Mutual funds: ‘Sahi Hai’ but they are not free
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When it comes to buying a financial product, consumers are largely hesitant and cautious. Their biggest fear is being taken for a ride. This perception is a result of the sales-based advisory approach that has been operating under the garb of ‘hidden pricing’ for so many years. One of the side effects of hidden pricing is mis-selling. The result is that products that should be self-adopted by most people—such as like mutual funds and insurance, given the prevalent need and conducive target market—score abysmally low on penetration. It is wrong to quote the lack of financial literacy among Indian consumers as a reason, since the real underlying issue is lack of right perception about these products.
It’s not enough to say “Mutual funds. Sahi hai”. The industry also needs to welcome the changes that Securities and Exchange Board of India (Sebi) has proposed in its investment advisory guidelines and the fiduciary responsibilities that registered investment advisory approach brings. This will pave the way to enhancing investor confidence.
The industry’s support may be half-hearted, but one can draw a parallel with demonetisation and GST implementation. If the government had asked for ‘industry opinion’ before taking these decisions, such bold policy decisions would have never been taken. Sebi must, however, conduct an investor survey to understand the seriousness of the situation.
When the distributor of a financial product calls herself a financial adviser, investors are bound to believe the nomenclature. Under the influence of this belief, in most cases, investors are not made aware of the magnitude of price hidden in the cost structures of these products. Moreover, knowing the price of a product before buying it is every consumer’s right. Industry and distributors can keep their profit margins secret, but not the price.
Mutual fund agents, for example, freely call themselves ‘independent financial adviser’, ‘investment adviser’ or ‘wealth manager’. Camouflaged in these labels, the price of product is seldom discussed. Investors usually invest their life’s savings for two things—creation of retirement corpus and investment of retirement corpus—both of which involve large sums. But strangely, price is kept hidden. This is because while the product is largely a buy-and-hold instrument, the hidden expenses towards sales commission are ongoing. The long-term impact of hidden costs can be substantial (see table).
Likewise, there are hundreds of cases of mis-selling in insurance products as well, where an insurance broker freely calls herself an ‘insurance adviser’ and influences buyers’ decisions. At the life stage when one should be buying term insurance, the person is given a unit-linked insurance plan (Ulip) or a money-back policy. Eventually, over a period of time, the policyholder discovers the hidden charges, the low returns, and low insurance cover, and on realising that no clear purpose is being achieved, is left with a bad experience and loss of confidence.
A stock broker freely calls himself an equity adviser, but actually runs a business of supplying unqualified equity- and derivative-market-trading tips to meet brokerage targets. This results in investors getting a bad experience and losing confidence, and it creates a wrong perception about equity products. A correct equity advisory approach could have turned an individual towards the path of long-term wealth creation.
There is a big difference between advisory approaches of agents and registered investment advisers. Things like risk profiling, asset allocation, unbiased product selection and portfolio review—which are critical aspects of advisory—remain theoretical concepts in the sales approach. For an adviser, there is no conflict of interest and her way of working revolves around financial planning, maintaining an optimal portfolio mix and aiming to generate consistent high performance. And, fiduciary engagement and transparent fees build investor confidence.
Sebi initiated the investment advisory guidelines about 4.5 years ago. A few professionals and companies chose to abide by the fiduciary law, believing these are developments in the right direction.
The industry is making a fuss about Sebi’s proposed guidelines, and this is delaying the implementation. Continuing hidden fees are against competitive co-existence of agents and advisers, and hence disclosure norms are important. The proposed guidelines also make it easier for agents to adopt an advisory approach.
Sebi must also instruct large distributors and retail banks to adopt a fiduciary model, and check the free usage of advisory nomenclatures by those who decide not to opt for the advisory approach. Intermediaries must be given two choices: either adopt strict disclosure norms, stop using misleading nomenclatures and keep operating like agents; or take the requisite license, adopt transparent pricing, and work as a registered investment adviser.
Delaying this any further is nothing but procrastinating, something that has to be implemented one day.
Kamal Manocha is chief executive officer of Bharosa Advisor, a Sebi-registered investment advisory firm.