Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Sophisticated products + complicated solutions = disaster

The concept of a sophisticated investor does not exist in India at present

There are more benefits to being part of the global financial advisory community and interacting closely with them than I would have imagined. One of them is keeping a finger on the pulse of events in other countries, so that we can prevent similar disasters, or be ahead of the curve in anticipating what actions our regulators may take next.

A few weeks ago, a good friend (and an adviser whom I hold in highest esteem) from Australia tweeted the link to an article (read it here: http://goo.gl/ij78Cg). My exchange of tweets with him led to the germination of this article.

“Macquarie advisers cheated on competency tests and exposed clients" was the worrying headline in question. On the surface, this does not seem to have any relevance to India, but on digging deeper, I feel it is worrisome due to a number of reasons. Let me highlight the more important ones and I’m sure you’ll get the drift.

The advisers at Macquarie cheated to clear the competency test, said the article. What adds fuel to the fire is that their management helped them cheat. Trusting an adviser who has demonstrated high competency but swings the other way on integrity will ensure greater harm than good.

Don’t get me wrong. I am a strong advocate of advisers being competent and knowledgeable. They need to clear competency tests not just set by law, but also higher standards based on global experience and best practices. Honesty, however, cannot be compromised.

As advisers, we have committed mistakes in the past and are likely to repeat them in the future too (hopefully newer mistakes). The first action to take in such circumstances is to inform the client. The next step is to evaluate if there’s a loss to the client, and arrange to compensate for the loss. What is of paramount importance is that the client is informed, even if there is no financial loss. This enables the adviser to demonstrate her belief in transparency.

When you are choosing an adviser, do not go by the acronyms that follow the name. Dig deeper and ask questions that reveal the adviser’s true self. For example, there are good chances that someone who is used to cheating on a test paper would not think twice before cheating professionally too. Of course, justification may come by way of downplaying the extent of the crime, but I do not know of only a partially dishonest person.

Laws are in force to ensure that investors are protected. However, investors cannot seek refuge under that umbrella alone: they have to be careful too. Do not be careless with your money. Irrespective of how much you trust your adviser, make it a point to ask questions on your investments.

An adviser with right intentions aims to create an informed investor out of you and hence will be more than willing to answer your questions in detail. In the Macquarie case, investors were asked to sign a document which made them “sophisticated investors". What that meant was a confirmation from them that they understood all risks on their investments and could not blame their advisers if things went wrong. Yet another instance where the moral is: Ensure you read every document before you sign it.

As advisers, we tend to focus on the risks that investors need to take to meet their goals. However, a risk tolerance test will determine how much risk the investor is mentally ready to take. This allows advisers to have conversations with the investor in case the risks required to meet financial goals and the capacity are widely divergent. The test allows for a deeper understanding of the concept of risk and allows for a optimal investment plan. It allows for realization and appreciation of the fact that the financial plan is a trade-off. It is all about priorities, and what one may need to sacrifice.

The adviser is responsible for the advice given to the client. The advice is based on the information that the client has shared with her. Apart from financial data, the investor’s dreams and fears play an important role in the devising of the plan. If some of these remain hidden, it may be difficult to pin responsibility on the adviser if some of the goals are not achieved. The financial adviser is like a family doctor and symptoms are a vital piece of information in the treatment prescribed. Hiding such facts from your adviser is a sure shot recipe for dissonance at a later date.

The concept of a “sophisticated investor" does not exist in India at present. But there are certainly sophisticated products which are placed on the investor’s buffet table so as to complicate matters. Investors seek variety and advisers dish out these products through a fire sale.

Complicated products, which can form the basis of cocktail conversations, are hardly the vehicle suited to get you to your destination. But till you as investors look through the options offered with a fine toothcomb, “advisers" will be laughing all the way to the bank.

Lovaii Navlakhi is founder and chief executive officer, International Money Matters Pvt. Ltd.

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