Intergenerational equity requires us to ensure that future generations inherit at least as much as we did. Traditionally, land was an intergenerational asset: future generations inherit the land while the present generation uses the income from the land. As India gets richer, there is a massive latent need for intergenerational assets. Can the asset management industry design funds specifically to invest intergenerational wealth? Potential investors include natural resource funds like the Goa Iron Ore Permanent Fund, corpus funds of charities, the estates of rich families, and sellers of land.
Intergenerational Assets
Traditional accounting recognizes two kinds of tangible assets, wasting and non-wasting. Most assets like buildings, plant and machinery reduce in value over time – they waste away and are subject to depreciation. Non-wasting assets like land, precious metals like gold & silver, or jewelry, are not subject to depreciation as they retain their value over generations – intergenerational assets.
Traditionally, families held their wealth largely in productive land (e.g. zamindars) and to a lesser extent as gold / silver / jewels. Land generated income, adding to the wealth. On the other hand, precious items were easy to hide, run away with, or encash but did not earn any income.
As the world gets richer, there is a significant unmet demand for intergenerational assets. The Sovereign Gold Bonds issued by the Government of India are an intergenerational asset, not as secure as real gold but yielding a 2.5% real return. Can the asset management industry create an intergenerational fund, invested for the long term (permanent capital) to earn the real market rate of return?
Theoretically, an intergenerational fund should have the ability to take on very high risk, albeit well diversified. However, the potential for severe losses from poor active management increases with time. It would seem preferable for such funds to be low-cost index-tracking with longer duration investments and higher risk asset allocation.
For such a fund to be truly intergenerational, income up to inflation must be reinvested, i.e., only the real income can be distributed. Economic theory suggests that the real market rate of return (r) should exceed the real growth rate of the economy (g), or r > g. If we expect India to grow at 7% p.a. over the coming decades, a properly designed fund should yield more. Singapore distributes only 50% of the expected long-term real return of their funds.
The need
There are at least four contexts where there is a need to invest in intergenerational assets:
Natural resource funds
All across the world, there are many funds whose corpus is invested in perpetuity. Sovereign wealth funds are a notable category, set up in many cases (like Norway) from the sale of natural resources to achieve intergenerational equity.
In India, natural resources, including Goa’s iron ore, are a shared inheritance, owned by the state as a trustee for the people and especially future generations. They are intergenerational assets. Mining usually results in the sale of the mineral, with royalties, etc as the mineral sale proceeds. The Goa Foundation, a non-profit whose Research Director I am, advocates that the mineral sale proceeds should be invested in an intergenerational fund for future generations to inherit in place of the minerals sold. The real income of the fund would be available for the present generation to use. The Supreme Court has ordered the creation of the Goa Iron Ore Permanent Fund (GIOPF) to achieve intergenerational equity.
Within India, each of the 28 states and 8 UTs could set up such funds. Odisha alone received more than Rs. 40,000 crore from minerals in 2021-22. The national government already has a National Investment Fund but does not save the proceeds from offshore oil, gas & minerals. The 5th and 6th scheduled areas provide some benefits from the extraction and sale of mineral wealth. The village of Mendha-Lekha in Gadchiroli has set up a village fixed deposit, partly from the sale of construction stones. In some states like Meghalaya, tribes, families and individuals can own sub-soil minerals: they can create such funds. Across India, the potential incremental assets under management are at least Rs. 1 lakh crore a year.
Corpus funds of charities, trusts, and non-profits
In theory, charities are perpetual entities. A corpus fund or endowment fund would usually be expected to provide returns in perpetuity. Historically, many charitable endowments such as waqfs were in the form of land donations, with the expectation that only the income from the land would be utilized, after ensuring proper maintenance. It is estimated that India has 3.3 million non-profits: of course, only a small fraction have corpus or endowment funds. While the total size is difficult to estimate, the wealth of the Tirupati temple trust is estimated at Rs. 2.3 lakh crore.
Family wealth
Some of us have been fortunate to receive inheritances from our parents and ancestors. It is customary to pass on inheritances to the next generation. This is true under the personal law of most communities and is the reason for Hindu Undivided Families and various family trusts. Here again, monetary inheritances may be best invested in perpetuities with withdrawals of only the real income. If the inheritance is concentrated, e.g. a parcel of land, it may make sense to diversify risk by selling and investing in a perpetuity. The extent of intergenerational wealth owned by families is very large. The wealth of the top 100 richest Indians is estimated at Rs.54 lakh crore. A 7% return would imply a real income of over Rs. 3 lakh crore annually, most of which would be saved.
Land sales and acquisition
If land is essentially an intergenerational asset whose income is being consumed, land acquisition raises the risk that the present generation quickly consumes the land acquisition compensation, leaving no income for later as well as depriving children and future generations of their rightful inheritance. Private sales usually result in a cash lump sum. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (LARR) provides for a lump sum amount, a job, or an annuity for 20 years indexed to the Consumer Price Index for Agricultural Workers. As can be seen, none of these alternatives are truly intergenerational assets. As cities and infrastructure expand, this will be a growing need.
Key design problems
A manager of an intergenerational fund is faced with three key problems. First of all, asset allocation – how to invest the corpus to generate real returns over long periods. Second is how to estimate the real return which may be withdrawn. Finally, how to smoothen the withdrawals as all investments are risky, and over short periods, may well show negative returns.
Generating real returns passively
What should be the asset allocation and investment strategy for intergenerational funds? Investment theory suggests that in most cases low-expense high-risk passive investments in the market index would deliver the best long-term risk-adjusted returns. Such an investment strategy also reduces the risk that the non-profit treasurer is incompetent or a thief.
However, this still raises the question of which asset classes and indices to invest in. The NPS provides a variety of default portfolios, of which the most aggressive is up to age 35 (75% equity, 10% corporate debt, 15% gilts). What asset allocation & benchmark indices should be offered?
Estimating real returns
Estimating real returns requires estimating nominal returns as well as inflation. Estimating nominal returns is well understood, albeit not trivial. Left to politicians, it is subject to over-optimism. Just as we have multiple capital market indices, there are multiple measures of inflation, mostly produced by the government and prone to under-estimation. Given the risk of inflation index manipulation, regulated inflation index providers may be necessary.
Smoothening withdrawals of real returns
Financial markets can generate negative returns for periods of time. In order to smoothen out the withdrawals, some sovereign wealth funds estimate the real return and use a Percent of Market Value method. For example, if the real return is estimated at 3%, they would withdraw 3% of the average market value of the fund over the previous [5] years. This is a moving average and will average out to the actual return over long periods. Would the POMV rule be practical for intergenerational fund managers? Is there a better way?
Conclusion
As can be seen, there is a significant latent demand for intergenerational assets, and there are no products specifically designed for this segment. If we consider the global opportunity, it is surely many times larger. If the asset management industry designed appropriate products, the Goa Iron Ore Permanent Fund could be an anchor investor.
A shorter version of this post appeared in the Economic Times as an op-ed on 10 November 2023 under the title Secure GenNext Future