To Pay Or Not To Pay

As per the securities and exchange Board of India (Sebi) portal, there are a little over 500 registered “Investment Advisors” active in India today. These 500-odd individuals and corporations are spearheading a brave new crop of financial intermediaries in our country; bolstered by a bold belief in their ability to command fees directly from their clients, they have sworn off commissions.

Sebi first rolled out their ‘Investment Advisor’ regulations in 2013, declaring war on the plethora of commission-driven mis-selling practices, which have tormented the ill-fated Indian investor for decades. Essentially, the ambitious regulations call for a clear segregation between the profession of “selling” financial products, and the profession of dispensing advice.

In October 2016, the regulator took matters a step further by releasing a hotly debated consultation paper proposing even stricter, tighter investment advisor regulations. For instance, the flippant usage of terms and designations such as “wealth manager” and “financial advisor” have now come under the Sebi lens, along with mutual fund distributors who earn commissions and provide ‘incidental’ investment advice to their clients.

Sunil Sebastian, founder and chief strategist of Chennai-based Radiant Orchid Investments, is in the process of transforming his practice to a fee-only advisory model. “This will help us institutionalise our positioning as a true fiduciary; offering unbiased, conflict-free recommendations and advice, based on what is most advantageous to the client,” he says. Sebastian plans to apply for a Registered Investment Advisor license by March 2017.

Besides Sebi registered investment advisors, CFPs (certified financial planners) have long been attempting to reshape the nature of their client dealings to a “fiduciary” nature; a term most clients in India don’t quite understand yet.

Under the fiduciary standard, all conflicts of interest must be disclosed clearly and all dealings between the advisor and the client must be conducted with full transparency. As it stands today, commissions represent the single largest conflict of interest that stands in the way of such an arrangement. An IGIDR (Indira Gandhi Institute of Development Research) paper published in 2013 used public data to estimate that Indian investors incurred a staggering loss of about Rs 1.5 trillion (Rs 1.5 lakh crore) owing to mis-selling of life insurance products alone, between 2004 and 2012!

Ranjeet S. Mudholkar, vice chairman and CEO of Mumbai-based Financial Planning Standards Board India (FPSB India) cautions investors against seeking out ‘free’ financial advice. “The free might actually be costlier, and prove to be expensive eventually,” he warns.

This raises a pivotal question related to your personal finances: should you seek out a fee-based financial advisor in 2017? To be clear, a “fee-based advisor” is, for this exploration, one who earns zero commissions from the sale of products and earns 100 per cent revenues by billing clients directly in lieu of advice.

The Benefits of a Fee-Based Arrangement
Globally, there is evidence that a fee-based arrangement works in favour of clients by aligning their advisor’s interests with theirs. In a commission-centric model, there is always a one-off chance that an intermediary’s product recommendations are coloured by their vested interests. This problem all but evaporates under a fee-based arrangement, as the intermediary no longer stands to profit from the sales of high commission products.

Second, since the client decides whether to pay for the service or not, it forces intermediaries to come up the curve and continually better their standards of advice and service to stay competitive.

Third, since the client holds the power to pull the plug on the relationship at any time, thereby affecting the intermediary’s future income stream; the malpractice of “selling and forgetting” is put to the sword, leading to a more long-term, enriching working relationship that benefits both parties eventually.

Mudholkar draws our attention to a 2014 study conducted by investment company Vanguard that concluded that a financial advisor can add “as much as 3 per cent incremental value in net portfolio returns per year” by helping clients make smarter financial decisions. Compounded over several years, this could add up to a mammoth figure. Over the long run, good advice can indeed translate into tangible wealth creation.

A Challenge for Well-Meaning Intermediaries?
Noble intentions and obvious benefits notwithstanding, a critical question hangs in the air: that is, are clients in India ready to pay fees in lieu of financial advice? Make no mistake; this would require a massive attitudinal shift on behalf of investors, too. After all, they would need to migrate from their unenviable but comfortable stance of unwittingly incurring hidden costs, to actively writing cheques to their advisors!

Sebastian is of the view that empowered clients will have no objection to paying fees.“An empowered client is the greatest brand ambassador, and we do not expect major hindrances in our next phase of evolution with a fee only remuneration structure,” he says.

Subhabrata Ghosh, director of Kolkata-based Step Ahead Investment Advisors (a Sebi Registered Investment Advisor) shares Sebastian’s confidence. “Most clients are not averse to paying fees. In fact, we realised that it is our mental block and lack of self-belief that creates the myth that clients are averse to paying fees,” he says.

What’s the ‘Right’ Fee Amount?
Globally, fees are usually charged as a percentage of assets, and fee-based advisors typically employ tiered structures that are contingent upon portfolio size. These are discussed and signed off at the time of entering the agreement.

In India, we are still at a very nascent evolutionary stage with respect to fiduciary advice; therefore, a clear range for what may be construed as a ‘fair’ fee arrangement is yet to be firmly established.

However, when one considers that the average fees charged in a lower growth market like the US stands at 1.3 per cent, an annual fee of 1.5 per cent to 2 per cent of assets managed may be an equitable arrangement in a market like India, which offers far higher prospects for asset appreciation.

Fee-based models in India are likely to undergo incremental evolutions over the next decade.“It has been an evolving process for us, and we are trying to create a win-win model for all concerned,” says Ghosh.

Two Key Questions to Ask Before You Sign Up
If you have made the decision to migrate to a fee-based advisor, there are still two key questions you need to ask your prospective money manager before you sign up. These are:

1) What is your investment strategy and philosophy?
Remember that you are paying for advice; and the last thing you would want to discover later is that you weren’t receiving any real advice at all!

Although CFPs and RIAs (registered investment advisors) are both subject to fairly rigorous testing and continuing education criteria, this doesn’t automatically guarantee that they have a robust plan of action in place with respect to your investments.

Pay particularly close attention to the strategy that your advisor professes to have with respect to evaluating your risk profile, screening investment products for quality, and periodically rebalancing your portfolio.

Admittedly, there is no one-size-fits-all approach to managing investments, but it is important that your fee-based advisor has a disciplined and repeatable approach, preferably having withstood the litmus test of at least two complete market cycles.

2) What am I really paying?
If you’re shelling out fees, you’d want to be absolutely certain that you’re not double-paying by incurring commission costs alongside in any form or shape. SEBI’s RIA registration process, for instance, asks the would-be advisor to sign a declaration stating that they would not obtain “any remuneration whatsoever from anyone but the client”; and this includes “soft dollar” arrangements with product manufacturers that could effectively serve to distort the quality and objectivity of advice. Counterintuitively, a very low fee might not be the best advisor selection criterion; as it could indicate that your so-called fiduciary advisor is earning moneys from other hidden sources. Before you begin, make sure that your advisor comes clean about all income that’s indirectly or directly accruing from your hard-earned capital; it’s your right to know.

Mudholkar encourages investors to seek out the services of a fee-based advisor, stating that: “It is indeed wise to hire a professional expert advisor and pay for financial advice, as it can have a serious and long-term impact on your overall financial well-being”.

This year, consider migrating your portfolio to a fee-based advisor; but do so with a hint of caution. It is still early days for the fiduciary model in India.