Indian investors happy to shun wider world

The Indian economy was among the first to recover after the global crisis. With domestic consumption picking up and long-term prospects sound, the International Monetary Fund has projected the growth rate to rise from 6.75 per cent in 2009-10 to 8 per cent in the 2010-11. In a recent report it said: “India’s economy has rebounded strongly and the recovery is well-entrenched. According to a ‘heat map’ of key economic indicators, India’s momentum is among the strongest in the world.”

As a result, the growth prospects for the Indian private banking and wealth management industry are also bright. India is expected to experience a 14 per cent annual growth rate in wealth according to forecasts from Merrill Lynch Capgemini. These are the strongest in the region with its high net worth individual (HNW) population expected to more than triple its 2008 size by 2018.

“India is a very very exciting market for the wealth management space,” says Vishal Kapoor, head of wealth management at Standard Chartered Bank, India. A fallout of the positive growth story of the Indian economy as compared to most other developed and emerging markets is that most wealth management clients in the country prefer investing in the local market. “From a portfolio diversification strategy it makes sense to invest overseas, but India has a very strong story for itself,” he remarks.

C. Jayaram, executive director, at Kotak Mahindra Bank echoes these views. While most clients understand the intellectual argument in favour of geographical portfolio diversification, he says, it does not make economic sense for them to do so. “As part of the overall portfolio construct, we advise our client to diversify geographically. But as Indian markets have performed very well, clients haven’t taken this option. As long as the dollar is depreciating, there is not enough conviction to put money outside.”

There are two routes to make investments outside India. One is to invest via feeder funds that target international markets. There are a number of such feeder funds such as, DWS Global Thematic Fund, ING Global Real Estate Fund and HSBC Emerging Equity Fund. “The history of feeder funds in not great in India,” says Mr Jayaram. They have performed much worse than domestic funds, most are logging negative returns and many investors have lost money. Nevertheless, recently launched feeder funds such as DSP Blackrock World Energy Fund and JPMorgan Greater China Equity Offshore Fund have had successful offerings. Recently Deutsche Mutual Fund announced plans to launch DWS Global Agribusiness Offshore Fund (DGAOF), an open-end foreign fund of funds. The fund will largely invest in DWS Invest Global Agribusiness Fund based in Luxembourg and similar mutual funds.

Wealthy investors can also invest directly. Indian regulations currently limit this to $200,000 per individual per year. Global firms such as DSP Merrill Lynch and Morgan Stanley are able to offer clients their international platforms. Kotak Mahindra on the other hand, has an arrangement with Lombard in Switzerland that enables clients to invest overseas using the latter’s platform. However, Mr Jayaram says this partnership has not yet been utilised.

Showing them the way

Atul Singh, head of India Global Wealth Management, DSP Merrill Lynch is more hopeful. “We have to show clients the value of investing internationally. That will raise their interest and then we can help them structure their portfolios.”

India’s sound macroeconomic position has meant that the risk appetite is coming back to the market, says Mr Singh. He says there is a renewed interest in equities and mutual funds, however he warns that “caution” is still the most notable trend. There is a clear allocation to debt instruments. Clients are directly investing in bonds, short-term mutual funds and monthly income plans that are a blend of debt and equity. Rather than an aggressive equity portfolio, he says clients are keen to maintain a balanced portfolio.

Despite this prevailing caution, the Indian wealth market does have the highest equity allocation in the region. The Merrill Lynch Capgemini report states that India HNWs’ equities allocation in 2008, although down 4 per cent from 37 percent in 2007, remains relatively large.

Himanshu Bhagat, head of sales for Morgan Stanley’s private wealth management activities in India, observes that the market is tending towards investment in equities and says that Morgan Stanley is bullish on equities for the next few years. However he strikes a note of caution: “The overriding principle for our wealthy clients is preservation of capital. They are quite conservative in their investment outlook. So the proportion of equity in their portfolios can go from 60-70 percent down to nothing at all.”

