First published in Mint Jan 6, 2014

Your Financial Advisor may have (hopefully) told you of the seminal research in Investment theory done in the western world about 30 years back, which proved that most of the returns (70-90%) from your investment depends on your selection of Asset Classes & sub-classes – Equity, Fixed Income, Gold, Real Estate. Only some portion of your returns (5-15%) depends on the exact instrument or security that you choose within these asset classes. And another small final portion on the timing of your investments (5-15%).

In turn, which Asset Classes you choose to invest in depends on your specific financial goals and your risk taking ability. This is what is called your ideal Asset Allocation.

But we have had a different on-the-ground experience in the Indian investment environment in the first decade of the new millennium – both through the boom of the first half and the Crisis of the second half. While the twin concepts of Asset Allocation and Financial Planning still remain the over-arching principles of investing, today’s Investment Decision-Making Process involves a higher degree of understanding of the Macro-factors – both Indian and global which have been influencing – no, dictating – the performance of entire asset classes.

Impact of Macro-variables :

We believe that today, Macro-factors have become integral to the decision-making process, and one has to diligently go through each of them like Steps , before one can claim to have made a “decently informed” Investment decision. These factors include the Impact of – Indian Macro-Economic variables, Changing Indian Political factors, Global Macro-Economic factors (e.g., Quantitative Easing), and finally, the Global Polity (e.g., impact of War in West Asia).

To test the rising significance of these factors, we went ahead and asked 25 of our senior Advisors to rate the above 4 factors on “Significance” of each in today’s Investment environment, after adding the three original steps – Asset class, Sub-asset class & Product Selection.

The Advisors collectively believed that 43% of the decision-making for investments today should come from an understanding of the four macro-variables (57% to come from the original three factors). Of this 43%, 15% significance was given to Indian macro-economy, 11% to global macro-economy, 10% to Indian polity and 7% to global polity.

Questions to ask within each of the Factors :

To make the Decision Process more real, we share here some of the ILLUSTRATIVE questions that you could currently ask your Advisor under each of the Factors, before making your decision.

Indian Macro-Economy – How fast will GDP grow in the near future ? Which components of GDP will grow faster than others ? Will interest rates reduce or increase in short-term ? How will inflation behave ? What is the impact of all this on the Asset Class we are considering to invest in ?

Indian Polity  – Which party will come to power in 2014 elections ? Will UPA become still more subsidy-oriented if they get re-elected ? Will NDA be able to carry out more aggressive reforms if they have to rely on a disparate bunch of coalition partners ? Will AAP type of parties take us “lefter than the left”, as far as economy is concerned ? What is the impact of all this on Indian Economy and on the Asset Class we are considering to invest in ?

Global Macro-Economy – Are EU economy conditions improving ? Is China still slowing down ? What will be full impact of Quantitative Easing slow down ? What is the impact of all these on Indian markets ?

Global Polity – Is Merkel’s getting re-elected in Germany improving EU conditions ? Have chances of war in Middle East subsided and will this affect oil prices and hence Current Account Deficit, and the Indian Rupee ? What is impact of all these on Indian markets ?

So what should one finally do ?

• Try to understand YOURSELF to the best extent possible from the Factors above, before making any significant Investment decision
• Ask your Advisor questions related to different scenarios possible in the macro-economy and polity, and what impact will such scenarios have on the performance of the products being recommended. Test with 1-2 more people, your Advisor’s view on probability of occurrence of different scenarios for economy and polity. Try to develop your own view also.
• Get an Advisor who understands the above framework of decision-making, and who involves you in your own Investment decisions.

After all, you owe it to yourself and to your family to invest wisely, and with the best information possible! Advisor should try to keep things simple. Explaining macro-variables to clients in simple terms will educate clients and help them co-own decision. As Leonardo Da Vinci has remarked “Simplicity is the ultimate sophistication”.