Mutual Fund Adviser VS Distributors
The Indian mutual fund industry is evolving very fast, thanks to the pro-active market regulator SEBI which is bringing in regulations that are pro-investor and helping the industry to grow. In one of its circulars last year, it asked the asset management companies (AMCs) to rationalise and categorise their schemes. The purpose of bringing this regulation was to make investment decision-making simple and informed for the investors. Despite, all its efforts to simplify and lessen the number of mutual fund schemes, there are still umpteen number of options available to investors when it comes to investment in mutual funds. The reason for such large offerings is because mutual funds as financial products help people attain their financial goals. As no two individuals will have the same goals and similar financial status, they need different products to achieve their financial goals.
The current practice
Before making an investment, a common investor most of the time looks at the past performance of the scheme to arrive at an investment decision. This is despite knowing the fact that past returns are not the right indicators of future returns and can lead to a wrong investment decision. There are various other parameters that need to be checked before you invest. A mutual fund need to be primarily analysed based on its underlying and their outlook. For example, IT sector was the worst-performing sector till one year back and if anyone wanted to pick the fund purely based on past performance, the IT sector fund would have never appeared on his radar. However, in the last one year, the picture has changed completely and the IT sector has emerged as the best performer, generating on an average a return of more than 30 per cent.
Why you need Advisor or Distributor
Therefore, the past performance alone cannot help you to take wise investment decision. There are other complexities involved when you select a fund and past returns remain only a part of the entire analysis. Understanding these complexities is not easy and you need to put a lot of time and effort to arrive at an investment decision. Besides, as they say, one size does not fit all, and this is true for mutual fund investment as well. Moreover, once you have constructed your portfolio, you need to keep track of your investments and, if need be, do the course correction at appropriate time.
Hence, you need someone to guide you. A financial adviser will help you in managing your financial goals. He may ask you the right questions to understand your needs and make a financial plan for you. After that, he will also help you with your transactions. He may advice you to invest in a specific fund offered by a specific fund house. One of the reason for recommending this specific fund is because he might be distributor of that fund house and may be earning higher commission on selling his product. Due to this tendency, there were cases of conflict of interest and misselling of the funds to the investors. The adviser was playing the role of both distributor and adviser.
The Past
Before the year 2013, there was no distinction made between these two financial intermediaries of the mutual fund industry. However, in 2013, SEBI came out with new regulation which made a clear distinction between distributors and advisers. The distributors earn their revenue in the form of commission by distributing mutual fund products, while advisers earn revenue from the financial advice provided to their clients. The Investment Advisers Regulations of 2013 required all the distributors to act in a fiduciary capacity and disclose to the clients about any conflict of interest. It also made necessary for mutual fund advisers to register themselves with SEBI as a registered investment adviser (RIA). These RIAs cannot earn from commission from the funds they are recommending. The banks and other corporate firms selling mutual fund products were required to separate their distributor and advisory services. However, the same company could offer both the services.
The proposed changes
But these regulations did not give the desired results even three years after their notification. Distributors are still giving advice and earning commission and is reflected in large number of distributors compared to advisors. The distributors outnumbered the advisers by a huge margin. There are only close to 500 RIAs currently compared to more than 1.4 lakh distributors. Therefore, SEBI introduced new consultation paper, which proposes further tightening of the norms and these intermediaries will be asked to make a choice between 'mutual fund distributors' or 'investment advisers'. They will have to register themselves either as 'distributors' or 'advisers'. Anyone using word as ‘investment advisor’ or ‘independent financial advisor’ need to register with SEBI as registered investment adviser (RIA) and distributor as ‘mutual fund distributor’ (MFD). Even the banks and other corporate agents need to have different subsidiaries to offer these two services separately. The proposed regulation also intends to bring brokers, portfolio managers, chartered accountants and company secretaries who give incidental advice to their clients within the ambit of the investment adviser regulations.
SEBI is yet to implement this, but it has received comments and suggestions from industry and investors on these proposals. So, in case these draft regulations become law, how is it going to impact you and what should you do?
If you are an existing investor
You may be already investing in mutual fund and taking the help of an AMFI registered adviser or a distributor who offers you advice too. Once the regulations come into force, you will be no longer allowed to avail both these services from the same financial intermediary. Depending upon what your current financial intermediary chooses to become, you will have to find someone else who provides you the other service.
So, if you are comfortable investing yourself, that is, you know about your risk profile, you can do your financial planning and select right kind of funds to invest, you may not need an investment adviser. At best, you can opt the service of mutual fund distributor who can help you in executing transactions. However, if you want someone to assist you in planning your investment depending upon your goals and risk profile, taking the help of RIA will be better for you.
Nevertheless, before opting for anyone to avail these financial services, you should understand the cost involved in these two services. If you are going for MFD, you do not have to pay anything out of your pocket. The commission component is given by the AMCs. The AMCs in turn take this from you by charging the higher expense ratio. The NAV at which you invest is calculated after deducting the expense ratio. In most of the cases, the expense ratio is higher by more than 1 per cent as compared to the direct funds, which is advised if you take the help of RIAs.
In case you go for MFD, do insist that he disclose his commission structures from different AMCs, so that you can be aware of any conflict of interest before choosing the funds. Although, in the shorter run, the higher expense ratio may not sound an alarming bell to you, but in the longer run, the difference in the return between the direct fund and regular fund can be substantial.
If you go for RIA, you will have to pay for his advice and you should invest in direct funds. There is no fixed fee structure for the services charged by RIAs and hence you can negotiate the fees with your RIA for his services, including risk profiling, goal setting and selecting the right kind of funds. Alternatively, you can use the services of robo-advisory companies that can help you in selecting suitable funds for you.
The experience of segregating these two important financial intermediary services in developed market such as UK has not turned out the way they had expected. Although the quality of advice improved, it led to an advice gap as many small investors find it hard to afford the advisory services. Therefore, a middle ground need to be worked out before segregating these services. For investors, they need to know the pros and cons of each services before availing them.