A few months ago, I met a young professional who had just started investing in mutual funds. He saw advertisements saying ‘ Mutual Funds Sahi Hai ’ (which translates to ‘Mutual Funds are good’).
He wanted to invest ₹75,000 for a year. He read a few posts and some news articles. Then he went to a website that displayed mutual fund returns data. He sorted the returns to find the scheme that had given the highest one-year return and invested in that scheme. He was pleased that this investment process took less time than buying online, where one must compare prices, coupons, and cashback offers from e-commerce websites.
But in actual fact, this investor inadvertently purchased a sector fund at elevated market valuation, with very high mid-cap allocations.
This reminds me of the 2007-08 period prior to the financial crisis when investors forgot that return of capital is more important than return on capital.
India’s middleclass relies heavily on “advice” from friends, family, insurance agents or bank employees. Often, this advice is not correct due to lack of financial education or intentional mis-selling of products. Unfortunately, the young professional’s portfolio size of ₹75,000 is too small for the well-trained wealth advisors.
With only around 755 SEBI Registered Investment Advisers (RIAs) for a population of 1.3 billion, India has a significant advice gap . Appropriate investment advice must reach the masses for real financial inclusion.
Technology tools to automate good quality, personalised investment advice are being developed by Robo-advisors. Robo-advisory in India is at a nascent stage and poised for significant growth. Successful Robo-advisors are expected to leverage advances in artificial intelligence and machine learning to transform the investment advisory landscape in the next decade.
When we discuss regulations for Robo-advisors, there can be various aspects such as security audit, periodic review of algorithms, disclosure standards and reporting requirements. When we hear the word “regulation”, the common perception is that some compliance processes gets added to increase the cost of doing business, eventually curtailing innovation. However, let’s focus here on positive regulations that can benefit all stakeholders in the mutual fund industry, including robo-advisors.Steps to follow
The following regulatory steps will go a long way in deepening penetration of mutual funds in India.
Simpler KYC process : Paper-based KYC remains one of the most resource-intensive overheads. The Aadhaar-based eKYC only permits an investment of ₹50,000 per year per Mutual Fund House. This is insufficient for even a monthly SIP of ₹5,000 per month.
Unnecessarily, investors may need to purchase schemes of several fund houses to take care of this limit. If digital firms have to process paperwork for full KYC, costs will remain high. An annual total limit of at least ₹5 lakh with eKYC (no separate limit at Fund House level) is a better solution.
The government is encouraging all citizens to link their Aadhaar card number with their bank accounts by the end of 2017. If this initiative gets implemented, then from January 1, 2018, full KYC for mutual funds should get automatically completed when the investor submits the Aadhaar-linked bank account number. The mutual fund industry need not duplicate KYC efforts of the banking sector.
Digital consent-based portfolio data : A long-term investment strategy is based on the investor’s financial goals, risk profile, time horizon, liquidity needs and tax implications. A Robo-advisor with limited past investment data may not be able to provide holistic advice.
A service that is based on explicit digital consent of the investor (may be through Aadhaar OTP) can be structured such that the RTAs deliver relevant portfolio data via secure APIs to both RIAs and MFDs. Investors should also be able to revoke this access to their consolidated investment data.
Use of Aadhar-based eSign : Although ‘Digital India’ is a trending buzzword, wet signatures and paperwork have not reduced significantly. There are many low-risk operational processes that need not require wet signatures. Greater use of Aadhaar-based digital signatures can reduce paperwork, increase process efficiency and make Robo-advisors cost competitive while maintaining useful audit trails.
Flexibility to decide business models : Robo-advisors should be allowed to continue their operations either as an RIA or MFD. Now, innovative apps are available for retail investors to start investing with just ₹500 in Liquid Funds.
However, these apps cannot charge an advisory fee for low transaction amounts. Small investments need to be encouraged for financial inclusion. The flexibility to decide suitable business models, either RIA or MFD, will encourage innovation.
Robo-advisors aim to improve investment experience : Investment experience should not be confused with convenience or user experience. For a good investment experience, the necessary condition is a stable growth of money over a period of time with an understanding of the risk-return trade-off. Investment experience should not be evaluated at the time of buying; it will be experienced at the time of selling.
Sorting schemes by returns and investing based on past data is not generally accepted portfolio management strategy. It is probably mis-buying where the young professional equates financial investments with buying a product on an e-commerce platform. Robo-advisors can help solve this ‘advice gap’.
The importance of sound financial advice may not be realised when the markets keep going up. However, for the Twitter generation with attention span of 140 characters, we must qualify: “Mutual funds Sahi Hai” w ith professional advice and financial research.
The writer is a CFA, Member, India FinTech Forum and Founder, CashRich
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