GAP – The Core Investment Objectives
In the previous article “Quantamental Investment Objectives”, we defined Fundamental Investment Objectives as (i) Funding, (ii) Financing, and (iii) Safe-haven that determines how the money is invested and where it goes.
Alongside, Quantitative Investment Objectives of (a) Risk-free, (b) Inflation, (c) Compounding, (d) Fat-tailed, and (e) Exponential are the shapes of distributions that determine how the returns on the investment and experience of the investor will be when investing this money.
These fundamental and quantitative investment objectives are used by institutional and seasoned investors to make investment decisions.
For individuals and families, these Quantamental Investment objectives can be overlapped to form easy Core and Satellite objectives that correspond to their needs and desires driven by the themes prevailing in their lives.
At Modulor Capital, we have identified 3 core investment themes for individuals and families — ★ Growth, ★ Accumulation, and ★ Preservation, that are driven by their need for ✓thriving, ✓survival, and ✓safety.
These core themes can be easily remembered as the GAP of Investing. Let us understand them in reverse order.
✓ The Need for Safety
Individuals and families have an inherent need to “save for a rainy day”. They are driven by their feelings to secure their immediate future and especially be prepared for rough patches in the immediate term (up to 1 year).
Before the concept of money or financial investments, families preserved some portion of their hard-earned wealth in provisions like food grains, firewood, fuels, etc. This made them feel safe against the low probability but high impact personal catastrophes (such as a health issue, accident, or loss of employment) where regular income is affected.
With the advent of money and the financial system, individuals prepare for rocky times by saving money in banks or investing it into not-volatile and positive-return generating instruments.
The investment objective for preparing for rough patches in a timeframe upto 1 year in order to meet the need for safety is Preservation.
Investing for Preservation
The quantamental investment objective of Preservation can be constructed by overlapping the fundamental objective of Financing and the quantitative investment objective of Risk-free. Financing ensures the return of capital (with some interest). A Risk-free shape of the investment returns distribution gives peace of mind. In short,
Preservation = f(Financing)+ q(Risk-free)
Financing instruments like Debt varying from overnight to 365 days, or Fixed Deposits up to 1 year are practically risk-free and give assured positive returns. These instruments have almost nil variation in their value and pay a determined amount at maturity.
A second-order preservation instrument is an Arbitrage. Arbitrage locks in the mispricing spread between 2 linked funding instruments and provides financing like security (using funding instruments). It is risk-free and can be an alternative to debt.
Preservation provides comfort, but it comes at the cost of poor returns (which vary as per the policies of the central banks).
Preservation only has as much utility to individuals and families. Once their contingency needs (covering emergencies and provisions for up to a few months to a year) are satisfied, they feel the need to get more out of their money.
✓ The Need for Survival
After investors insulate themselves from rough patches that they may face in the immediate future (of less than 1 year), they are motivated to think longer-term and wish to accumulate wealth to be able to survive through protracted tough times (or times of no growth). The instinct here is to accumulate.
Typically this was done with gold, silverware, gems, etc. These were items that could be easily traded with others in challenging times because they always hold some value across cultures, societies, and geographies.
The second core investment objective that investors engage in order to be able to survive through protracted tough times that may happen in the short to long term is Accumulation.
Investing for Accumulation
The quantamental investment objective of Accumulation can be constructed by overlapping the fundamental objective of safe-haven and the quantitative objective of Inflation & Compounding.
Safe-haven ensures the money always holds some value that does not vary too much. Alongside, this value of money should not decrease in its capacity to purchase and it should also give some returns to be able to stay at par at least. These come from the quantitative investment objective of inflation and compounding. In short,
Accumulation = f(Safe-haven) + q(Inflation / Compounding)
The universal asset for safe-haven investing which beats inflation is Gold. Investing in gold (over the long term) beats inflation and it always carries value across geographies and time.
The compounding sort of safe-haven asset is government bonds of tenures longer than 1 year. These instruments not only assure a certain value at their maturity but also compound in value over time.
Accumulation ensures that individuals and families stay wealthy and can survive through tough times. However, beyond a certain utility of staying wealthy, the need to become more wealthy kicks in. This is the third core investment objective.
✓ The Need to Thrive
In a different time, thriving meant having more livestock producing greater output, and having more workers contributing to the growth of the household, in comparison to others. However, today it means having investments that grow with the efforts of others. An individual’s or family’s wealth needs to grow to stay relevant to others.
The inherent drive to thrive as much others is the third quantamental core objective, called Growth.
Investing for Growth
Growth happens when other people’s effort goes into increasing the value of the investor’s money. From a fundamental investment objective, this is a funding activity. On the quantitative side, growth happens when there is a consistent faster-than-inflation increase or a positive probability of outsized returns. Therefore, the quantitative investment objectives of Compounding and Fat-tailed return distributions come into play. In short,
Growth = f(Funding) + q(Compounding / Fat-tailed)
Passive equities as a collective are the best growth asset. Buying equity portfolios gives funding to companies working hard to create output. This means the employees of the company are collectively putting in efforts to increase the investor’s wealth. Equities also exhibit fat-tailed returns. Over long periods, the net returns are positive.
Another growth instrument that seems like financing (but has the underlying of funding effort) is corporate bonds. These bonds of 1-year duration or longer, provide compounding sort of returns. They mostly give positive returns and rarely have a negative outcome (depending on the quality of bonds held).
The GAP of Investing
Growth, Accumulation, and Preservation i.e. GAP are progressive themes in the lives of individuals and families. By following the ★ Preservation → ★ Accumulation → ★ Growth route a portfolio satisfies the psychological need for ✓ safety first, followed by ✓ survival through tough times, and finally the need to ✓ thrive.
Our Approach to the GAP of Investing
At Modulor Capital we build portfolios that provide a holistic solution to the needs of individuals and families. This is done by combining different needs and providing tailor-made solutions as follows:
- Comfort Portfolio covers the need for ✓ safety through the investment objectives of ★ Preservation. This is done by taking strategic exposure to the debt of up to 365 days duration and equity arbitrage.
- Prosperity Portfolio covers the investment objectives of ★ Growth, ★ Accumulation, and ★ Preservation by taking exposure to Broad-based Equity, Gold, and Equity Arbitrage, thereby fulfilling the need for ✓ safety, ✓ survival, and ✓ thriving. A variation of the Prosperity Portfolio for beginner investors comes through the Evergreen Portfolio (using debt for Preservation).
- Investors can take an easy route by combining the Comfort and Prosperity portfolios in an age-decade-linked glide path through the Foundation Portfolio.
- For long-term goals that need exposure to growth giving equity to ✓ thrive and ✓ safety giving equity arbitrage, investors take the Milestones Portfolio Route with the investment objectives of ★ Growth and ★ Preservation.
Once the core portfolio needs are met, the secondary desires come into the picture. These are the Satellite Investment Objectives of Capital-appreciation, Income-creation, and Profit-generation that we will discuss in the following article.