In terms of those who hold wealth and those who create wealth, an interesting metamorphosis is currently underway.
- First, wealth is changing hands as it gets transferred from the older generation to the new generation.
- Second, sources of wealth creation are changing as new-age tech entrepreneurs and even corporate personnel, armed with employee stock options (ESOPs), have created wealth.
- Thirdly, an increasing number of people from diverse backgrounds and with varying perspectives about wealth, join the ranks of the wealthy.
It is important to note that because of all these changes, the ability to take risks by wealthy and sophisticated investors has gone up significantly in the recent past.
Correspondingly, the investment landscape has also undergone some modifications and inclusions. Traditional investment avenues which do not generate positive real returns are being replaced with innovative solutions, which are to the further right of the risk-return spectrum. In the backdrop of such an environment, ultra high net worth (UHNW) investors are looking for new avenues to both preserve as well as grow their wealth.
Here are five emerging avenues that such investors can consider include:
Equity-linked Market Linked Debentures (MLDs) and Non-convertible Debentures (NCDs)
MLDs are usually issued by non-banking finance companies (NBFCs) and offer returns that are linked to specified equity indices based on an underlying condition. For example, a 30-month MLD would pay the investor a predefined internal rate of return at the end of the tenure if Nifty 50 Index does not fall by more than 75%.
Proceeds from MLDs have a tax advantage compared with regular debt instruments but also have issuer risk as repayment of principal and defined IRR is at the end of the tenure. On the other hand, lower rated NCDs are debt products that offer higher interest rates than common debt instruments with the option of having regular coupon payments. These avenues are high in terms of risk and return as opposed to conventional debt instruments.
Additionally, both these products are rated by credit rating agencies and hence, can give investors a clear idea of the amount of risk involved. It must be noted that the options in the secondary debt market have increased significantly and while a lot of money goes into direct secondary debt portfolios made up of a mix of highly rated secondary bonds or deposits a small portion is also being used to increase portfolio returns through calculated decisions of investing in higher risk fintech companies that are backed by strong investors.
While equity participation in early and growth stage unlisted companies is known to all, one more avenue is venture debt which refers to providing short-term loans (18 to 24 months) to established early and growth stage venture capital backed companies. Venture debt is underrepresented in investor portfolios in India and provides a healthy mix of high yield, regular coupons and equity participation through warrants.
In India, venture debt funds that provide investors an option to participate in this debt financing option are fast gaining momentum. According to data from private company tracker Venture Intelligence, the total amount raised by venture debt funds through private equity and venture capital debt funds jumped from $62 million in FY 2019-20 to $85 million in FY 2020-21.
Over the last decade, private equity and venture capital has metamorphosed from a nascent alternative asset class to a mature ecosystem. As a result, in the year 2019, private equity and venture capital investments in India grew to USD 48 billion or 1.7% of gross domestic product (GDP).
Buoyed by a thriving start-up ecosystem and strong exits, private equity is becoming an attractive investment option for an increasing number of UHNIs. The rally in the markets as also the immense money being made by the start-up founders and promoters has created an appetite for early-stage investing ideas or even ideas in listed companies targeting new sectors.
As a result, UHNW investors are looking to invest for the future whether in the unlisted or the listed space to reap benefits in the long run. They are interested in futuristic themes such as consumer tech, retail fintech, renewable energy, electric vehicles and associated components.
In addition to asset class diversification, it has now become equally important to achieve geographical diversification. As a result, international investing is beginning to assume a key role in sophisticated investor portfolios.
Firstly, there is the potential to invest in innovative global companies that are currently not listed in India but have a place in the consumption basket of India. Secondly, investors can enhance the risk-adjusted returns of their portfolio by generating higher returns while reducing overall portfolio risk through diversification. And, thirdly, investors who have liabilities in a foreign currency can hedge the risk of rupee depreciation through exposure to international investments.
Indians can invest in international markets either through international mutual funds or directly under the Liberalised Remittance Scheme (LRS) of the Reserve Bank of India (RBI) that allows resident individuals to remit $250,000 during a financial year outside for the purpose of investment. Interesting options are also available now via direct stock investing internationally into US stock exchanges, where one can invest either into growth stocks directly or indirectly participate in new opportunities like a Bitcoin ETF or a new listing on the day of the IPO.
Real Estate Investment Trusts (REITs)
Traditionally, real estate has been a significant part of high net worth individuals (HNI) portfolios. However, due to the illiquid nature of real estate and the fluctuating real estate market, there has been a clear shift towards reducing real estate exposure. This does not mean that real estate no longer holds sway. What it means is that HNIs are now gaining real estate exposure through instruments like into Real Estate Investment Trusts (REITs). These are investment companies that either directly own real estate or have a share in the income of real estate properties. Thus, HNIs can gain the relevant real estate exposure by investing in REITs.
We live in an era where innovation is enabling investors to create optimal investment portfolios that can meaningfully straddle their risk-return requirements. In these exuberant times, increasingly the concept of core “asset allocation-based” portfolios, which are stable and managed for the long-term, balanced alongside “tactical portfolios”, where profits booked can be put into well-thought-out investment opportunities, seems to be the flavor of the sophisticated investors mindset.
Finally, it must also be noted that UHNW clients are also increasingly interested in ensuring their investment portfolios are protected and optimized through professional legacy planning and tax planning.