Risk is difficult to evaluate, warns Harsh Roongta.
Some of my clients have asked me for my views on cryptocurrencies.
My standard response has been that this is an 'investment' that I don't understand.
We encourage clients with large portfolios to earmark a small portion (3-5 per cent) as 'mad money' allocation -- basically money that can be used to make risky investments that may provide a big payoff or become worthless.
Our recommendation to clients has been to use their mad money allocation to invest in cryptocurrencies if they feel like it.
Some of my clients have wanted to know how an investment adviser can refuse to research an investment class, especially something like cryptocurrency, that has provided spectacular returns in recent times.
This deserves a well thought out answer.
Firstly, no individual or investment advisory firm can possibly acquire knowledge on all 'asset classes', some of which can be quite exotic.
Think of art, collectible items, wines, etc.
Secondly, one should be able to evaluate any asset on the three basic parameters of risk, return and liquidity.
While data on returns is available for some of the older cryptocurrencies, risk is difficult to evaluate.
Apart from the normal risk of price fluctuations, cryptocurrencies have almost undefinable operational risk.
One hears tales of cryptocurrencies being lost due to theft from the digital wallet, computer failure, or even loss of password.
Look up the story of Stefan Thomas on the Internet.
He is likely to lose over 200 million dollars because he has forgotten the password to his secure hard drive that allows only 10 attempts before it encrypts the contents.
Thirdly, all governments and regulators are hostile towards this 'investment'.
The Reserve Bank of India had banned banks from holding or facilitating cryptocurrency transactions, but the Supreme Court set aside that circular. A law could be passed to achieve this end.
The reason for such hostility is not difficult to understand.
Anonymity of the holder is a cryptocurrency's hallmark.
This anonymity is, unfortunately, very useful to terrorists, drug and sex traffickers, crime syndicates and other money laundering outfits.
My question is, would you like to be a party to facilitating such people just for high returns?
Fourth, even if we acquired expertise in cryptocurrencies, we would not be comfortable executing that advice through the unregulated platforms that have mushroomed to cash in on this mania.
Their clients can't complain to a Securities and Exchange Board of India or RBI, should something go wrong with their buy or sell trade, or if an exchange refuses to honour a trade.
Fifth, the cash-like feature of cryptocurrency means you can't ensure this wealth is passed on to your chosen nominee after your death, except by handing it over yourself -- which you can't do if you are dead.
I could go on with a host of other reasons on why I am not apologetic about not examining this 'investment' deeply.
To use an analogy, if we were a firm training people to run a marathon, our objective would be to help them complete it in the time they have set for themselves, and feel confident throughout the process about the eventual outcome, notwithstanding the inevitable ups and downs.
It would not be to help them win the marathon.
The same holds true for investments.
Our goal is not to maximise clients's returns. It is to reduce risk, to the extent possible, while achieving the return our clients need to meet their goals.
Truth be told, we are okay with clients trying to maximise their returns on their own with their mad money allocation.
Harsh Roongta heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor
Feature Presentation: Aslam Hunani/Rediff.com