised to individual requirements. But within that there is certainly an approach towards looking at your opportunities. Those opportunities may not always be about maximising returns, but optimising the risk that you took to create the same set of returns. So, it is bespoke. At the same time, it is always looking for opportunities to find extra sources of returns, as well as, extra medium of optimising risk.

S. Mukherjee: Post 2020, it is not dramatically different but there's a secular rise in acceptance of alternative asset classes. Certainly, unlisted has become quite a mainstream investment today. Derivatives have a longer history. Our client are more comfortable using derivatives as part of a strategy. But since 2020, the big change has been the acceptance of unlisted -- from early-stage to mid-stage to growth-capital to pre-IPO. The entire lifecycle on the unlisted side has seen a massive pickup in terms of allocations from family office to high-network clientele.

R. Saluja: The idea of giving a mandate to a wealth manager like us, is to try and create returns post-tax, post-inflation. That's the idea. That's all-wealth creation happens. Otherwise, you are basically just preserving or sometimes depleting when you keep it in traditional asset classes.

So the core approach of wealth management has not changed.

Of course, client temperament may change given the situation. So post-Covid, there may be a little bit more allocation towards fixed income as compared to equities. I think the broader point, Mukherjee was making, is the need of the really super rich to try and generate a little bit of alpha, over and above what they get in equities through the unlisted space. And Covid again has resulted in many companies taking the leapfrog in the way we look at technology.

So, technology has suddenly become one of the key agenda items for most business houses. Therefore you are seeing a lot of new entrepreneurs who are coming up in the so-called technology space. The only way you can participate in that growth story is through the unlisted space. So, you see post 2020, many more ultra HNIs who have larger portfolios are willing to take some portion of their portfolio and invest in the unlisted space, through the fund route. Lots of funds that have come up whether early-stage, mid-stage or even late-stage. Covid has driven the shift to technology in a very, very big way.

S. Mukherjee: What has happened is 70 or 80% of our clients are entrepreneurs or businessmen. They have seen the sort of disruptions that has happened to their own businesses and to the extended ecosystem. Covid provided that cusp wherein a lot of new age disruptors proved market fit, or at least in the views of capital markets, proved its product market fit. The scalability of some of these disruptors became a different curve altogether, from what was envisaged pre-2020. If you see it in your own business, then evidently you want to also evaluate what happened to other related businesses.

R. Saluja: It is bespoke. The ultra HNI in this market environment, on an average, would have exposure of roughly about 50% in listed equities, of which 10% would be in international equities or global equities and 30-35% in fixed income, in fact, more towards 30%, and between 15 to 20% in alternative investments. These are private equity funds, real estate funds, structured credit funds etc... For most wealth houses including us, the stance is neutral at the moment, given whatever is happening globally, on inflation front and rising interest rates. We have an allocation that is neither 'overweight' nor 'underweight' in equities. It remains a neutral stance.

R. Saluja: We don't do direct real estate investment, because we don't believe that's the right way to manage real estate. Our advice to clients is buy real estate for consumption. From an investment standpoint, there are ways to invest in real estate through more liquid financial investments like REITs, which are listed on the commercial side and real estate funds that are available on the residential side, can generate decent returns. Get someone else to manage the risk and diversify your assets. For most HNIs there was an era where a large portion would go into real estate, and they would make good returns. But over the last eight to 10 years, the trend has changed. People have realised that real estate by itself is not necessarily a very lucrative investment opportunity. It's also very tough to manage and maintain as you need to give it out to a tenant etc. Then, there is the whole hassle of maintaining it. Slowly but steadily, people are moving to liquid financial investments in real estate.

S. Mukherjee: We have been in business for 38 years, and we have seen many ups and downs. One trend that we have noticed that clients have become slightly more matured and patient when it comes to long-term investing in equity. This means that even during times of Covid, when, frankly neither as wealth managers, we knew what was going on and neither the clients. It did create a little bit of panic, but people remained invested. They did not take cash calls for the exit from equities in a big way, barring a few sets of people who panicked.

S. Mukherjee: Fresh allocation, I think from the mid-2020 when market valuations were really attractive. Many of our clients did come back into equity. We didn't see a trend where a large portion of clients remained on the sideline. That has happened only recently over the past three, four months or I would say, five or six months as there is that expectation of interest rates going up progressively and commodity prices rising. It was where even our call as a house, was to keep clients out of equities and stagger their investment over six months.

