My recent visit to the networkFP national conference & exposition has set me thinking. At the outset, I was deeply impressed with the overall conference and was delighted that my two days at Mumbai were well spent. The conference was practitioner centric and brought to the fore the variety of issues that are faced by the industry at large, with some thought provoking ideas and tools on how to address these issues.
An aspect of the conference that specifically caught my attention was the nervousness around the recent development of a new financial intermediary – RIA (Registered Investment Advisor). While distributors are responsible for the suitability of the product being recommended to clients, RIAs are held to a significantly higher standard – the fiduciary standard, wherein the interests of the client come before and above those of the RIA. Not only are RIAs prohibited from accepting any income that does not come directly from the client, the RIA is also expected to clearly declare all conflicts of interests to clients and always keep client’s interests above its own.
Distributors have conveniently cloaked themselves behind this oft repeated completely obfuscating term known as IFA (Independent Financial Advisor). In practice all IFAs are simply distributors who have an AMFI Registration Number (ARN). AMFI stands for Association of Mutual Funds in India. The ARN code allows distributors to be identified by which clients they have brought into any specific mutual fund scheme and allows the mutual fund houses to disburse commissions based on this. So dear investor – do note that the moment you see a ARN being entered on your application from – there is a commission involved (at your expense) that you are not necessarily enlightened about. Further, if someone claims to be an IFA, Wealth Adviser , Wealth Manager or any other term please ask whether they are a distributor or a registered investment advisor (RIA) or both.
Worldwide regulation is moving towards a 0% commission and a 100% direct fee model. Australia and U.K have already adopted this, the US however is behind the curve. In India too SEBI is increasingly turning up the ante on the world of commissions. It first started with abolishing entry load for mutual funds, followed by the mandatory introduction of direct schemes for mutual funds and now there is increasing debate about upfront commissions. I may dare allege that entrenched interests are not allowing direct schemes of mutual funds to flourish. Whether it is the mutual fund execution platform offered by BSE or the mfutility platform under AMFI recently launched, there are no options to purchase direct schemes of existing mutual funds through an RIA. The only exception is the iFAST mutual fund platform which however still does not have the top 5 Mutual Fund houses on board. The only entities recommending direct schemes are RIAs who practice a 100% fee model. It is obvious that direct schemes are being throttled to prevent their desired penetration into the Indian hinterland. While there are ~52,000 ARNs (as of March 2013), there are only 227 RIAs (SEBI website as on 27th Jan 2015). Not only are RIAs such a small fraction of the distributors, even among the RIAs there may be only a handful who practice a 100% direct fee model. SEBI still allows an RIA to be a distributor provided it can show that the ARN and RIA entities are separate business units and function completely independent of each other – how much this is possible in practice is a question clients must ask.
All this has set me thinking that the RIA is a truly disruptive force that can undermine and seriously threaten the distribution industry. RIAs can act as enablers for the unbiased, direct fee only model that the Indian public is so craving for – and RIAs must unabashedly use this as a marketing tool to clients. Thanks to “cloaked” distributors (IFAs, Wealth Advisors, Wealth Managers etc etc ) the bar is very low – there is very little the RIA has to do to show that it is adding value. In most cases it is not even about generating superior return, it is simply helping the client in avoiding costly investing mistakes. Mis-selling is so rampant in the mutual fund, insurance and broking industries in India today, that only RIAs who practice a 100% direct fee model will be in a position to deliver advice that is free of bias and in the sole interest of the client.
In establishing the fee structure for my advisory practice, I have followed the principle of pay only for out-performance against a mutually agreed benchmark. This is absolutely essential if the client has to generate superior returns in an actively managed strategy. However, what about helping clients in avoiding costly investing mistakes on an ongoing basis? How do we bring out the value in dissuading clients from taking up costly ULIPs and instead guiding them into a term life policy? How do we show what we bring to the table by being a sounding board for our clients and preventing them from taking on excessive risk in euphoric times, and keeping them invested in tough times. Should we be paid only for investments that we prescribe ? What about the value addition we can bring for investments that we proscribe? Surely there is value in all these activities. Attending the networkFP conference opened my eyes. I have now decided that in addition to the services of (a) Investment Policy Statement and (b) Portfolio Advise, I will add a third – and that is (c) Comprehensive Financial Advice and Wealth Management. Under (c), we will be a sounding board for ALL financial advice the client seeks and advice will range across the spectrum of financial products the client is involved in on an ongoing basis. I have not yet clarified in my head on how the fee structure should be for (c). May be in discussions with my clients this will become more apparent over time.