Indian households traditionally invest in a mix of physical assets such as gold, real estate, precious metals, and financial assets such as equity, mutual funds, fixed deposits and debentures. Over the last few years, a major shift in retail investments has taken place from physical assets to financial assets. The share of investments in financial assets is on the rise and has increased by 17.42% Y-O-Y to 60.22% and the proportion of physical assets have come down to just 39.78% in FY18 as compared to 41.52% in FY17. Moreover, a recent report by Karvy estimates the share of financial assets in total individual wealth to increase to 68% in FY23, while that of physical assets will get reduced to 32%.
A strategy that holds wise investors in good stead during periods of market volatility is not putting all of one's eggs in a single basket-be it pure debt or pure equity. Investment options like Alternate Investment Funds (AIF), Municipal Bonds, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are exceptional investment instruments for stability and predictable returns. While relatively new to Indian markets, Infrastructure Investment Trusts, better known as InvITs, are popular investment vehicles for long-term infrastructure funding. InvITs are prevalent across the globe with over 400 listings of similar instruments accounting for over $1 trillion of investments.
Being a hybrid instrument having features of both equity and debt, it is pertinent to wonder how does it compare against popular asset classes like stocks, mutual funds, corporate bonds, real estate and gold? Here is a comparative analysis.
Stock Market: Factor in Volatility
Most investors enter the stock market with unrealistic expectations, often incited by claims made by the media, stockbrokers and charlatan advisors or inspired by the success of celebrity investors like America's Warren Buffett and India's Rakesh Jhunjhunwala. Consequently, several investors end up losing money. Take Buffet, for example. The Oracle of Omaha has earned an average of 22% return per year for over six decades now on his various investments, globally, with a substantial part of his wealth being generated only after he crossed the age of 50. Let us not forget that during the period Buffett too had to witness several bear markets, crashes and recessions.
Mutual Funds: Not Without Risks
Mutual fund schemes are generally considered to be comparatively less risky than a direct investment in equity markets. But in the same breath, financial planners consider them to be unsafe as compared to bank deposits. Equity funds are considered high-risk mutual funds in India due to market volatility. Without a doubt, one of the highlights of 2018 was the IL&FS debacle. Fear of a liquidity crunch following the IL&FS crisis hit the mutual fund industry hard. Liquid debt funds were the worst hit. Therefore, unless the fund manager manages the portfolio well, return on investment in equity funds is low. Close-ended mutual funds come with their own set of issues, as they require a lumpsum investment upfront. Bond mutual funds dependent on debt instruments are rated on the basis of parameters such as safety, quality, returns and liquidity. If the quality of a debt instrument is dubious, investors will lose money.
Corporate Bonds: Risk of Default
Corporate bonds involve the issuance of a debt security by companies for sale to investors. These are considered riskier assets than government bonds, as the latter may result in higher interest rates. The market for corporate paper in India scores abysmally low given that trading in most bonds is negligible. The onerous exit that is inherent in every corporate paper makes it difficult for all entities to park funds in this fractured and opaque corporate bond market. With regard to emerging economies like India, McKinsey reported in 2018 that 20 to 25% of corporate bonds issued by companies with an interest coverage ratio below 1.5 were at higher risk of default. In the eventuality of a 200-basis point rise in interest rates, that share could increase to 30 to 40%, the report added.
Real Estate: An Underperforming Asset Class
From 2001-2007, investment in real estate in India would guarantee an investor up to 30% annual returns or a two-fold appreciation in investment from anywhere between three to five years. Unfortunately, that no longer holds true. Stories of investors in distress with their money stuck in delayed projects abound these days. Moreover, one also comes across numerous reports of unsold inventory and delayed projects. In fact, starting with the decline that started in 2013, real estate demand hit an all-time low in 2017. The market which was already in doldrums was further impacted by the enactment of the Real Estate (Regulation and Development) Act or RERA in May 2016 and subsequently demonetization of high-value banknotes in November of the same year. Furthermore, against the backdrop of a rise in interest rates, high maintenance costs and GST on rentals and capital gains, it makes little sense to invest in property in the near to medium term. Although the present distress in the property market is not here to stay, most market analysts believe the days of irrational price increases are over.
INVITs: Tremendous Growth Potential
Investors in India often ask if InvITs are a safe investment, to which the answer is a resounding 'Yes'. InvITs are governed by SEBI's (Infrastructure Investment Trusts) Regulations, 2014, which is among the strongest frameworks of its kind globally. What's more, a cocktail of three factors, viz. interest rates, capital appreciation and dividend income, is driving fund houses to bet on InvIT within specified limits. With the InvITs listed today offering upwards of 13% yields, it provides a compelling value proposition on a risk adjusted basis. Some of the key features highlighted below adds to the attractiveness for investors, institutions and individuals alike.
1. Predictable stable distribution vehicle: SEBI requires InvITs to distribute a minimum of 90% of their cash earnings to investors at least semi-annually. This can provide clear visibility to investors on cash flows and they, in turn, earn frequent distributions.
2. Robust corporate governance framework by SEBI: InvITs are managed by independent trustee and investment managers. They operate the assets on behalf of the unit-holders. The board of the investment manager comprises at least 50% independent directors.
3. Low risk: SEBI requires InvITs to invest at least 80% of their assets in completed and revenue-generating projects, and not more than 10% of their assets in under-construction projects. This ensures that InvITs are not exposed to any execution/construction risks inherent in the infrastructure sector such as financial closure, construction delays, regulatory approvals, and cost overruns, etc. Low risk in InvITs is also evident from the fact that all the three InvITs – IndiGrid, IRB InvIT and Indinfravit, are rated AAA by CRISIL, India ratings and ICRA. The beta value of 0.22x for Indigrid InvIT compared to NSE 500 also illuminate the inherent low risk in these instruments.
4. Superior risk adjusted returns: InvITs are supposed to provide regular stable distributions (semi-annually as per regulations, both listed InvITs provide quarterly distributions) over the long term, whereas mutual funds don't focus on distributions/yields providing an option to increase returns through acquisition of more assets. Also, since InvITs are listed products, option to exit is available as compared to close ended mutual funds in which the option to exit is only upon term maturity. In terms of return on investments, InvITs have an upper hand over instruments like fixed deposits, PPF, EPF, corporate bonds, etc., where returns are low and capped. Furthermore, InvITs enjoy zero capital gains tax if the units are held for over three years and sold through the stock exchange.
At the time of framing the regulations for InvITs, SEBI wanted to target this product for institutional investors, thereby keeping the minimum lot sizes of Rs 10 lakh and Rs 5 lakh in primary application amount and secondary transaction amount, respectively. However, retail investors such as HNIs are understanding the product and its attractive risk adjusted returns. Case in point is InvIT of Indigrid, where the retail investor participation has increased from ~15% to 25% as of December 2018.
In conclusion, InvITs are inherently highly regulated, low-risk products that adhere to robust corporate governance norms prescribed by SEBI, even higher than those for corporates. By virtue of their structure, they offer superior risk-adjusted returns and eliminate volatility through visibility on the cash flows of underlying assets.
(By Harsh Shah, CEO, India Grid Trust)
(This is the author’s personal view. Readers are advised to consult their financial planner before making any investment)