There are a set of clients, especially the super-ultra HNI who have taken a call to remain out of the market. They may have staggered. You know what I would say, take a little bit of exposure when markets really dip in a big way. But largely, we see most clients are going ahead with a staggered allocation for the last one year, continuously taking advantage. I do not see a situation where many are feeling left out. They have taken an asset allocation call. They are not going aggressive nor letting cash call or stopping small flows into equity.

R. Saluja: Neutral right now. Six months back, we were still okay to have staggered investments in an overweight manner. It’s only in the last three months, we are neutral. But prior to that, in the last nine months, we were overweight.

S. Mukherjee: We usually adopt a fairly well allocated approach and in times of volatility, it's better to stick with quality and large caps. So that's been the bias -- stick to quality, large cap, especially in times of volatility.

If you look at profit pools, its predominantly concentrated at the top 30-35 companies. So, if those profits pools are under some incremental threat, it is lot better to stick to the top 35-40 companies than to the next 100 or 150 companies or go down below that because profit pools will be under greater threat there. It will be the larger company that will have better cushion, better market share to absorb some of the margin compressions and comparative pressures arising out of both rates and commodity prices.

R. Saluja: Our bias has been more towards large cap in the last two years. 65% will be large, 35% small cap because we've seen, again based on our experience of various market cycle, during tough economic condition, companies with better quality balance sheets tend to do well. We have seen this over the last few years, across each industry and segment, the larger companies tend to become stronger at the cost of the smaller ones.

Secondly, in tough economic conditions, small companies who have maybe smaller balance sheets, have other kinds of stress, which make them take a different direction. So, the risk is much higher in small caps especially in India. Although, you know this is an allocation call that we are taking. It's on that we are averse to investing in small caps. We have to be extra selective in small cap in terms of quality of management, quality of business, the balance sheet, the promoter background, etc. You have to be very careful.

R. Saluja: First agenda is preservation of capital. No clients who's giving us money to take some risks where he loses capital completely. We have seen in India contrary to what people believe that equity is risky, actually fixed income carries a higher risk than equity in India. Because, typically you go by just credit rating. You don't have an overlay of quality there and this can get you wrong. So, we are extra careful on both sides, not only in equity where we prefer large cap, even on the fixed income side. Other than the ratings, we have seen many 'AAA' ratings gone overnight. We put an overlay over market intelligence, the business on the promoter, etc. We would be happy to even promoter 'A' rated companies as compared to 'AAA' company in which we have more confident about the business. That is the way, we look at it.

R. Saluja: Many before that, it's always fixed income that has made people lose their capital than in equities. People lose money, tend to treat equity like an affair and deal with it in the wrong manner, through tips and advice from friends. They do not do it properly. If you invest in equity in a proper manner using good quality fund manager, we really have to work hard to lose money in equities.

S. Mukherjee: The 8% benchmark is something that is embedded in our psyche over several decades. What we have to understand that India has structurally settled into a somewhat lower interest rates regime compared to what we were a decade and a half back. In India fixed income today represents an interesting bouquet of opportunities. Fixed income typically has broad basket, the high-grade ones, which is the sovereign and 'AAA' rated, and the high-yield one’s which is anything that is 'AAA' in the Indian context.

In the high-grade investment, the yield curve determines the value of investing. The yield curve is quite crooked in India. So, between the repo and six years you have 250 basis points of spread, between six years and ten years, basically 25-30 basis points of spread. It’s a no brainer where you have to invest in, where the value lies. We think that the five-six-year range affords a fairly reasonable value and probably very close to offering a compelling value for investors to come in and there is a whole range of products.

Bharat Bond is very exciting investment instrument. Basically, take out the credit risk out of the whole equation and you are playing the rates and duration side. At six years, volatility on the duration side likely to be the least and even as rates adjust themselves and on the high yield. Corporate Indian balance sheets has been cleaned up in a massive fashion in the last six to seven years, thanks NCLT and the range of other things that has happened, giving investors a wider choice. Especially for those who are not terribly keen on taking extraordinary credit risks. Having said that, it is an area that requires a lot of discerning choice. But, if that choice is carefully done, we can afford fairly reasonable rewards for the risks that are being taken.

