Level 1-5 Investing - IME Capital

The concept of Level 1-5 investing, helps explain what an investor
is truly investing in
when they build a portfolio of investment funds (MF, PMS,AIF).

Each level of Level 1-5 investing has it’s own relevance for an investor’s wealth creation journey, and taking the right decision at each of these levels is essential for investment success & wealth creation. We provide below some additional details on each of these levels, and their importance in your portfolio.

Level 1 - Your Advisor / Wealth Manager

Most end investors, use an advisor/wealth manager to help them identify how their wealth is to be managed. Since advisors can often have a large impact on how funds are allocated, the correct choice of an advisor is an important decision for investors to make.

What to focus on while selecting the right advisor

Specilisation: Does your advisor have the required depth of expertise for the funds being recommended?
Costs: What is the most important for you? The lowest-cost or the highest-quality of advice?
Customisation: Is advice & portfolio construction truly customised to your unique requirements?

Level 2 - Investment Vehicles/Funds (MF,PMS,AIF)

This is the level that is typically given the most amount of focus on, by end investors & wealth managers. This is an analysis of the specific funds that make up the investors portfolio.

Focusing on Level 2 is a fundamental flaw in Wealth Management Most investors & their advisors focus on fund selection (Level 2), without a more nuanced understanding that funds are nothing more than containers that allow you to gain exposures to specific underlying companies (Level 3), economies (Level 4) and underlying trends (Level 5). The performance of funds are driven by the exposures these funds provide investors on a Level 3-5 basis.

While fund selection is clearly an important part of portfolio construction, focusing too much on Level 2 leads to the following fundamental errors common in investor portfolios

Meaningless over-diversification: Investing in multiple funds, all of whom are giving exposures to similar Level 3-5 investments. This results in investors thinking they have diversified their risk, while in reality actual diversification is very limited.
Weak Fund Selection: Focusing on fund selection, without a deeper understanding of what is driving fund performance (Level 3-5 trends), often leads to investor's investing in funds at precisely the wrong time.
Sub-optimal portfolio construction: Portfolio construction should actually start with analysing what Level 3-5 trends are appropriate for an investor, and then identifying what funds provide the desired exposures to these trends.

At IME Capital, our focus in on shifting investors focus away from Level 2 (fund) investing, and towards gaining an appreciation that focusing on
what is truly important for wealth creation - The Level 3-5 trends you wish to have exposures to.
Once this is understood, the right funds that give you exposures to these trends can be identified.

Level 3 - Underlying Investments (Equity Shares, Debt Securities, Real Estate etc.)

Any Level 2 Fund (MF, PMS, AIF), is ultimately nothing but a means for you to hire a professional fund manager, to build a portfolio of underlying investments for you (based on the mandate of their fund). A fund that holds equity shares gives you exposure to value creation of these businesses, a fund with debt securities gives you a certain safety of capital along with steady income generation, while other funds give you exposures to their specific portfolio of underlying securities.

Focusing on the Underlying Investments you desire leads to superior fund selection & portfolio construction This is where we believe the wealth management industry fails in portfolio construction. If you were to ask an investor to choose the kind of portfolio they would desire to have in terms of underlying investments, and compare this to the actual underlying investments they have invested in via funds, in the VAST MAJORITY of times there will be a substantial difference.

Funds are nothing but containers of underlying investments. The focus of portfolio construction & portfolio reviews, NEEDS TO BE ON LEVEL 3 (and below), since this is where performance of the funds are generated.

Level 4 - Economy

The performance of underlying investments are very dependent on the underlying growth of the economy that these investments are based in. Economic growth, that drives business growth, is ultimately a foundational factor of longer-term wealth creation.

Meaningful geographic diversification can help substantially reduce risk Having 100% concentration on a single geography can be a good option if that economy truly goes demonstrate growth outperformance. However, from a risk-perspective this also indicates that your entire wealth creation is dependent on the growth of a single economy, and that your portfolio is a 100% exposed to that single-countries risks (political, forex, policy, geo-political etc).

Building in a certain level of diversification in your investment portfolio to international economies, can have substantial benefits from a risk-reduction perspective (as well as the potential to outperform if those geographies do well). In our experience, this international diversification is either something which is overlooked or only given some very minimal allocations to in investor portfolios.

Level 5 - Trends

Every economy has certain underlying trends that are the core drivers of growth in that economy, and companies (Level 3 underlying investments) that are exposed to these growth trends tends to deliver disproportionate value creation. True wealth-creation and substantial outperformance is driven by having large allocations to specific trends that are driving wealth creation.

Level-5 Investing is complex, but can lead to substantial wealth creation Concentrated investments in Level-5 trends, is a more sophisticated form of investing and may not be ideal for a large segment of investors. The return volatility & dependence on a particular trend playing out, make this much riskier than normal diversified investing via funds. However, this is the Level at which the right investment decisions can lead to a disproportionate level of wealth creation.

Most investment funds tend to diversify across sectors & trends, in order to reduce risk & return volatility. While sectoral or thematic funds are an option, many of these suffer from very loosely defined mandates, that allow for a large amount of style drift.

True Level-5 investing is typically best achieved via direct-equity investing, but most investors do not have the skill sets for the same, making it out of reach for non-sophisticated investment professionals. This is why at IME Capital, we have developed a unique PMS model, that allows investors to gain exposures to specific micro-trends that they wish to invest into (without having to get involved in stock selection, timing an exit from a trend etc.).

The concept of Level 1-5 investing, helps explain what an investor is truly investing in when they build a portfolio of investment funds (MF, PMS,AIF).