Trust and jargon can be dangerous. Invest only in what you understand

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There’s a fascinating investment mis-selling case that’s been talked about and written about in recent days. It involves a group of prosperous NRIs being sold a kind of fund that most of us would not believe exists.

This fund, run by Carlisle Management Company, a Luxembourg-based firm, buys life-insurance policies from older Americans who no longer need them. It then pays the premiums, and when the policyholder dies, the fund collects the death benefit. The returns are this payout, minus what it paid to buy the policy from the original policyholder , plus the premiums. Of course, that would be impossible under Indian insurance regulations, but this is permitted in the US.

The problem is that redemptions in the fund have been frozen since late 2020; the terms have been restructured, and fees continue to be charged. A group of aggrieved investors who purchased Carlisle's products through HDFC Bank has reportedly approached the Reserve Bank of India and the government and is contemplating legal action.

Why would prosperous, apparently financially literate people buy such a product? I can identify three types of mistakes these investors may have made, and all are equally applicable to us, domestic investors.

First, how much of the investment was publicly visible? The answer is nothing. The returns depend on strangers dying; it's a black-box investment. From the accounts posted on social media, it would appear that the trapped investors still do not know how many of the insured died, what the mortality assumptions were, and the detailed numbers of why exactly the fund has been frozen. The freezing of redemptions also coincided with the covid-19 period, when mortality among older people rose sharply. Yet the information available to investors appears limited.

The details of this fund are peculiar, but the urge to invest in an opaque investment that you do not fully understand is common, and we see it every day.

Second, these are not financially illiterate people. Some of them are actually retired bankers. You might therefore expect them to recognise the risks and scrutinise the terms and conditions carefully. However, when an investment sounds clever and complicated, people can sometimes become more accepting of opacity.

The apparent sophistication of the product—uncorrelated returns, alternative asset classes, etc. lured people. The impression it creates is that it’s meant for the sophisticated financial elite while routine mutual funds are for ordinary people.

The third reason points to a broader issue in financial services. It seems unlikely that many of these people would have independently gone looking for a Luxembourg-based life-settlement fund. What may have mattered was the relationship manager who approached them and the brand of the bank he represented. The transaction was selling not the investment, but the trust.

Now that the investment has run into trouble, the bank’s position appears to be that it was distributing a third-party product, with performance and liquidity being the responsibility of the original fund manager.