In the ongoing bull market, hordes of new retail investors have been taking to equities for the first time, becoming a target for sharp operators to woo with the prospect of stellar returns. The pitches range from brokers showcasing sky-high returns on algo trading strategies, to derivative traders-turned-educators sharing fake P&L screenshots to lure folks to their courses. The Securities Exchange Board of India’s (SEBI’s) proposal for an independent Performance Validation Agency (PVA) to verify performance claims is a good attempt to impart greater credibility to such claims so that investors can sift the wheat from the chaff.
SEBI has proposed that the PVA verify returns showcased by registered entities for a fee. It has suggested that the agency be set up as a subsidiary or an affiliate of stock exchanges. The setting up of an independent PVA is certainly a positive for regulated players operating in portfolio management services, mutual funds, research analyst and investment advisory services, and brokers offering proprietary trading strategies. So far, genuine claims made by law-abiding players in these segments were drowned out by tall claims from dubious operators. Now, legitimate players can make their claims stand out by securing a stamp of accuracy from the PVA. Earlier this year, in a bid to stop mis-selling, SEBI had barred all registered research analysts and advisory services from sharing any performance numbers in their client communications. This was a blow to the business, as return record is a key input to investors looking to choose between advisors. The creation of a PVA will enable research analysts and investment advisors resume the use of performance data.
But if SEBI expects the PVA to put a stop to all exaggerated performance claims by regulated entities or to deter unregulated entities from duping investors, such objectives are unlikely to be met. In markets, there are always avenues available to money managers looking to manipulate performance data. They can use convenient start and end dates for return calculations, extrapolate past returns into the future, present short-term results as durable, or attribute returns earned by fluke to skill or a ‘proprietary’ process. SEBI has put the onus on the PVA to ensure that entities do not cherry-pick data. But as the PVA will be compensated by market players seeking validation, it is moot if it will turn down assignments based on hair-splitting over data.
The creation of the PVA may also have limited impact on unregulated entities making outlandish claims in private pitches to investors over the phone or social media. It will be up to the investor to demand PVA validation in such cases, and to reject the services of players who refuse to provide verification. SEBI can create investor awareness about the PVA mechanism. But it cannot solve for retail investors giving in to greed.