BackIn defence of trail commissions
In defence of trail commissions
PremiumShyamal Banerjee/Mint
The Securities and Exchange Board of India (Sebi) has taken a welcome step to bring in a set of adviser regulations. It has released a concept paper on the regulation of investment advisers. India needs a new set of regulations to bring order to a marketplace that moves money between households and fund managers. Investors stay in inflation-unfriendly deposits and negative-real-return endowment insurance policies because they are unable to trust the intermediary who talks about putting their money in markets through mutual funds and pension products. The unit-linked insurance plan (Ulip) fiasco where investors were looted systematically by insurance companies, banks and distributors has not helped foster trust. The Ulip debacle was a case of misaligned incentives and for trust to be built we need to align the incentives of the investor with that of the intermediary, keeping in mind the fact that the bulk of the market finds it difficult to pay for services. There is still time before we come to a stage where there is a well-recognized designation such as MBBS or LLB that qualifies the person giving financial health advice to charge for services as an accepted part of the practice.
It is a neat model but needs a handshake across the regulatory table with the Reserve Bank of India, Insurance Regulatory and Development Authority and Pension Fund Regulatory and Development Authority nodding in agreement for it to work. My one point of difference with the paper is on the treatment of trail commissions, the payment made by the manufacturer to the intermediary each year that the investor stays with the product. The paper envisages a world where an intermediary getting trail is an “agent" and not an “adviser". The adviser is fully compensated by the investor. Let’s unpack the pure distribution model that has the manufacturer paying the cost of intermediation. Who needs execution-only services? Would it be the educated investor who has done her research and is now looking for an efficient payment gateway to make the transaction in a manner that brings operational efficiency or would it be a person who is looking for a financial product and needs somebody to help her with the decision? I’d imagine that execution-only services are needed by the savvy investor who is not looking at a one-fund, one-time transaction but for an ongoing relationship where she can continually invest and manage her investments through one gateway. The uneducated investor needs help—an adviser.
Paradoxically, the educated investor is willing to pay for advice and the uneducated investor is not. We need a market solution that will find a way to compensate the distributor and adviser without compromising on the long-term financial well-being of the investor and is not clunky in its execution to deter the investor or the intermediary. We’ve experimented with upfront commissions and seen the damage they can do to trust, so that’s off the table. What about trail? This is one payment that largely aligns the interest of the investor, the intermediary and the fund manager. The investor wants his long-term corpus to grow. The fund manager and intermediary too earn more over the long term as the investor’s funds grow in size.
I would suggest a twin trail model with zero loads for long-term investment products. For an execution-only vehicle (think online, mobile, e-banking investing), there is a lower cap on a trail commission. For financial advisers—those who actually spend time with the investor on educating her and then finding a product to solve her financial problems—there is a higher cap for trail. All other payments from the manufacturer are banned—no per-form payment, no upfront commission from the fund manager to the agent. For this model to work, we need caps on trails and disclosure annually of amounts paid to distributor and adviser. I would argue for legalizing rebating of trail so that as the net worth rises, the investor is able to negotiate a lower trail. I know that trail commissions are under fire in some markets such as the UK and Australia, but we need to recognize that there is never going to be a perfect solution. For the market that we have today, using trail looks like a way forward. But we need to be open to throw out this model in another decade or so and maybe look at another solution as the market matures and changes.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com
Also Read |Monika Halan’s earlier columns
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