Cold logic

Fintech companies are offering investors cheaper advice for increasing their wealth

Death and taxes, both certain and both unwelcome. We ward off the first by having smoothies out of algae and bee pollen, and the second by investing smartly, usually in instruments that give us maximum tax savings. Sadly, we may be wrong about our investments.

Swapnil Madankar is a 30-year-old marketing professional working with a multi-national company. He puts his money into mutual funds — from HDFC or SBI — which fall under Section 80C. Both have their offices near his house but, more importantly, he says, “when you invest with a strong brand, you won’t lose money and also you are assured strong return”.

But, his returns tell a different story. Five years ago, he invested in SBI Magnum Tax Gain, which has given a single-digit CAGR return of 6.33% compared to S&P BSE 500, which gave 9.50% return. Similarly, his investment in HDFC Focused 30 Fund also failed to beat the benchmark indices, giving a return of 5.82%. If one adds an inflation rate of 4% and an expense ratio of around 2%, Madankar stands in a precarious position.

This throws up important lessons — following the herd isn’t the best strategy, and the most popular fund house won’t guarantee great returns. This is where new-age wealth techs such as Orowealth, Scripbox and Kuvera come in (See: Lucrative bet). These fintechs offering wealth-management services started cropping up post 2010. There was higher penetration of technology, more user-friendly interfaces and a better awareness about investment products. Also, the process of completing KYC became faster because of Aadhaar and PAN cards. Using technology, these fintech firms have since helped customers build a well-diversified portfolio. And, today, these young companies are challenging the hegemony of mutual-fund houses (See: Future of investing).

Go Algo

It’s hard for a person to ignore big ad campaigns run by large fund houses, and these can lead him/her to put their money into less-productive schemes. Tech-led advisory firms such as Scripbox, founded in 2012, hopes to guide you towards more objective decisions. “Our algorithm helps in eliminating these biases,” says Sanjiv Singhal, the founder of Scripbox. Also, algos don’t push schemes to earn a higher commission, as an agent could. With Scripbox’s algo, the selection of mutual funds is done meticulously, slicing and dicing the schemes based on various parameters, such as consistency of returns and size of asset under management (AUM).

Sanjiv Singhal, Founder, ScripboxEndFragment

The start-up studies the returns of a fund over various time periods. “If we only take a single period, then it could be misleading. For example, if we take into account ten-year period between 2008 and 2018, every fund will show good performance as the initial date of investment is after the market crash,” says Singhal. Thus, the start-up examines multiple periods and then compares it to benchmark, he adds. It claims to have amassed Rs.15 billion in AUM.

Vijay Kuppa, Co-founder, OrowealthOrowealth, another start-up that helps people pick a good MF, has a customer base of 100,000 with AUM of Rs.5 billion and asset under advisory of Rs.45 billion. Besides scrutinising returns over different periods of time, it looks at how the fund has performed against its peers, the track record of a fund manager, Sharpe ratio (return on investment compared to its risk), expense ratio, stocks in a fund and its size. After the data is fed into the algorithm, it suggests the five best funds to the customer, according to Orowealth co-founder Vijay Kuppa. All of that done with clinical precision without any human intervention.

Everyone has a friend who dispenses rational (even unfeeling) advice, such as don’t have another piece of cake. But that does not prevent anyone from making silly mistakes, such as having that piece of cake. It is called ‘behaviour gap’. There was even a book written on it, subtitled “Simple ways to stop doing dumb things with money”. While advisors at mutual fund houses can tell us to behave responsibly with our investment, they really have no way of knowing which one among us is going to pick that piece of cake or panic into bad trading when the market is volatile. They don’t know our behaviour and that is where these new algos score over them.

Gaurav Rastogi, Co-founder and CEO, KuveraAccording to Gaurav Rastogi, co-founder and CEO of fintech Kuvera, most of the investors end up making losses because they tend to invest when the market is on the rise and pull out during a bear run. To stop this panic selling, Kuvera has come up with a plan. After investors upload their portfolio on the platform, the start-up scans through their previous transactions, and finds patterns in them using AI and machine learning. The investors are then classified into groups based on their investment behavior — whether they are chasing the market, churning portfolio regularly, timing the market or are satisfied with steady returns. “If we learn that you are someone who has a tendency to sell when the market is low, we will advise you a lower equity weightage to avoid losses, compared to someone who is less dependent on market and has more patience,” says Rastogi. Currently, the platform has over 500,000 customers, and its portfolio recommendation consists of four funds.

Kuvera also nudges investors to act in their best interest by emailing them a set of data to show why their decision to sell isn’t justified. He has observed that if they can push the decision of an investor to sell an asset by 5 to 10 minutes, better sense prevails. Strangely, even nutritionists tell you to wait about 10 minutes before you serve your seconds, because the brain takes that long to register satiety. It seems like good advice therefore, but regular mutual fund houses don’t have the ability to stop redemptions.

