GAMES financial advisors PLAY

Source:Your Money, Times of India, Mumbai,28^th August, Page 37.

Learn the rules thoroughly to ensure that charlatans don’t play roulette with your hard-earned money

 

Shilpa Nayak

 

   BACK in the good old days, you had investment advice thrust upon you only if you were born great or achieved greatness. But that is no longer true; the financial services industry has cottoned on to the great Indian middle class, and is going all out to woo the customer—any customer. Banks, brokerage houses, investment advisors, and insurance agents are all making a beeline to your house or office. What do they want to sell, you ask? Good heavens, nothing! Of course they wouldn’t dream of trying to peddle something you don’t need. They’re Relationship Managers, or Investment Consultants, or Portfolio Advisors. They go by many names these days. And they all profess to have your best interest at heart. They promise to help you manage your wealth, allocate your assets, and invest wisely.
   There’s no denying that investors can always use good advice. Despite having an excellent savings record, Indians are at the bottom of the heap when it comes to financial planning. Left to ourselves, many of us would let our money languish in the solitary confinement of a dingy savings account.
   But today, it’s also true that banks and broking firms offer advisory services. These give the Indian investor a good shot at planning for the future. They can help you evaluate your capacity for risk and identify your investment goals, and then advise you on the investment that best suits your needs. You can get help to properly plan asset allocation based on where you are in your life cycle, as well as get suggestions on regular rebalancing.
   Banks have long offered such services to clients who are high networth individuals (HNIs). Now they offer them to a much larger client base. Over the past few years, Indian brokerages, too, have started offering all kinds of products under their banner as they scaled up distribution. This has introduced many Indian investors to the concept of financial planning, asset allocation and regular investments. So far, so good. Well, then, why the alarmist headline, you’re probably wondering.

Simon says...

The problem is that, as banks and brokerages expand their branches and sales force, they are adding fixed overheads. To break even, they need to increase turnover and generate higher commissions. Financial services is a target-driven industry. And while it’s understandably an imperative for a company’s survival, it also puts its interests at odds with those of its clients. What’s good for the investor may be bad for the advisor, who has targets to meet, and maybe quarterly results to announce. It can lead to unhealthy practices, usually at the cost of the investor.
   Let’s look at the experience of a typical client who’s looking to invest in equities. The relationship manager recommends mutual funds as per the client’s requirements. A few months later, the relationship manager has a new monthly target. This may impel him to get the client to switch to a new mutual fund. He may justify the switch to his client even if it hurts the client’s interests. Many industry insiders admit that this practice is widespread. Some of the biggest banks generate sizeable commissions by churning their clients’ portfolio, often unnecessarily.

Musical chairs    

Long-term evidence shows that an investor is well advised to stay invested for a long period in a good mutual fund. Constant switching is expensive due to the entry/exit loads and the impossibility of chasing returns. But sticking to a mutual fund goes against the advisor’s interests, as a long-term investor yields low commissions of 0.5% per year, as against a new investment, which fetches the advisor 2%. And two switches a year means the advisor makes 4%. Tempting, isn’t it?
   Add to this the fact that new fund offers (NFOs) pay more than 4% as commission. Some go as high as 6%. Little wonder, then, that so-called advisors regularly incorporate a few NFOs into their advice. Investors are to blame, too, due to their infatuation with an NAV (net asset value) of Rs 10. An industry that feeds off this infatuation is hardly likely to educate the investor, or hold his hand and guide him down the path of judicious investing.
   It’s not just equity investors who get the short end of the stick. Debt investors, too, see their interests sacrificed in the race to meet targets. Mutual funds are a tax-efficient route to investing in debt, due to a significantly lower dividend distribution tax, as compared to, say, fixed deposits. But relationship managers at banks have their targets for fixed deposits (FDs), and will try to push investors towards their own bank’s FDs, even though these yield relatively low post-tax returns. Only corporates and HNIs take advantage of debt mutual funds. Many investors don’t even know they exist.

Blind man’s buff    

Another lucrative area for socalled advisors is insurance. For historical reasons, insurance is popularly viewed in India as investment and not as, well, insurance. Indians are over-invested in insurance, but, oddly enough, heavily underinsured. Despite the appearance of new private players on the scene, insurance continues to be sold as an investment product. Hardly surprising, given that commissions are ten times those in the mutual fund industry. For the seller, it’s even sweeter because every policy sold brings an assured recurring income—the investor pays yearly premiums, and cannot withdraw.
   Unfortunately, all the above are standard practices. Industry leaders and regulators should curb these malpractices. But with the large-scale expansions in the industry, and the consequent jump in fixed costs, the pressure to meet targets isn’t about to abate.

Be the referee, not a spectator    

The best way to protect yourself is to educate yourself. You could also get fee-based advice, meaning that your advisor charges a fixed fee to help you structure your portfolio. To be even more cautious, you could actually do business through a different route, so there is no conflict of interest on the part of your advisor.
   Some investors will find it difficult to pay a fee for financial advice, and may have to settle for one of the relationship managers discussed above. Consider that this is likely to prove more expensive in the long run. The best plan of action is to talk with your relationship manager and take his broad advice on structuring your portfolio—and then stop taking his calls. Now, that’s cricket.

IF YOUR ADVISOR...

suggests switching from current mutual fund investments to other schemes
hypes new fund offers as big investment opportunities
insists on building insurance products into your investment plan ...then you may need to look for another consultant!