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I wrote last week (Click here) an article on why I believe SEBI's RIA consultation paper is anti-investor. With over 5 crore MF folios, the industry now serves over 1.5 crore unique investors, most of whom are served by the distribution channels as we know them today. A very small percentage of individual investors have gone direct and an even smaller percentage have opted for a fee-only advisor.
Huge positive shifts in distribution trends in the past decade
Over the last few years, in an effort to enhance investor protection, SEBI has been steadily raising the bar on sales processes and disclosures. Product suitability responsibilities, EUIN capture at a transaction level, tighter mis-selling regulations - all of these have been implemented to protect investors - and all of these are very welcome steps.
Distributors have also progressively adopted more investor centric sales processes over the years - the most visible one being a goal based approach to selling SIPs. Trends of inflows into equity funds over the last 10 years clearly suggests a remarkable shift from the erstwhile NFO culture to a culture of selling track record and consistency of performance. Funds that perform sell - irrespective of whether they come from a big brand or a small one.
Two key trends that highlight the remarkably positive shift in distribution trends is the stupendous rise in SIPs as a proportion of total inflows and the huge importance of performance more than any other factor that drives fund sales. As an industry, we should be proud of the huge behaviour shift that has occurred in the last decade.
Would not have happened if incidental and basic advice were banned
Both achievements would not have happened, by the way, if distributors were restrained from offering advice that is incidental to distribution, and were asked only to talk about features of debt and equity funds. They would not have recommended funds based on track record and consistency of performance - because they would not have been allowed to make any recommendations. They would not have engaged investors into goal based discussions, identified an appropriate amount to be saved for a defined need, identified an appropriate asset class to invest into and within that asset class, and then identified the right fund to commence a SIP in - because all of this is going far beyond just describing the features of debt and equity funds, and enters into the territory called basic and incidental advice.
To be fair, the behaviour shift was also aided by regulatory intervention. Ban on entry loads was the first step towards reducing churn - which was a huge problem for the industry. Consistent pressure on reducing upfront commissions - culminating in a 1% commission cap on upfronts, has effectively killed overenthusiasm in selling closed ended funds, and done its bit to reduce churn in the open ended category. The recent decision on enhanced commission disclosures - though unpopular with distributors - will do its job in terms of putting pressure on excesses if any, on commission payouts. And finally, the regulator induced investor education drive of the entire industry has certainly done its bit in terms of educating investors about investing sensibly.
Why undo all the good work now?
The collective efforts between regulatory intervention, distributor upskilling and education and investor education, have resulted in a situation where the quality of inputs that investors get today from mutual fund distributors is hugely superior to what they received a decade ago. Investors are clearly better off as a consequence.
And now, in one fell swoop, SEBI wants to unwind all the good work of the last decade in which it too has played a part - by suggesting that going forward, distributors should be stripped off any responsibility to offer incidental advice and make any recommendations. As I said in my earlier article, regulators around the world are trying to see how they can raise the bar on investor protection - irrespective of whether you are a distributor or an advisor. SEBI will now be the first regulator to actively work towards reducing investor protection. On what basis can SEBI be certain that most distributors will seamlessly migrate to the RIA model, thus ensuring continuity of service and adequate protection for 1.5 crore investors? On what basis can SEBI take such a risky gamble, where it wilfully lowers protection for 1.5 crore investors, in the hope that this move will force migration to the RIA mode of all the intermediaries who are currently serving these 1.5 crore investors? The track record of adoption of the RIA model by intermediaries over the last 3 years certainly will not inspire any confidence in the merit of taking such a huge gamble and putting 1.5 crore investors' interests at risk. And the track record of countries like the UK and Australia, who took this gamble earlier, clearly suggests that the gamble did not pay off for retail investors as it resulted in an advice gap in the retail segment - which these regulators are now working overtime to address.
Let investors decide - don't make the decision for them
The question that SEBI needs to consider is not how to force migrate intermediaries from one channel to another, but how to ensure that the investor gets a wide choice and is well protected in all options. A mature regulator will not make a choice for the investor - it would rather understand that the investor is mature enough to make his choice. Open up options, push for disclosures, ensure investor protection in all options - and then leave it to the investor to decide what he thinks is right for him.
SEBI has already done all of this. It has opened up choices by introducing direct plans (though the pricing mechanism of these plans needs to be reviewed), by introducing the RIA fee-only model and by working towards introducing e-commerce platforms as an alternate channel. It has already done what it needs to do on commission caps and perhaps more than what is really needed in commission disclosures. This would normally have been a time for SEBI to step back, and allow market forces to take over, and let investors decide what they want. To now jump back into the ring with a proposal to make one channel look so bad in the eyes of an investor and thus force migration of this channel to one that has not yet established its commercial viability even 3 years after its introduction, is a needless step that I believe will do more harm than good for investors.
3 recommendations for SEBI's consideration
A mutual fund distributor represents fund houses and earns commissions from them. He is by definition not product agnostic, as he is a fund distributor. An advisor represents the investor and is by definition supposed to be product agnostic. He does not hold himself out as either a fund distributor or an insurance agent or a retirement advisor - he holds himself out as a financial advisor who will look at the entire universe of options to recommend that which he believes is most appropriate for his investor. And he gets paid by the investor for this service.