R. Saluja: Yes, 8% whatever people are thinking about is purely based on the trend with interest rates going up. Over the next three, six months, that opportunity may come in where there will be some good, fixed income paper available with much better yield.

Having said that, it will still not be a decision as a wealth manager for us to take and go overweight on fixed income because we continue to believe on a mid and slightly long-term story. India is very well placed on whatever is happening currently. China's story, we are aware of, is creating interest for Indian manufacturers. We believe that there is a very strong possibility of manufacturing revival over the next five years, at least from the promoters we have talked, and the capex plans that they have. It's going to be quite exciting right from specialty chemicals to pharmaceuticals, to electronics, to electric vehicles. There are lots of places where serious investment is being planned, once the commodity prices settle down many of these will come into play. So, if you see India and how it stands to benefit from whatever's going on globally, we believe this next decade will be golden one for India, even much better than what we have seen. So, to our clients, allocation to equities and to some of those businesses that are going to take advantage of what's really going on will probably the single biggest advice we will be giving to our clients.

S. Mukherjee: If you have long-term money and if you have got age at your side, like I said, most of these solutions are bespoke. If someone just retired, just wants income out of this portfolio, then his portfolio will be 75% fixed income. I am just talking about an average portfolio of 50 plus wealthy client who's got you flourishing business running. He has got this money on his side, the allocation will be more towards growth assets which is equity and alternate. It will go up to between 60-65% of the portfolio and upper-end on the fixed income side will be 35%.

R. Saluja: There are benchmarks. At portfolio level, it will be a function of asset allocation. The percentage between fixed income, if you take each asset class, and equity with average 4-5% GDP growth. Our belief is that the Sensex or the Nifty earnings typically are anywhere between 10 to 12%. If that was the case, at an average, good quality businesses, who are the leaders in businesses and the size of opportunity is huge, should be able to deliver 15-to-18% kind of earnings growth as a company. Hence a good portfolio manager who has the ability to pick up some of the best business should deliver 15 to 18% kind of compounded growth on equities, over a five to seven years. Historically that has been proven irrespective of all the challenges we have seen viz Asian crisis, global crisis, whatever. If you see good quality fund managers and the PMS side of the mutual funds, they have delivered between 15 to 18% return. Given the next 10 years growth story of India, this should not be a challenge.

On the fixed income side, it is linked with the interest rate and as Mukherjee was mentioning structurally we are at a period where interest rates are never going to be as high as earlier. So broad range is 6-8% kind of on fixed income, which I would say a broad range. On the alternative side, where we are taking a higher risk and on the private equity side at the gross level, the returns can be anywhere between 20 to 25% especially in new age businesses where there are tons of opportunities.

On the real estate side, we feel it will be anywhere between 10 to 11%. In each asset class, I have given you a broad idea. Now the combination will decide the portfolio.

S. Mukherjee: Good proxy of that is mutual fund feeder-fund market which has hit the cap. The cap was nowhere close, to be hit two years back. Part of it is just because US markets have done so well.

It’s been 10-15 years, since US markets have done so well.

In the last three-or-four years, the noise and visibility of some of the larger companies in the US whether it is the entire branding around FANG, whether it is the entire social-media visibility company like Tesla, all the derivative action of arc investments etc. This has osmotically oozed into Indian investor mindset as well. There is obviously a very compelling preposition here--its not only about the opportunity but also the diversification of the risk. The kind of opportunities you see globally are distinctly different from the tons of opportunities you see in India. So, it works out beautifully for portfolio and Indians have taken to it, at least the high-net-worth families. They have taken to international investing in a very enthusiastic fashion. Most of the allocations till now has been on the listed side, predominantly for obvious reasons in the US. But also little bit in emerging markets in China. There is interest across the globe. There is interest, also, in the private pockets, in very small and selective but to the extent of access available to the people. There is interest in private market transactions as well. It's an avenue asset class that has increased interest and a compelling reason to be there in your portfolio.

