Technology Driven Wealth Management Is In The Interest Of Investors

As we approach the twenty-fifth anniversary of ‘liberalisation’ of the Indian economy, the role of Wealth Management/Financial Advisory industry is one of the most visible difference from the ‘pre-liberalisation’ era.  There are reasons for this. The growth witnessed by the Indian economy in the last couple of decades has coincided with a historical reduction in interest rates and a substantial increase in the share of private sector in formal employment.

A historical lowering of returns from fixed income instruments and absence of guaranteed post-retirement income made retail investors test waters with financial instruments other than fixed deposits and insurance products bundled as investment products. This has been encouraged and felicitated by the fund managers and private life insurance companies that have come into existence since 1991.

These developments have corresponded with an explosion in media, across electronic, print and online platforms dedicated to news focused on capital markets and the wider economy. An amalgamation of all these evolved into what is commonly referred to as the wealth management/financial advisory industry.

The cornerstone of this industry is the mutual fund management and mutual fund distribution business. Association of Mutual Funds in India, (AMFI) has 44 members and they manage assets worth Rs 14 lakh crore. There are over 1 lakh mutual fund distributors registered with AMFI.

Although the wealth management industry has seen double-digit annual growth over the last decade and a half, the majority of investors, haven’t seen the same growth in their portfolios. At the same time the equity and debt markets have generated healthy returns at an index level.

The last decade and a half have also seen unprecedented levels of volatility in the equity markets and investors have felt let down by advisors, as calls on realignment of their portfolios has gone missing. Two data points lend credibility to this submission.

Industry estimates that the average tenure of an investor’s participation in an equity scheme is eighteen months. This means the investment in an equity scheme is typically redeemed or switched to another scheme every eighteen months. Anecdotal evidence would back this calculation. The Net Asset Values (NAV) of two of the largest funds in the industry, HDFC Equity Fund and Reliance Growth Fund, have grown from Rs 16.16 to Rs 405.96 and Rs 22 to 714.544 respectively, in the last fifteen years. However, one rarely finds investor portfolios that have delivered these returns.

This ‘churning ‘of portfolio prevents investors from staying invested on a long term basis thus nullifying the benefits of equity investment. Regular switches unfairly benefit the advisors, as advisors are incentivized by fund management companies on deployment of funds to their schemes and not on how long the investors stay invested in these schemes.

The skewed nature of advisor incentive, higher commissions on deployment of funds to schemes called upfront commissions and lower commissions for having clients staying invested in the scheme called trail commissions, has led to a serious of conflict of interest. The investor need to stay invested for a long term but their advisors are incentivized for ‘churning’ their portfolios. 

The second data point that gives credence, to the ‘advisors have let the investors down’ theory, is the allocation to equity funds when equity markets are expensive. Industry estimates that flows, in equity mutual funds go up drastically when index trades at > 18 forward PE ratio.  FY 2014-15 and FY 2015-16 have seen net equity flows of Rs 1.3 lacs crore, out of total industry assets of 4.5 lacs crores. Index has traded between 18-22 forward PE in this period.

This means clients have been advised to invest in equities, at levels from where equity markets have historically given below average returns. The inability of financial advisors to construct the right portfolios and educate investors on the perils of investing on the basis of past returns, deserves closer scrutiny.

Both the aforementioned suppositions lend credibility to the oft mentioned criticism that wealth advisors regularly face. Their inability to translate ‘investment returns’ in to ‘investor returns’

The capital markets regulator, SEBI, has taken cognizance of skewed commission structures. It has forced mutual funds to come up with Direct Plans, these plans do not pay any commissions to advisors and have lower expense ratios. It has also tried to cap the expenses that can be charged to funds and upfront commissions that fund managers can pay to advisors.

Such measures could put sever stress on the business models of wealth advisory outfits. They may struggle to align their existing cost structures to reduced brokerage income. The cost pressures may see advisors deploying funds to investment schemes based on the Portfolio Management Service (PMS) platform or the Alternate Investment Fund (AIF) platform. Both the structures allow fund managers to charge higher fund management expenses to investors and pay higher upfront commissions to advisors. The increased flows to PMS and AIF schemes suggests that this scenario may have started playing out, although the efficacy of PMS and AIF schemes to outperform mutual fund returns is yet to be proven. Also the regulatory requirements vis-à-vis minimum subscription amount, for investing in PMS and AIF schemes, make them unviable for a large majority of investors.

As things stand, the wealth management industry will see a major disruption. The conflict of interest that underlines the industry; advisors with a business model that is dependent on commissions from fund managers and fund managers focused on building distribution by skewing commissions in favor of distributors at the cost of investor returns, will be challenged and eventually broken.

The last couple of years have seen SEBI put in place building blocks of a robust client advisory platform. Advisors can now register themselves as Registered Investment Advisor (RIA) and charge clients an advisory fee. This model will evolve as financial advisors follow the path of chartered accountants. Industry will see Certified Financial Planner (CFA) charter holders freelancing as wealth advisors and differentiating their services on the basis of portfolio performance. The RIA’s will earn their remunerations exclusively from clients and break the conflict of interest that currently prevails in the industry.

The other trend that will gain momentum is technology driven wealth advisory. An online platform that helps an investors design, execute and review their financial portfolios.

A Do It Yourself (DIY) platform that brings the investor and the fund manager on an even keel and does away the cost of an intermediary, in this case the financial advisor. The platform reduces the subjectivity in the financial advisory process and makes it more scientific. It enables investors to design and rebalance their portfolios on their own. They get unbiased advice, ease of transaction and incur costs far lower than their existing cost of portfolio management.

The onus of delivering unbiased and suitable investment advisory will rest on the online service provider, regulator will need to ease the paper work required for investing in mutual funds and the banking system needs to back these two in smoothing the process of money transfers.

However, the key to breaking the conflict of interest in the industry and to delivery of superior portfolio returns, will have to be the investor. Investor’s need to realize that it is their hard earned money and ask advisors the right questions. They need to devote time to educating themselves of the risks that financial investments entail and the need and means to manage those risks. It is about time investors stop being intimidated by ‘expert advisors’ and getting carried away by commentary of media pundits.

As technology enhances its footprint on all walks of our lives, it is only a matter of time before wealth management industry gets a fair share of attention. Do It Yourself platforms, taking away human emotions from decision making and delivering unbiased advisory with ease of transaction and at low cost is clearly the way forward.