In keeping with this well-established principle, I believe a sensible way forward is the following:
Mutual fund distributors - as suggested by SEBI's paper - should not call themselves anything other than that, to ensure that they don't mislead an investor about their proposition. Equally, they must focus only on mutual fund distribution and should not distribute any other products. They must, for the sake of investor protection, continue to be responsible for product suitability and must undertake to do risk profiling of their clients to establish product suitability. They must be allowed to recommend specific funds, and must be mandated to have a clearly spelt out process through which they come up with their recommendations. The "incidental advice" that they offer alongside mutual fund distribution, must be retained as such, in the interests of investors. They must be encouraged to adopt investor friendly processes including goal planning, asset allocation and periodic rebalancing - and should not be asked to discontinue such services because they fall under the ambit of "incidental or basic advice". The SRO for MF distribution must be formed without further delay, and it should be tasked with ensuring compliance with laid down sales processes. Just like we have the concept of scrutiny of income tax returns which is taken up on a sampling basis and on the basis of identification of "sensitive" parameters, the SRO must take up scrutiny of sales processes of distributors on a sampling basis, to cover big and small distributors. Any multi-product distributor (an intermediary who sells mutual funds, insurance, bonds, NPS etc) is automatically scanning the entire universe of alternatives before recommending one to his investor. It is only fair therefore that such an intermediary be asked to migrate over the next 3 years to the RIA model, and formally position himself as representing the investor and not an array of different product providers across categories. The FAQs published by SEBI in early 2015, took this position. Now, in a sharp reversal of its own position, SEBI is suggesting that even if you are not a multi-product distributor, you will have to register as an RIA if you try to offer basic advice on only mutual funds. This new position is not investor-friendly and must be reversed back to the position it took in early 2015. By doing this, SEBI will automatically make RIA an aspirational intermediation level, as many progressive intermediaries will be keen to offer the widest range of solutions to their clients. But those who are happy to remain focused on only mutual funds, must be allowed to serve their investors well, by giving them basic and incidental advice related only to mutual funds, without being compelled to become RIAs. SEBI must be pragmatic about allowing multiple options for fee recovery for those who migrate to the RIA model. When I speak to RIAs, one of the biggest impediments they share with me is that many investors who opt to pay the agreed fee on a quarterly basis, tend to hold back fees in quarters where market performance has been disappointing. Imagine an advisor saying, "Sir, this quarter the market went down by 4%, but our judicious management of your portfolio resulted in your portfolio going down only by 2%. May I please have my cheque for this quarter?" Many clients don't like cutting a cheque when their portfolio statement says they lost money. So in effect, an advisor's fees are significantly influenced by performance of markets, on which he has no influence or control. Imagine a situation where fund expenses were not deducted every day from the NAV, and investors were told to authorize payment of the agreed TER every quarter, and only upon this authorization, fund houses can debit the schemes to recover fund expenses. How many investors will willingly authorize this quarterly payment in quarters where the schemes lost money? If SEBI can understand this practical issue, it must permit fee recovery by RIAs through the transaction processing mechanism of fund houses. Let an investor decide, at the time of filling out an application form for a fund investment, how much he is authorizing as advisor fees to be recovered on a quarterly basis from his investment amount. Let there be a cap (of say 1% or 2%) to restrain sharp practices. Once an investor fills this box in the form with say 0.5% p.a., let the R&T agents recover 0.5% p.a. on a quarterly basis from the investor's folio and arrange to pay this to the RIA. What this does is to put the power of deciding the fees in the investor's hands (which is what SEBI wants), but then automate the process rather than have an investor decide every quarter whether he wishes to honour his commitment on fees or not.
Next steps
If our industry's stakeholders believe that these 3 recommendations are pragmatic, there needs to be a collective effort to put the point across to the regulator. To start with, AMFI must put together a crisp presentation with data over the past 10 years, which clearly showcases changing distribution trends as articulated in this article. Hard data is what is required to showcase clearly to SEBI how investors are today much better off now, in an environment where they are benefiting from "incidental and basic advice" from mutual fund distributors. Data on 10 year SIP flows as a percentage to total inflows, data on sale of funds with 4 and 5 star ratings as compared to lower rated funds over the last 10 years, data on inflows into NFOs vs existing funds - all of this will help showcase how investors are being better served today than they were 10 years ago, thanks to enhanced focus on basic and incidental advice. Its only when we are able to put these points clearly to SEBI, that we can hopefully help them understand the risk of undoing a lot of good that has happened in the last 10 years, and therefore the risk that SEBI will be exposing existing fund investors to, if it goes ahead with its RIA regulations as envisaged.
Its time I believe, for AMFI to take a firm stand on the merits of the current distribution model (with basic and incidental advice) from an investor protection standpoint. Its time for AMFI to proactively mobilize support for this stand from all quarters that can influence SEBI's thinking.
Its time for AMFI to commission an investor survey among existing investors to determine what they think about not getting any advice from their distributor and about paying a fee for advice, rather than having the cost of this advice embedded into product cost.
Its time in short, for AMFI to proactively work on multiple fronts and not just submit a single written response - if it genuinely believes that SEBI's proposed RIA regulations will do more harm than good to existing fund investors and the industry.
Will AMFI, under its new leadership, please take these ideas forward?
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