Investing by itself is scary enough for the common man. Equity and debt products (even if packaged as a mutual fund) are very confusing – we have upwards of 5000 schemes!  However it can be downright dangerous with the increasing ‘differentiation’ and ‘complexity’ of many financially engineered products. Many of today’s SIP investors have been scalded by expensive ULIPs, a bear market and poor product design.

In the US a simple product called the mortgage was bisected and financially engineered products were created. Did the buyer understand that for a product bought in NY what was the implication of a mortgage default in California or Texas? This is the problem with all esoteric products. It is cheaper to buy a simple index fund with low managing costs and very low tracking error.

Complex investment products have risks that are not so easily visible to the investor. Such products are unnecessary for a simple investor. For her to know whether it is a money making product or a hedging product is difficult to understand.  An Index fund with a linear relationship with the index is easier to understand. ‘Strategy oriented funds’ are difficult to understand, expensive and at most times under-perform the market.

If an investor has a small amount of money, will he have the guts to put all his money in a PE Strategy fund?

And if the is a big time investor, what alpha will such a fund generate in her ‘overall’ portfolio?

Will an investor sell ALL HIS EQUITY INVESTMENTS today and put it in a PE STRATEGY fund – and assume that the fund invests MORE when the market Pe is 19 and removes money when the PE is more than 24. What happens if the market stays at a PE beyond the investing range and above the buying range? Will they return all the money saying “our mandate is not clear what we should do if the market moves out of our range”?

The worry is whether the company creating such products understand the risk as well –at the time of the launch of the product.  If yes, was it well communicated to the client at all? In a recent case the PE STRATEGY scheme raised Rs.490 crore from about 1,000 investors. An investor was required to invest a minimum of Rs.40 lakh. Eight years later, investors could make a return of a mere 0.26%.

What if the investors panic in face of an adverse investing climate?  If he sees the fund manager sitting on cash in a rising market he may seek redemption EXACTLY at the time when the strategy is about to help him BY BEING IN CASH!

http://www.dnaindia.com/money/report-complex-products-unnecessary-for-a-simple-investor-2263378