Investing: The (al)lure of complexity

Jayant Pai |

A couple of weeks ago I read that some unauthorised persons had succeeded in discovering some details regarding the much-guarded secret ingredient contained in Coca Cola. I am really surprised that something as mundane as a cola-ingredient (of course, this statement will be sacrilege to Coke fans) should be treated like a national secret but that is how the company (and many of its followers) preferred it to be. After all, a dash of mystery and intrigue are worth a million words of ad copy.

Come to think of it, I should not be too surprised because in my line of work there is no shortage of this desire. That is why investors love complex and opaque investment products as compared to simple ones. Why is this so? Probably because they feel that if they are handing over the money to someone else, the fund manager should be able to do something which they themselves cannot. Everyone fancies himself to be a good investor and feel that the only reason they are outsourcing this function is because they lack the time to do the research. Nobody will deem it their lack of ability. However, if the manager conjures up an image of being able to make money for them by performing complex financial feats they feel that they are getting their money’s worth.

This has given rise to a panoply of structured products*, black-box trading strategies, algorithmic trading etc. For every producer of such products there are two to market them and four “investors” to lap them up. Of course, the usual pitch while selling such structures is their potential to offer outsized returns vis-a-vis plain vanilla products.

Strangely most of the prospective customers belong to the “High Net Worth (HNI)” category. These are supposed to be savvy, successful people who have excelled at their own business or professions. It is surprising indeed that businessmen who earn net margins of 8-10% in their business believe the words of marketing personnel / relationship managers who promise to double their money in a short period of time by using complex derivative strategies (with alien sounding concepts such as strangles, bull-spreads, etc.). They are even willing to invest large sums in apparently “less correlated” assets such as art and wine. Unfortunately for them, nobody reveals that these assets are always accompanied by low liquidity and opaque valuation practices.

The sooner the rich stop having that “infra-dig” feeling regarding conventional investments the better it may be for their longer-term financial health. Satisfy your craving for intrigue by reading an appropriate novel or two. Otherwise you may merely end up enriching the Shivraj Puris and Bernie Madoffs of the world….

* You may like to read our related blog post titled “Structured To Deceive?


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