Multibaggers could be dangerous? The good, bad and ugly about investing in smallcaps

It’s natural for the ultra-wealthy to get attracted to innovative and new products which seem far removed from the retail investments made by the salaried class. Therefore, they often shun commonplace mutual funds, even if a particular mutual fund is the most transparent and well-constructed investment.

Innovation is sophisticated. It is sexy. Perhaps so in other realms such as fashion, technology and entertainment. In investments, there can be no substitute for simplicity. A simple portfolio can be navigated and de-mystified at will. Meanwhile, innovation (you could also say sophistication or complexity) can hide losses and risks. For instance:

A well-known Indian Wealth Manager ran a seemingly promising fixed-income product and leveraged it to take 3 times the invested amount as loan from their own NBFC at the rate of 11.5 to 12%. The assumption that the interest rates will climb down never materialized. Meanwhile, the investor paid a hefty commission and experienced a negative carry from day one.

Quant products are supposed to be based on algorithms that benefit from past trends and data. However, new trends throw up new blind spots that are not accounted for in the algorithms, rendering their innovativeness meaningless.