Investment advisory: a delicate balancing act

Right from the 15th century House of Medicis, who institutionalised banking, there has been a history of financial service providers misusing their information advantage to the detriment of their customers


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Unlike the simple game of Monopoly, modern financial systems are complex and have multiple moving parts. Consider wealth management. It is the only meaningful conduit for actively connecting investors and savers of capital to institutional finance. But awareness that wealth management is critical, and in many ways an essential service, is lacking. The bigger challenge, however, is structural. The world of institutional finance operates at a level and pace that matches industry-grade efficiency that only large organisations have. However, the end investor (the retail customer) is often unaided, unmotivated, uninformed and burdened with all the problems of retail consumers. This makes the connection between the two—retail investors and financial intermediaries—delicate. It is arguably the most difficult fault line for all stakeholders: end investors, investment advisers, financial intermediaries, regulators and the companies or the consumers of capital.

Retail-wholesale imbalance

The vulnerable nature of the interface between retail consumers and wholesalers is not recent and neither is it limited to financial services. Right from the 15th century House of Medicis, who institutionalised banking, there has been a history of financial service providers misusing their information advantage to the detriment of their customers. Over the years, neither higher literacy levels nor the internet-driven information explosion have adequately addressed the information asymmetry problems between the end investors and the financial intermediaries. Indeed, global surveys, such as the early 2016 Edelman Trust survey commissioned by the CFA Institute, found that financial services ranked a dismal ninth among 12 different sectors. Unsurprisingly, to address information abuse, regulators have stepped in from time to time.

In particular, in the wealth management practice world over, there have been moves to adopt a fee-based investment advisory model. The biggest change in a fee-based investment adviser model is the way the service provider, who connects the end investor to a mutual fund, is paid. A fee-based model empowers the end investor and also elevates the investment adviser’s role. The investment adviser gets paid only by the end investor and not by the mutual fund manufacturer as is the case in the non-fee based model. The fee-based investment advisory model tries to address the information asymmetry problem through empowering the end investor. In the non-fee based model, mutual fund product distributors play an important part to sell mutual funds to the end investors. Product distributors double up as wealth advisers. Many of the distributors have the technical and moral capacity to deliver on investor needs. But for others the higher, and more certain, pay-off from mutual fund manufacturers creates a conflict of interest. A move towards a fee-based model has now been recognised as a desirable best practice. If the investment adviser rule amendments by the Securities and Exchange Board of India (Sebi)—which came out in October—are implemented, India would be among a handful of countries to fully embrace a fee-based investment advisory model.

Transitioning challenges

Transitioning from non-fee based to a fee-based model, however, may not be easy. At least in the transition phase, investment advisers are likely to face at least four key challenges. First, advisers who are mainly dependent on high net worth families for their fees may have to work harder, given increased transparency as well as competition. Second, small investors who were not used to paying any direct fees to the investment advisers would have to be educated and convinced of the merit of paying for advice. Third, advisers would have to deploy technological tools for sustainably engaging and understanding client needs. Lastly, advisers may have to increasingly rely on technology to seamlessly execute client transactions.

In any case, the difficulties of managing prosperity are not limited to the problems of moving from a non-fee model to a fee-based model. The intrinsic challenges in wealth management practice are to do with the vulnerable nature of the retail-wholesale connect. Results from a recent global survey, by the same institute, to rate obstacles confronting wealth managers are notable.

Winning and maintaining trust is topmost. The results from 521 survey respondents confirm some of the trends identified earlier. In particular, 43% of poll participants believed that earning and keeping investor trust is the biggest challenge facing private wealth advisers. How should private wealth managers overcome this deeply ingrained trust deficit? The answer is not easy, given that the investment adviser is more a facilitator, mentor, and market strategist at best—rather than someone who can alter market outcomes. Training the end investor on behavioural gaps and the benefits of long-term investing are important areas to address. A human touch and an ethical approach—one that embraces full disclosure, among other attributes—can also help bridge trust gaps.

Other challenges highlighted by the survey include: regulatory changes with 34% vote, investment adviser communication with 11% vote, technological changes with 8% vote and retirement planning with a 4% vote.

In the post-financial crisis era, there have been a series of regulatory changes. Abusive practices can be regulated and guilty practitioners will be punished, but identifying and regulating excessive short-term greed may be impossible. All stakeholders would need to work closely to create reinforcing incentives that empower everyone involved, to be long-term greedy.

Shreenivas Kunte is director–content, India, CFA Institute.

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