Simple and complex investments
Equity-linked debentures. Capital protection-oriented mutual funds. They sound like complicated instruments, don’t they? And with new types of financial products hitting the markets regularly, the confusion is set to increase. So Crisil’s complexity rating of 77 financial instruments should be a huge help to investors.
Not only do these ratings give you an idea of how difficult it is to understand a financial product, it also busts the misconception that complex means risky. An equity mutual fund is fairly high on risk but low on the complexity scale. So read on to find out how simple or complex are the instruments you have already invested in or are keen to try out in future.
MUTUAL FUNDS — The complexity levels range from the simple fixed maturity plans to the highly complex constant proportion portfolio insurance
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| Gilt funds, liquid funds, debt funds, fixed maturity plans, interval funds, Monthly Income Plans, plain equity funds, sector based funds, balanced funds, gold funds, exchange traded funds, index linked mutual funds | SIMPLE |
| Floating rate funds, capital protected fund—static hedge, arbitrage funds, derivative funds, fund of funds, international funds, special situation funds | MEDIUM |
| Capital protected fund- leveraged, Constant Proportion Portfolio Insurance (CPPI), Dynamic Portfolio Insurance (DPI), art funds | COMPLEX |
EQUITY — Proof that simple does not mean risk-free. Stocks are among the simplest investment class to understand, but also among the riskiest
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| Exchange traded equity shares | SIMPLE |
OTHERS — A truly mixed bag, ranging from the simple and low-risk PPF to the complex unknown entity that is REITs. The popular Ulips take the middle path.
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| Public Provident Fund (PPF), National Savings Certificates/Indra Vikas Patra/Kisan Vikas Patra, recurring deposit | SIMPLE |
| Unit linked insurance plans | MEDIUM |
| Real estate investment trusts (REIT) | COMPLEX |
DERIVATIVES — Futures contracts, forward contracts, options and swaps are the most common types of derivatives. And they are quite as complex as they sound—not one makes it to the simple category
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| None | SIMPLE |
| Buying index/stock options (long position), index/stock futures (buying and selling), commodity futures, simple single currency forward rate agreement without any features (cap, collar, knock outs, etc), credit default swaps-protection buying-single asset | MEDIUM |
| Selling index/stock options (short position), forward rate agreement with customised features, cross-currency forward rate agreements, currency options, currency swaps, interest rate swaps, cross-currency interest rate swaps, credit default swaps-protection selling-single asset, credit default swaps-multi asset (both buying and selling) | COMPLEX |
HYBRID INSTRUMENTS — Other than fixed coupon, no hybrid instrument is easy to understand. As an investor, it requires some level of sophistication to understand the risk involved in these instruments
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| Fixed coupon | SIMPLE |
| Fixed coupon with features (say a put/call option), floating rate (yield linked to benchmark), upper tier 2 bonds, plain vanilla, convertible preference shares, optionally (fully/partially) convertible bonds, compulsory (fully/partially) convertible bonds, Separate Trading of Registered Interest and Principal Securities (STRIPS) | MEDIUM |
| Floating rate with features (say put/call option, floors/caps), perpetual innovative tier 1 bonds, perpetual preference shares, Foreign Currency Convertible Bonds (FCCB), security receipts (issued by asset reconstruction companies), equity linked debentures, commodity linked debentures | COMPLEX |
SECURITISED DEBT — A complex set of investments but not necessarily high on risk. Asset-backed securities and structured bonds take some understanding, but the risk may not be particularly high
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| None | SIMPLE |
| Bonds backed by escrow of identified cash flows such as water charges and property taxes, bonds backed by guarantee, fixed coupon-prepayment protected, single asset (single loan sell down) | MEDIUM |
| Bonds backed by partial guarantee, fixed coupon- prepayment not protected, floating rate-(both pre-payment protected and not protected), mortgage backed securities (MBS) with reset of yields, repacked instruments backed by asset backed securities or MBS, multi asset, bonds structured for pool financing for urban local bodies | COMPLEX |
CORPORATE DEBT — From the simple fixed deposit to the highly complex floating rate bond, this class of investment has it all
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| Fixed coupon, commercial paper, certificate of deposit, fixed deposit | SIMPLE |
| Fixed coupon with features (say a put/call option), floating rate (yield linked to benchmark) | MEDIUM |
| Floating rate with features (say a put/call option, floors/caps) | COMPLEX |