R. Saluja: Three key things are driving this. They are also one of the reasons we, over the last five years, has been recommending. First, there are lot of HNI and ultra HNI client, whose children are studying abroad. So many of them may want to remain there or work there. There is a need to create assets outside the country, because there is a limit under the Liberalised Remittance Scheme law every year. Tomorrow, if they want to buy a house in London, or somewhere else, how do they put in two-three millions in one shot. So, they are building up through LRS, a portfolio outside which can be utilised.

Second, geographical diversification. Because we have seen India being an emerging market over a five-to-seven-year period. You have these two, three years that seemed, the trend, that the economy is not doing well or some government is changing or something or the other keeps happening. So you have your portfolio diversified and take advantage of some of the more stable economies.

Third is exposure to certain sectors or industries, which you don't find replicated business models in India. So, you will not have the Googles and the Apple or Microsoft or Salesforce in any of the Indian companies. Many of our clients are very keen to take exposure to some of these really large brands. Our current advice over the last five years have been primarily equity. We have not been recommending fixed income. So, we have selected one or two really strong portfolio managers in the US who just have the same thought, philosophy and approach like us. They created 20 stock portfolios, which includes some of the best businesses available in the US. We get our clients to feed into that portfolio. That’s how we have been investing.

S. Mukherjee: The most important material is the currency. India is the high inflation country, notwithstanding our current CPI. Structurally, we are a high inflation economy, which means the rupee will keep depreciating over a longer period of time. We have seen it in the last 30 years, and we are going to see it for the next 10-15 years. Plus, we are also structurally a current account deficit country, as opposed to large parts of Asia which are current account surplus. Put both of these together and you have to do theoretical calculation of 2.5% to 3% depreciation on the rupee against the US dollar. So, it just adds on to the next layer of returns.

S. Mukherjee: It is not so much of a competition, as it is a different engagement model. What kind of families find it worthwhile to set up a family office of their own. One, it has to be CSE large pool of assets because only then it will attract the talent and the bandwidth. The bandwidth required in a fashion that makes economic sense to build that family office. That number is variable, but certainly nothing less than 700-800 thousand crores. Family office invest the money in the entire infrastructure required to manage the money on your own. What happens then is engagement models with wealth managers, change of those family offices. The engagement model goes more into ideas, more into transactions more into newer ways of managing money, newer styles because the overarching asset allocation, goal setting etc. is presumably done by the inhouse family office. But it is not so much a competitive thing as it is a change in engagement model. But it is a trend, the larger families with that kind of wealth have started setting up their own family offices, but it makes sense only if they have that kind of assets.

R. Saluja: I think the issue is always talent because if someone is setting up his family office and hiring someone who's only working for one family, very tough to retain that talent. So, I have seen as a trend where family offices have come into existence and probably are growing but they still look at allocating money through wealth managers, if they have an in-house idea. So, let's say ASK is a group who want to run their own PMS, which is very well-known, so many families inhouses may not take our advice on wealth planning, or you know some other solutions where they may have access. Second, there are lot of fixed income structured products you do which are unique to wealth managers and family offices don't have the ability to garner a large sum of their own. So, specific unique ideas, this will come from wealth managers.

R. Saluja: It’s very important to have goals related to what you want to do with the money. I think that's the first thing. Because you came into money and then it's only about investing. You can probably learn that by taking sub optimal decision. So, wealth planning has to cover two to three areas. One is what's the right structure under which it should be held to make it more tax efficient, or I would say not only tax efficient, but a structure also that can help pass on the assets to the next generation. This is again another goal as an individual depending on what my age is and where I where I am in life. I have to decide what I am going to do with that wealth. How much is required for me. How much is required for the next generation. How much could be required for philanthropy. If I have those goals in mind, then the planning part becomes easier to implement as to how much should I keep long-term, short-term. If I require anything for my lifestyle from it, do I have any other sources of income. So, it's really that part of the exercise where you sit down and understand your current assets, your future sources of income, your future goals, related to the money, your family structure, all of that and then put a fully integrated plan in place, which covers wealth preservation, wealth creation and wealth transfer. So that's the aspect of planning which many people miss out. When they start investing over a period of time, think about it, and suddenly realise that they have to undo many of their decisions, or consolidate, or maybe they didn't think of certain things upfront, etc.

Our goal is to get them to think around the planning part, and give it as much importance as the investment side.