Just as MF advisors take the risk appetite of clients into account, these start-ups do, too, and craft a portfolio using technology. For instance, Orowealth asks its customers to fill out a questionnaire to know their age, monthly cash inflow and liabilities. Based on this, each client is given a risk score. Orowealth currently advises on equity (large, small and mid-cap), stocks, debt (corporate bonds, gilt and money market) and gold.

Along with risk profiling, the time horizon is also taken into account while creating a portfolio. “Typically, if a customer is investing for less than three years, then we suggest debt mutual funds. An equity-oriented portfolio is more suitable for a long term investor,” says Kuppa. For example, if a person is looking to invest for two years for a Euro trip or a holiday plan, he or she is recommended debt funds. On the other hand, if the person is looking to raise money for a major expense (around Rs.5 million) over seven years, equity funds with small and mid-cap focus are suggested. Again, all this is purely data-based, weeding out human biases.

Scripbox also follows a similar strategy. It has portfolios for tax saving, long-term wealth, short-term money, retirement and children’s education. After an investor feeds in a time period for investment and chooses the goal, he/she receives a recommendation for a basket of funds with equity and debt.

Alternate Style

With a few fintech start-ups, you don’t even have to be investing in mutual funds. You can trade in stocks directly. Smallcase Technologies, a Bengaluru-based start-up, creates a variety of stock portfolios. From sectoral (banking, retail, insurance) and thematic (rising rural demand, smart cities, affordable housing) to model-based (dividend, value, momentum) and smart beta oriented.

Its customer base of 650,000 can buy these baskets of stocks through eight brokers — Zerodha, Kotak Securities, HDFC Securities, Edelweiss, AxisDirect, IIFL and 5Paisa. Managers or analysts make these portfolios just like how a mutual fund manager picks stocks for the schemes. But, this is where the similarity with mutual funds ends.

Vasanth Kamath, Founder and CEO, Smallcase Technologies“Unlike a mutual fund where an investor receives units, in the case of Smallcase, the investor gets underlying shares in their demat, making it more transparent, customisable, cost-effective and liquid,” says Vasanth Kamath, founder and CEO, Smallcase Technologies. Investors have complete control over their portfolios and they increase, decrease or eliminate a stock from it. “We have an advisory model. The investor takes the call,” says Kamath. This option isn’t available to an investor of a mutual fund scheme. To make it easier for investors to decide, the start-up explains the advantages of every basket of stocks through its blog posts.

Another major advantage of Smallcase is that it’s less expensive compared to an MF scheme. Investors pay around 1% to 2% expense ratio (direct and regular) annually to a mutual fund as a part of the management fee, which could significantly dent long-term returns. “In 20 or 25 years, a person might end up with 20% to 25% less capital,” says Dhirendra Kumar, CEO of Value Research. Through Smallcase, the investor can eliminate that expense.

The start-up claims that it doesn’t charge management fees and the investors would only have to bear a nominal brokerage fee, which makes a huge difference. For instance, HDFC Securities charges 0.50% or minimum Rs.25 or ceiling of 2.5% on transaction value, which are incurred during buying and selling stocks. Whereas discounting firms such as Zerodha do not charge any brokerage for delivery-based equity transactions.

Like Smallcase Technologies, Orowealth, too, offers an alternative route of investing. “Using algorithms, we create a diversified portfolio of stocks, going by their dividend, quality, momentum and valuation. This diversification ensures a return of 15-20% annually in most market scenarios over a three-year period,” says Kuppa. Investors are also advised when to enter and exit, and all of this comes at an annual fee of Rs.2,000.

Future Tech

Lower fee, convenience and the absence of human error might give fintech an edge over regular mutual funds, but is it enough for them to gather more customers? Big brands such as HDFC AMC and SBI AMC might not be able to consistently give returns or outperform the benchmark indices, but their stature in the market, strong distribution network and customer service have helped them grow. “Fintech companies don’t have the trust of customer,” says Kumar of Value Research.

He adds, “It’s early days for fintech and these companies also lack history.” Fintech companies acknowledge that they can gain faith only through performance. They will have to continuously deliver good returns in order to build trust and brand recall. “We don’t have a strong infrastructure like an AMC has, since it has been in the industry for years. So, to attract and retain customers, we have to deliver returns,” admits a fintech founder requesting anonymity.

Kumar admits that fintech is providing a new kind of framework for investing and that it is beneficial for investors. But, he says that MF houses still score in terms of convenience, besides brand value and distribution strength. “For instance, an investor doesn’t have to conduct transactions himself. If one puts Rs.1,000, then it gets diversified instantly in a mutual fund. However, in Smallcase, one may have to do 20 transactions if they want to buy or sell frequently,” he says.

These are still early days to write off or even eulogise these start-ups. But they will definitely interest more retail investors in newer financial instruments. As Howard Marks says, “Not being very emotional is very useful in the investing world.” This is one trait an algo can ace.