Direct plans put onus on advisory
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I recently read a small news item about sharing of mutual fund (MF) direct plan feeds with distributors and advisers. This one small step can, however, plays a catalytic role and change the way MFs will be bought.
Direct plans of MF schemes offer lower-cost investment options for investors as they bypass distributors. The lower cost can translate into better returns. But it also means no operational or reporting support from distributors.
Also, in direct plans, there is no adviser to offer counsel. This lack of advisory input can be detrimental, if advice is not accessed separately. Else, the investor should be savvy enough to understand the landscape and be able to make considered decisions.
Earlier, advisers did not have access to feeds of investments done in the direct mode. This created a hurdle in accessing advice. The investor had to send across all information on their investments every time, which the adviser had to work on further; a time consuming process. Hence, advisers were mostly not suggesting direct plans. While direct plans have been in existence since 1 January 2013, it was very cumbersome to invest through these as there was no intervention from the distributor and the investor had to go through the entire process herself. This meant doing all the paperwork for every mutual fund and then submitting it. Discrepancies had to be followed up and rectified.
Many MFs have enabled online investments, but an investor still had to go to each site separately. So, if an investor was dealing with a dozen MFs, there will be a dozen user IDs and passwords. Online platforms were supporting regular plans, which were distributor-led. Direct plans were completely ignored on these platforms due to commercial considerations. Other platforms are emerging, but may take time to be fully operational with direct plans. Even today, MF Utility does not offer direct plans to investors online; only offline.
This small step of allowing access to the feeds to the distributor or adviser will remove one hurdle. Advisers can now get access to the data, offer advice for a fee while the client benefits from the lower expenses of a direct plan. When online platforms offer the direct option, there will be a transformation. But we need to wait for that.
But will the advice be unbiased? The Securities and Exchange Board of India (Sebi) had come out with Investment Adviser Regulations in 2013 to enable a class of advisers (Registered Investment Advisers or RIAs) to provide unbiased advice. It imposed several responsibilities such as higher education, experience, certification, reporting, compliance, record maintenance, audits and more, thus, effectively raising the bar. The regulation sought to avoid conflicts of interest, needed segregation of activities like distribution and advisory, high levels of disclosure and arms-length dealings.
It also imposed fiduciary responsibility on the adviser. Fiduciaries are those who put the client interest first. This is a sea change from the caveat emptor (buyer beware), which generally prevails in financial services. With the emergence of a true class of advisers, advice and product sourcing could be separated.
The problem till date has been that product distribution and advice were tightly bundled. Remuneration came from the product manufacturers and not directly from the clients. Distributors were representing the fund houses, rather than the clients. Direct plans unbundle distribution and advice. No commission is paid and so expenses charged are lower. With a direct plan, distributors would have to charge their fee for distribution and advisers for advice. This puts the onus of offering good services on the distributor and the adviser, and helps clients access better quality advice without having to pay over and above what they are currently paying.
It is wrongly believed that direct plans would mean lower costs for investors. It is only true that the charge deducted from the fund is lower. But investors would still need advisory and implementation services, which need to be paid for. Investors, however, can decide the level of services she wants and pay accordingly. So, if someone wants to do everything herself, the costs are lower. For most people, the overall costs would remain more or less the same. Only the way it is paid changes.
If we look at a portfolio consisting of direct plans (both equity and debt), exchange-traded funds and low-cost funds, the difference in charges as compared to regular funds would be about 1%, on an average. Based on services offered, the investor would now pay this amount or more or lesser to the adviser and distributor. That’s how it should be. In direct mode, the investor has more control over the level of services they receive and pay for. This is good for the entire ecosystem—the investor is assured of unbiased, client-centric advice from an adviser who does not receive remuneration from the product manufacturer.
Distributors can charge for their services in line with the services rendered—implementation, reporting and enablement.
Hence, the biggest change is in the way people are paid for services rendered. For some, this may be difficult to stomach. But in time, we will all start appreciating the advantages of this. Advisers and distributors having access to direct plans is a win-win proposition that will transform MF distribution and advisory, and eventually the financial product landscape itself.
Suresh Sadagopan is founder, Ladder7 Financial Advisories