If you’re an active investor, or even someone who likes to keep in touch with the latest investment trends, you would have heard about SEBI’s directive asking investors to deal only with SEBI Registered Investment Advisers (RIAs) and to ensure that they pay the RIAs only through advisory fees. This has sparked a bit of a debate because investors are wondering whether they should really be asked to pay for investment advice.
It’s not that we’re strangers to paying fees for advice; we all pay our doctors, lawyers, accountants for their advice and services. With investment advice though, it may seem like we’re already getting it free of cost. Bank relationship managers, insurance and mutual fund agents, numerous mutual fund or insurance awareness websites, expert articles online, are all giving investment advice for free. So why should we now be asked to pay for it?
Unfortunately, there is no such thing as free advice. Globally, financial products have sold well with the commissions-driven remuneration structure because investors feel that they are getting free service and advice just by buying a product. But most of this ‘free advice’ is either too simplistic and generic to be of any use, or worse, is a sales pitch to meet a certain sales quota.
Thus, investing successfully with free advice is a bit like trying to cure an illness by consulting a pharmacist instead of a doctor. Can it be done? Sure. But should we do it? Probably not if our lives depended on it.
The people advising us have to be paid – whether by fees (paid directly by investors), or commissions (determined and paid by product manufacturers). Having an opaque commissions structure embedded in the product cost is the de facto distribution model around the world, including India, because it is the most effective way to promote sales: investors feel they are getting advice and transaction services for free, and the product manufacturers can devise various means to incentivise sales. It is a win-win for both the sellers and product manufacturers, but not for the investors.
But with the retail investors investing into the markets in larger numbers, a few facts have emerged universally: 1) The traditional model where selling or advice costs are hidden in the products have led to mis-selling and general distrust because the distributors or agents are biased towards the product manufacturers – there is no one looking out for the investors’ best interests; and 2) Generic, product-focused advice, even where well-meaning, fails to give investors holistic guidance on managing and growing their wealth. Investors need better quality of advice, and consistent coaching, to be able to invest successfully and meet all their life goals.
Since 2012, several countries around the world, notably the UK, the European Union and Australia had issued legislations banning commissions, raising the qualification bars and requiring standards of fiduciary duty and increased disclosure from financial advisers with the aim to increase transparency, trust and quality in the financial advisory industry.
India was the first country to do so in Asia; in 2013, India’s Securities and Exchange Board (SEBI) launched the Registered Investment Adviser Regulation (2013), mandating that only qualified professionals who are licensed by it as Registered Investment Advisers (RIAs) can advertise themselves as ‘advisers’. And that they can only be remunerated by their clients in the form of fees. As a result, mutual fund distributors, share brokers and insurance agents, who would earlier double up as our de facto investment advisers, can no longer claim the title.
With the fee-based model and standardisation for adviser qualifications as a regulation, SEBI aims to ensure that:
# Advisers, like other fee-based professionals, are only accountable to their clients (investors)
# They operate under a strict code of conduct and can only offer advice that is in the investors’ best interests, disclosing any conflict of interest while doing so
# They are subject to monitoring and audits to ensure that they follow best practices in managing and administration of investor records
# Advisers can do more than basic risk profiling, take a 360-degree assessment of our financial health, and build portfolios that include more than one product
# They are capable of developing ‘financial plans’ that can help investors make rational and disciplined investments, protecting them from making emotional investment decisions in volatile markets
Ultimately, though, does paying fees for investment advice make monetary sense for you? Can you be assured that you will get better results on your portfolio by going with a fee-based adviser?
Yes, it does, and this is why:
# When the adviser is working for you, and sitting on the same side of the table as you, they will recommend cheaper product options because their income does not depend on the commissions from the products they sell. Across multiple investments, and multiple family portfolios, this can make a significant reduction to the ‘Total Expense Ratio’ or TER, of your investments. The late John Bogle, legend of low-cost investing, estimated that hidden costs ate away as much as 2/3rds of an investor’s return over the long term. Thus, simply by reducing costs, fee-based advisers can help you make more money.
# Without the influence of the commissions paid on specific asset classes (equity pays the highest commissions), you can be sure that the asset allocation for your risk profile and financial goals will be aligned without bias. The adviser will also reduce your risk exposure where necessary.
# A fee-based adviser will perform disciplined portfolio reviews and rebalancing throughout all market movements, without worrying about the impact to their income. For example, moving from equity to fixed income when the markets become overvalued or to realign to the target asset allocation, will not result in lower income for the fee-based adviser. Asset allocation and disciplined rebalancing also helps to generate risk-adjusted returns in the long term.
# Finally, as the client, you have the power to choose the level of service you want; to assess the adviser on their performance; and ultimately, to stop paying fees when you aren’t satisfied with their service. With commissions, you do not have this control, and continue to be charged for the distributor’s commission, long after they stop giving you service.
Thus, with the fee-based model, SEBI aims to nudge investors towards goal-based, holistic financial planning in an environment of complete transparency and trust.
(By Erik Hon, Managing Director, iFAST Financial India Pvt Ltd)