Investors have lost trust in financial markets today not just because of state of the global economy but also because the trust they had placed in their personal financial advisor has been broken.

Globally, the Madoff scandal started this expose of errant advisors.

The Rs 300-crore Citibank fraud brought the issue closer home in India and galvanised various regulatory bodies to look closely at the fledgling wealth management industry.

Unfortunately, the industry despite being regulated by multiple regulators including the Securities and Exchange Board of India, the Reserve Bank of India, the Insurance Regulatory and Development Authoruity and the Pension Fund Regulatory and Development Authority has not had a cohesive oversight body.

As a culmination of the various discussions held this year between the market participants and the regulators, a self-regulatory organisation is being proposed as an overseer of the wealth management industry by SEBI in a recent concept paper. SEBI is taking the onus for formalising regulations and coordinating with the other regulators.

For an investor to trust him, an advisor needs to be transparent in his dealings. Today quite a few financial advisors have moved to a fee-based advisory model from a model based on compensation by product distribution commissions.

But some institutions who claim to follow the former, in their quest to increase their asset base, have minimised the asset-based fees they earn from a client to as low as zero per cent, but retain all the product distribution commissions.

As per SEBI's concept paper released at the end of September, those who receive remuneration from the manufacturer will be called ‘agents' and only those who receive all their compensation from investors will be called ‘advisors'.

This definition can cause further upheavals for retail investors in mutual funds, as fund houses do rely on IFAs (Independent Financial Advisors) to market products. Most of these IFAs are compensated by commissions since clients are reluctant to pay for advice.

Aligning investor interests

Under this suggested model, price-sensitive non-metro customers may find fewer independent advisors to service them.

To truly align a client's interest with the advisor, the fees for services should only be a percentage of assets as SEBI's recommendation, but with full credit given to clients for all product commissions earned. This would be a fully transparent model if the client's cost is capped.

This aligns an advisor's interest with the client's and minimises asset recommendations based on maximising earnings from product commission. It also makes sure product recommendations are based on a client's risk profile and appetite to withstand market volatility. Recommendations to an investor by an advisor should be based on prudent guidelines where investments are not only diversified across asset classes, but also across asset management companies (AMCs).

Accreditation

Minimal qualifying education requirements, continuing education requirements, accreditation and registration with the regulatory body will root out the unqualified entities and persons from calling themselves advisors.

This should allow a central agency to track the movement of individual advisors across various institutions and will help clients in obtaining an advisor's background, qualifications and track record.

This can be achieved through an investor-friendly Web portal. Errant advisors cannot easily slip through the cracks and resurface at a different institution and continue their wayward ways. Institutions will also be held responsible for monitoring and maintaining records of all client transactions for a reasonable length of time.

SEBI's proposal also includes a clause for grandfathering in advisors who don't have the relevant educational background.

This clause needs to be carefully articulated and enforced since the experience of a person in narrow product sales function may not be comprehensive to enable them to perform the functions of a true advisor.

Educating investors

Above all these, the key to safeguarding an investor's interest is investor education (awareness). Financial jargon needs to be simplified and investor awareness campaigns held to educate investors about the basics of finance.

It is strange to think an investor who spends at least a few minutes carefully picking a kilo of tomatoes which cost Rs 10 does not think twice before investing in the market.

When investors are asked about this discrepancy, it becomes apparent that their actions are governed by their lack of understanding of the investment and blind faith in their advisor. This makes the role of a financial advisor even more critical.

Many a times a client is reluctant to ask questions thinking it may be a basic question and it will reveal his ignorance, but all of us are not experts in all walks of life.

As one does not hesitate to ask a medical doctor basic questions when one goes for a health diagnosis, one should not hesitate to ask questions to a financial doctor when diagnosis and recommendation are made.

Advisor or agent?

A number of today's issues arise from the fact that an investor is unable to clearly distinguish between a product distributor and a financial advisor.

A financial advisor looks at the overall financial picture of a client, including, all assets, liabilities and goals and develops a plan to help the client achieve his objectives. In this process, an advisor spends time not only understanding the investment risk profile but also the financial risk a client can take given the personal circumstances.

No two plans are alike and no two solutions identical but solutions are customised to suit each client's need. A product on a standalone basis may be considered a great investment choice, but given a client's personal circumstance it could be considered poison.

This ability and willingness to make the distinction and act in a client's best interest is what truly distinguishes a product distributor from a financial advisor.

(The author is CEO and MD, ASK Wealth Advisors. The views are personal)

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