Change is a constant now in the financial services space. The financial community has had to adapt quickly to the fast-changing regulations.
Here is one change. Financial service providers had traditionally been selling products and bundling incidental ‘advice’ with them, for ‘free’. All good, but the problem was that the distributors’ were guided by the interests of the principal and of their own. While customers thought they was getting ‘true’ advice, they were being sold what the distributor wanted to sell. Apart from that, often, distributors did not have certification, hence their ability advise was constrained. The Securities and Exchange Board of India (Sebi) introduced the Investment Advisor Regulations in 2013, so that customers had access fiduciary advice. These Registered Investment Advisors ( RIAs) were prohibited from getting commissions; their remuneration had to come directly from the customers. Today, there are over 530 RIAs.
Worldwide, there is a debate on the fee-based model. There are also those who vouch for the asset-linked model. They say that as the value of assets goes up, so does the complexity, hence expertise and more time is necessary to manage them.
The other argument is that if advisers nurture clients’ wealth, they should be allowed to participate in the upsides too. A CFO in a company is well compensated as her acumen in managing the financial affairs of the company is vital. The compensation reflects the value added, and not just the time spent. The same holds true for a ‘personal’ CFO, which is what an adviser is.
Even in the investment field—mutual funds, insurance, portfolio management services—the prevailing and accepted model is to charge fund management charges as a percentage of assets. Apart from these, there are management fees, premium allocation charges, policy management charges, and profit sharing too, in different products.
Those who disagree with the asset-linked model opine that the effort involved in managing a Rs1 crore portfolio is not very different from managing a Rs1.5 crore portfolio. Hence, the extra charges are unwarranted. Again, there is again some truth in this.
But if the charges are almost static, there is no incentive for the adviser to perform. The costs for an adviser are going up and without a compensation structure, the relationship will not work. So, is there really an alternate model? There is.
A project-based compensation model could work well when there is a clear-cut project that needs to be completed and delivered. A financial plan would work well under this model. After this, various services can also be accessed a la carte. This means that a customer could opt for some services and not others. So the adviser-client relationship is an on-off affair and not a continuous one. The disadvantage is that the adviser does not have a regular source of revenue. Plus, she also does not have an overall control over the client’s financial well-being. So, the amount an adviser could earn is capped, and scope of engagement is limited.
If a project-based compensation model was the best model, the corporate world would have only consultants and no employees.
Consultants need to have many rods in the fire as a project has a specific tenure. After one project is done, they have to move on. They would receive less and their long-term engagement is at the whims and fancies of the client. From the customer’s point of view, they would be paying less and would be getting a less engaging relationship too, in this project-based model.
There are advantages and disadvantages to both models. Which model the client wants to choose, depends on how deep she wants to engage with the adviser. The asset-linked model enables a deeper engagement. The adviser is invested in the customer’s future and is the client’s CFO. The benefits in this engagement could be high, though the fees paid will also be more than in the other model.
The project-based compensation model would allow the client to pick and choose what she wants. This pre-supposes the client’s clear understanding of what is useful for her—it may look straightforward but may actually be complicated. Most people don’t know what all is needed to live a financially well-funded life. So, with this model, they may pay less but also achieve a lot less.
The fee alone should not be a determinant while choosing a model. Rather, the choice should be based on the value an adviser could add and whether they can live a fulfilling life, bereft of financial worries. But it’s best to leave it to the wisdom of customers to choose what is best for them.
Suresh Sadagopan is founder, Ladder7 Financial Advisories.