Advice set to get expensive, execution cheaper
Currently, most distributors know the product’s features very well, but the customer poorly. So, the same product is sold to all their customers
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The recent draft guidelines by the Securities and Exchange Board of India (Sebi) on investment advisers have caused a flutter, to say the least, among distributors or the independent financial advisers (IFAs). The regulator’s objective seems to be clear: to move from a commission-based (distributor) model to a fee-based (adviser) model. In other words, the intermediary will be paid by the customer and not the manufacturer (mutual fund houses, insurance companies, or similar others). There seems to be a global wave towards this fiduciary model and regulators in many countries are taking steps in the same direction. To my mind, the biggest change will be a shift of power from the manufacturer to the investor. Let me explain.
In the current scenario, an agent or distributor is appointed by an asset management company (AMC) or insurance company to sell its products for a commission. The agent also receives training, inputs on various products and help in acquiring and servicing customers. Thus, she is obliged to sell or promote the company that helps her more than the others. In the new scenario, the tables turn as the customer is the only one who pays the adviser. Thus, customer interest is the only business driver. So, there is a shift, from product focus to customer focus.
This is easier said than done. Currently, most distributors know the product’s features very well, but the customer poorly. So, the same product is sold to all their customers. In the new setup, the customer’s profile and matching of product to profile will be paramount, which will require a far better understanding of the customer. That, in my opinion, will be the real ‘know-your-customer’. The separation of advice and transaction execution will also be a big game changer. A distributor probably spends more time and effort in transaction-related work like cheque and form collection and deposit, follow up, and commission-related issues. In fact, she spends more time on these issues than on research and with the customer.
In the new world, there will be many execution platforms that the customer or the adviser can pick from. Almost all transaction-related activities will be performed by the platform, leaving the adviser with more time for the customer. Technology obviously will play a huge role in this transformation, with most aspects of the transactions being paperless and seamless.
Focusing on the customer will also bring in more innovation, even in product offerings. Most customers are now being sold mutual funds or insurance products, partly because these are the most heavily promoted products. But in a pure fiduciary model even a bank fixed deposit should be advised, if it is suitable for the investor.
Also, new products will emerge. One product that is fast gaining ground globally—and is bound to become popular in India too—is the exchange-traded fund (ETF), as an alternative to actively managed equity funds.
It is true that in India actively managed funds have done better than ETFs, as compared to, say, in the US market where the median fund has underperformed the index. However, for a longer-term passive investor (most retail investors will fit that description), ETFs take out the variables of fund house selection and fund manager selection. After all, the index will most likely be around after 20 years, which cannot be said for the fund house and surely not for the fund manager. Equity ETFs have already crossed assets under management (AUM) of Rs10,000 crore, up from Rs4,000 crore in 2014. Globally, the rise of ETFs has also been correlated with higher use of technology and internet in the investment process, a trend that is irreversible. Costs or expenses were never a part of the discussion as the investor was not aware of the costs. Now, when the investor has to pay a fee to the adviser, all aspects of the costs will likely come to the fore.
Low-cost options like direct plans of mutual funds and ETFs will gain further ground in such an environment. Advisers will be pushed to justify the fees that they are charging (versus the earlier “all for free”), resulting in better services and hopefully more innovation.
Technology will play an increasing role in the advice process also, as the customer becomes more involved. The Sebi paper gives special mention to robo-advisors, or advisers who use data and technology for advising customers. There has been huge activity in this space with sites being launched almost on a daily basis.
However, most of them tend to be execution focused and extant research providers, and so are not strictly speaking robo-advisors. Also, they deal primarily in mutual funds. For any adviser to be truly customer centric, she will have to know multiple products, because the customer portfolio will likely be multi-product.
This transformation becomes more interesting as we are at par with changes happening in other countries, and there is no precedent to learn from. Whether the existing intermediaries will rise up to the challenge, consolidate and collaborate or a completely new class of advisers will emerge, we will have to wait and see. But one thing is certain. The value of customer connect and advice is going up, while the value of execution is going down.
Atul Rastogi is an investment adviser and founder of Ardawealth.com