Monday, October 31, 2011

Comments on Concept Paper on Regulation of Investment Advisors--Part II


At the outset, I wish to introduce myself as an AMFI qualified Independent Financial Advisor having ARN number 18533.

Sir, the broad mandate given to SEBI is to safeguard the investors’ interest. The said concept paper on regulation of investment advisors is another step—whether right or wrong only time will tell—in that direction.

Having read the Concept Paper on Regulation of Investment Advisors, I firmly believe that India is not yet ready for such sea change in the way investment advice is given and accepted. The reasons have been outlined as hereunder:-

  • Para 2.1:- Tackling conflict of interest in Distribution of financial products:-       
You believe that because of conflict of interest, investors’ interests are compromised. Sir, may I humbly ask you to point out any industry where conflict of interest is absent? Just as a businessman strives to maximize his revenue/profits, the client hopes to keep his costs minimum-- can we say that there is a conflict of interest between his business and his clients? Every manufacturer believes that his products have an edge over the competitors’ products and rightly so! Similarly, the consumer buys the product only after doing sufficient research about the similar products available in the market; thereby mitigating the conflict of interest as far as possible. 

  • Para 2.3(a):- You believe that a distributor—being only loyal to himself—would happily churn his investors’ portfolio and also squeeze more commission from the manufacturer. 
Sir, with due respect to your knowledge and expertise in the domain of investor protection, may I humbly state that today a  distributor is able to receive commission from the manufacturer as well as fees from his investors only because you have authorized him to do so. By abolishing entry load from mutual fund investments w.e.f. 01/08/2009, you have allowed not only the AMCs to pay upfront commissions to the distributors (albeit out of their own pockets), but also authorized the latter to simultaneously collect advisory fees from their investors as mutually agreed amongst themselves. How can you now blame the hapless distributor for an act authorized by you? At the time of abolishing entry loads, you should have barred the AMCs from paying any sort of incentives (upfront) to their distributors so as to prevent such conflict of interest! The first conflict of interest has only been accentuated by you rather than being mitigated.

You further go on to state that it is because of the dual stream of fees, the distributors are churning the portfolios of their investors. Sir, do you really believe that the today’s investor—whose cause you are championing—is so na├»ve so as to allow the distributor to churn his portfolio without any commensurate gains—direct or indirect? However, I do not rule out such churning done by a section of the distributors! But to paint the entire community of IFAs as irresponsible and un-ethical because of the act of a few is least expected of you.

  • Para 2.3 (b):- Distributors to sell products of manufacturers offering highest commissions:- 
Sir, you have visualized a situation, where a distributor would sell products only of those manufacturers who offered highest commissions---is more hypothetical than real! If this had been indeed true, then in all likelihood the bottom 10 AMCs (by AUM) would have been the Top 10 AMCs (by AUM) since August 2009. However, since this has not happened only goes to prove that distributors as well as investors have started to subscribe to schemes of MF with regard to its past performance, funds’ suitability to their goals etc. and that commissions do not play a major role in fund selection.

  • Para 2.5:- UK to phase out the upfront commission. 
Sir, please note that markets like UK, USA are more matured than ours and to expect India to adopt advisory fee system overnight is a trifle too early! Investors as well as distributors in UK have been given time for the said transition. It will be disastrous for the distributor community (and by logical extension—the investors) at home—many of whom depend on MF advisory to run their households—to move over to advisory without any safety net. There is still a significant amount of resistance amongst investors as far as paying fees for an advisory service is concerned. Investors have first to be educated that paying fees for advisory services is same as paying fees to a doctor! This resistance is visible in the metro cities itself—where the investors are supposed to me more learned than their counterparts in Tier II & III cities (where you plan to make mutual funds popular in time to come). Education and not regulation is the requirement of the time!

  • Para 6.2:-- Chartered Accountants like advocates are exempt from registration:- 
The sole job of Chartered Accountants is to audit the books of accounts; while an advocate is supposed to render legal advice. Can a Chartered Accountant/advocate be the right person to offer investment advice or is it a Certified Financial Planner a better person to offer investment advice which is in sync with the financial goals of the investor? Mandate of a Chartered Accountant/Advocate is totally different from that of a CFP. I AGREE with you, though, that only those persons with a certain minimum professional qualifications should be allowed to offer investment advisory services. 

Sir, the distributor community has done a service to the investor and also to the nation by taking the Mutual Funds to Tier II & III cities. It is they who have tried to bring about an inclusive growth in Mutual Fund industry! In a study (conducted jointly by Boston Consultancy Group and CAMS) published in it has been shown that over a period between 2003 and 2010, share of Mumbai, New Delhi and next Top 8 cities in Mutual Fund holdings have gone down from 90%(47%+14%+29%) to 75%(32%+12%+31%) respectively. Simultaneously, the share of next 90 cities+others has gone up from about 9% to 25% during this same period. Certainly, this shift would not have been possible without the MF agents/advisors! And now to expect them to work virtually for free—given the resistance to paying advisory fees—is akin to doing injustice to the entrepreneurial ability of the advisor.

