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Summary: Prosperous NRIs. Retired bankers among them. A fund that profits from strangers dying. They didn't buy the investment; they bought the relationship manager and the bank's name. The mistakes that led there are ones any investor can make.
A mis-selling story in the news these past few days sounds like it concerns only wealthy NRIs. The mistakes behind it are ones any of us can make, and that is why I am writing to you about it.
The case involves a group of prosperous NRIs being sold a kind of fund that most of us would not believe exists. In fact, I could hardly believe my eyes when I read the description of what the fund does. This fund, run by Carlisle Management Company, a Luxembourg-based firm, buys life-insurance policies from older Americans who no longer need them. It then pays the premiums, and when the policyholder dies, the fund collects the death benefit. The returns are this payout, minus what it paid to buy the policy from the original policyholder, plus the premiums. Of course, that would be impossible under Indian insurance regulations, but America is a strange place.
The problem is that redemptions in the fund have been frozen since late 2020; the terms have been restructured, and fees continue to be charged. While this is a fund sold in foreign jurisdictions, HDFC Bank sold it to these investors. These investors have apparently approached the RBI and the government and are contemplating legal action.
You can read more news on this episode elsewhere, but my topic today is something else: why would prosperous, apparently financially literate people buy such a product? I can identify three types of mistakes that these investors made, and all of them are just as applicable to us domestic investors.
First, what part of the investment was publicly visible? The answer is nothing. The returns depend on strangers dying; it's a black-box investment. From the accounts posted on social media, it would appear that the trapped investors still do not know how many of the insured died, what the mortality assumptions were, and the detailed numbers of why exactly the fund has been frozen. Given that the freezing coincided with Covid, the biggest mortality-impacting event for older people in decades, there’s no transparency at all. But while the details of this fund are peculiar, the urge to invest in an opaque investment you understand nothing about is common, and we see it every day.
Second, these are not financially illiterate people. Some of them are actually retired bankers. They should have recognised the traps and read the terms and conditions, don’t you think? But I think if an investment sounds clever and complicated, people somehow accept opacity. The apparent sophistication of the product (uncorrelated returns, alternative asset classes, etc.) lured people. The impression it creates is that it’s meant for the sophisticated financial elite while routine mutual funds are for ordinary people.
The third reason is the biggest condemnation of the financial services industry. I don’t think any one of these people would have deliberately and independently gone out to buy a Luxembourg-based life-settlement fund. What they were actually buying into was the relationship manager who chased them and the brand of the bank he represented. The transaction was selling not the investment, but the trust. Now that the money has stopped coming in, the bank’s position seems to be that they were just selling someone else’s product and performance and liquidity were the original fund manager’s concern. This is technically true, of course. Being technically true and compliant is the core competence of the financial services industry.
If you put together the three points I have listed above, you will realise that the root cause is the same. Each one could have been mitigated by investors understanding what they owned. The opacity, complexity, apparent sophistication and brand are all designed to be proxies for a good investment, and investors fell for it.
Note that I’m not saying that you should not invest abroad. But investing in a simple NASDAQ ETF is very different from a weird fund run by a Luxembourg-based firm. And in any case, my real point is against complexity, not domicile. Even domestically, we now have many investments that are close cousins of funds like this. The details might differ, but the dangerous parts are the same: an apparently sophisticated product that you do not understand, lacking in transparency and sold on the strength of a brand that you feel you can trust. Your defence against this is the same as it has been for all these years since I have been writing this column: invest only in what you understand.
Also read: A fall is not a loss
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