Overall, he says that the portfolios of their wealth management clients had an allocation to all asset classes, including equities, private equity, mutual funds, debt, short-term bonds, real-estate funds, structured products and ETFs (exchange traded funds). ETFs are a very efficient method of taking exposure in any asset class, says Mr Bhagat. “ETFs helps us to act as an adviser rather than a product pusher. The cost of transaction is also very low.”

The ETF market in India is still at a nascent stage although they have been available for nearly a decade now. The first ETF was launched by Benchmark Asset Management Company (AMC), India’s only fund house specialising in ETFs. Benchmark also launched the country’s first gold ETF and more recently, the first international ETF, the Hang Seng BeES that tracks the Hong Kong equity market. Kotak Mahindra AMC also offers ETFs, launching Kotak Nifty ETF early this year, focusing on stocks in the S&P CNX Nifty.

“It is early days for ETFs, but they will soon pick up,” says Mr Jayaram of Kotak Mahindra. “Globally, ETFs have a huge traction since there is a strong trend towards passive investing. But in India actively managed funds have outperformed indices by a wide margin.”

He believes that as the market becomes deeper and more sophisticated, passive investing will pick up. “It is an evolution. Investors will in due course understand that passive investing is as good or even better and less costly than active investing.”

High net worth clients have of late been demonstrating an interest in structured products, says Mr Bhagat of Morgan Stanley, adding that given that capital protection is a key focus for the firm, this interest was limited to principal protected structured products.

“Structured products help keep away undesirable risks and keep desirable risk in the equation,” adds Mr Singh of DSP Merril Lynch, saying that at present DSP Merrill Lynch is not manufacturing structured notes but offering the product on a third party basis.

Non-metros targeted

There was a huge demand for structured products in India a few years back but after the collapse of US investment bank Lehman Brothers in mid-September 2008, the market virtually came to a standstill. However, over the past year, as the market has picked up, interest in structured products has been on the rise. The difference, states Mr Jayaram of Kotak Mahindra, is that in earlier days, structures were pushed like just another product in the market, but this is not the case now. “Now we now analyse the portfolio of customers and then see if there is a case for a structured product. And after client discussions, only if it is considered appropriate, do we introduce a structure,” he explains.

A new trend developing in the Indian wealth market is the movement of wealth beyond the main Tier 1 cities such as Mumbai, Delhi, Bangalore and Chennai. Industry estimates suggest that nearly three-quarters of India’s 80m middle-class households reside in smaller cities and towns. While players such as Morgan Stanley and DSP Merrill Lynch are mainly focusing on deepening their footprint in the metropolitan areas, others are awakening to the potential beyond. “We do find high potential clients in tier II cities,” says Mr Kapoor of Standard Chartered, which currently has 94 branches across 37 cities in the country. Although the bank is at present concentrating on most of its efforts on growing its business in the Tier I cities, he acknowledges that the contribution of non-metros to Stanchart’s wealth business is “not-insignificant”.

Kotak Mahindra has adopted a hub and spoke model to target non-metro areas. The firm has offices in ten cities in the country that also service smaller cities nearby. So Cochin is serviced by the Bangalore office and Coimbatore by the Chennai office. “Smaller cities do not warrant opening a full fledged private banking office. We will not get high quality relationship managers in these places,” observes Mr Jayaram.

One bank that is actively going beyond the Tier I cities, is HDFC Bank. Out of its 29 wealth management centres, 12 are located in tier II and III cities and towns. Abhay Aima, group head for equities, private banking, third party products, NRI and international consumer business, estimates that nearly 25 per cent of the bank’s wealth business comes from these smaller locations. Compared to the 200 percent growth experienced by HDFC Bank in the metros over the past three years, he says, the wealth business in smaller towns grew by almost 900 per cent.

Operating in smaller cities and towns is not without its challenges. Apart from infrastructural issues, Mr Aima says the main challenges include creating a greater awareness about wealth management, understanding the cash-flow pattern, especially for those clients that are dependent on agriculture, and building a long-term rapport with potential clients. “The financial sensibilities in the smaller cities are as good as the metros, but you need to change your language while dealing with clients,” he says.

Himanshu Bhagat, Morgan Stanley