Sir, at the end I only wish to state that what we need is an atmosphere where both the advisor as well as the investor—can work for each other’s benefit. Series of regulations have been counterproductive to investors’ interests— as it has only been directed at the so poor distributor –without any voice or lobby--leaving out the manufacturer as well as the investor. The earlier system of simultaneous existence of entry load & no entry load regime was to my mind the most transparent system where investors knew exactly what they are paying. Such a regime had worked perfectly-- in absence of dual commissions—for the growth of a healthy and transparent growth of mutual fund industry—the ideal vehicle to channelize the people’s savings to equity market.

Lastly, I only wish that you take a balanced view of the present ground realities while framing regulations for investor protection. 


Neena V Mehta


Friday, October 28, 2011

Concept Paper on Investment Advisors' Regulations--Comments


At the outset, allow me to introduce myself as an AMFI qualified Mutual Fund advisor.

I have read the Concept Paper on Regulation of Investment Advisors!

It is heartening to note that you are keen to make the world of investments a safer place for the investors at large. But the moot point is whether it is going to make the life of an IFA any better—an important link between the AMC and the investor-- whether we like it or not.

I believe that the said concept paper will not be able to deliver the results as anticipated by you.  One possible reason is that you are targeting just one segment of the financial market while investment world also covers secondary equity market and life insurance. An investor willingly pays upfront charges while buying an insurance policy but is hesitant in paying fees to his financial advisor is contradictory and self defeating.

The reasons why the said concept paper will fail to bring the desired changes are:-

  • Low Level of Financial Literacy and awareness in India(Para 2.4):- 
There are 2 parties to any advisory business—the advisor—giving advise and the investor—the person receiving the advise. For an advice to bring desired results it is imperative that both the parties are on the same plane. Consider the real life case of a Client X who stopped all his SIPs only because he thought the markets would crash. (the SIPs had been started to build the retirement nest). The client—who holds an important position of Sales Head in a private insurance company—cannot be considered as a layman to investments. In such a situation, who is to be blamed—the investor or the advisor? If this be the case in case of an informed investor what more can we say about an average investor? The fact that client has to be informed/knowledgeable enough to appreciate the value of the advice given so as to enable him to meet a goal in his life. Further, since the level of financial literacy is low, the concept of paying fees to the advisor is also rarely accepted.

  • Conflict of Interest(Para 2.3):- 
In any business, the distribution channel has a cost. Nowhere in the world would you find a distributor working for free. If churning is what you want to prevent, then is the MF industry the only place where churning happens? The possible solution to the issue of the so called divided loyalty is by doing away with upfront (and mostly differential) commission altogether. If there are no upfront commissions coupled with advisors being able to charge advisory fees, or better still, linking the quantum of commission to the age of the investment, then the urge to churn would not be there! The proposed regulation will in all likelihood kill the industry and then there will be nothing left for SEBI to govern. 

  • FSA, UK model (Para 2.5):- 
You have quoted the case of Financial Services Authority, UK as a reference. However, what you have overlooked is that a market like UK is far more matured than ours. To expect an Indian investor to start paying advisory fees overnight is too optimistic given the level of financial literacy in India.

  • Educate rather than regulate 
Having admitted that financial literacy is low in India and that roughly less than 10% of the population in India have access to equity markets, the key to healthy—enough to regulate-- development of financial markets is investor education rather than intermediary regulation. If investors are made to realize that equity markets are supposed to be a vehicle to plan and fulfill their goals and that a financial planner is a vital link between the investor and his goals by virtue of his expertise and knowledge. And that such expertise has a cost. A healthy industry is characterized by healthy growth of all stakeholders. Ensure that education and experience comes to play a distinctive role in the evolution of the industry a la medical profession.

Sir, a regulators job is to regulate the market and ensure healthy growth of all its stakeholders. Regulate by all means—but you should also see that the industry survives—for you to continue to regulate. The earlier regime of concurrent existence of entry load and no entry load structure was in my opinion fair enough. The investor chose for himself whether or not he is willing to pay fees?

Sir, an Independent Financial Advisor is an important link between the product manufacturer and the investor. It is imperative that he survives so that the investor can even dream about fulfilling his goals—meeting them successfully is another story! Hence, I request you not to implement the proposed Investment Advisors Regulation which will be nothing but a death knell to the already ailing investment advisory services industry!


CA Vijay Mehta CFPCM