I recall a circular issued by the Securities and Exchange Board of India (Sebi) towards the latter half of 2007, suggesting that asset management companies—those running mutual fund (MF) schemes—introduce a concept called ‘direct plans’, which allowed for a lower cost to investors who do not need an MF distributor to make and manage their investments. That became law only in January 2013, a few weeks before the issue of the registered investment advisor (RIA) regulations.
What did this mean for investors? Those who understood where and when to invest (and also when to exit) and, hence, did not need any type of advice or hand-holding could avoid paying the costs of intermediation, which was largely equal to the commission distributors got. The returns that such investors made on their investments were obviously higher than that of those who paid the cost of intermediation.
The investors of RIAs who paid fees for the advice did not want to be charged double the amount and would ideally have invested in direct plans. However, the data of investment, namely the units allotted and cost-per-unit, would be accessible only to investors. For RIAs to receive this information and consolidate the statement would have been cumbersome, and there would need to be manual interventions to ensure such statements were up to date. This problem was resolved after an October 2018 circular from the Association of Mutual Funds in India allowing the feeds of direct plans to be received by RIAs based on specific consent from an investor. Of course, the process was smoothened only after about a year as used cases were resolved with trial and error.
Two types of direct investors
While the cost structure of direct plans is defined—cheaper than the regular plans that banks or MF distributors offer—what muddles the mix when analyzing the impact of direct plans is that it includes both types of direct investors—those who need no advice, and those who are dependent on, and pay for advice.
So, what is the issue? For the regulator, investor and the RIA, it is essential to track the behaviour of investors and determine the value-add from the intermediary. Did investors who were advised behave differently from the ones that went “direct” when the markets fell in a heap during the onset of the pandemic? Was there value for the fees that the investor paid?
Financial planners who are a subset of RIAs, as per the regulation, know too well that creating an elaborate financial plan and offering advice is not enough—what is essential is that the investor acts on such advice. A few days ago, I read an article in another publication that analysed how direct plans were growing, but ignored the fact that they were also the cheaper plans, which may be advised by RIAs.
What’s the solution?
It is obvious that the purposes of the two types of investments, currently named as direct for both, are poles apart—one is self-directed, while the other is dependent on the RIA. There is a simple solution: create a new term, ‘advised plan’, which can be used for investments made through RIAs. The net asset value can be the same as a direct plan, but the questions raised could be answered.
It will also answer a question I often get asked from new investors when I suggest that as an RIA, we shall invest in direct plans of Sebi-administered financial products: “Will I have to do it all by myself?” It is a small tweak that will result in more than commensurate benefits. Of course, a smart investor recognizes that advised plans are cheaper, transparent and the honest way to go, if only they could find a reliable investment advisor.
Unfair advantage for PMS/AIF?
Sebi has made it clear that the difference between the costs of regular and direct plans of MFs is equal to the commission paid to a distributor. The RIA’s role stretches well beyond investment products to include risk protection, cash-flow and estate planning. In investment products, RIAs would recommend not only MFs, but also bonds, portfolio management schemes (PMS) and alternative investment funds (AIF) for larger portfolios. Why should these product manufacturers benefit at the cost of an investor? At the heart of it, the RIA acts as a fiduciary in the interest of investors—let us make a start by ensuring that all PMS and AIF product manufacturers follow the lead of MFs in providing a clean and fair pricing mechanism of advised plans to their investors. Today, only some do. Is Sebi listening?
Lovaii Navlakhi is managing director and chief executive officer of International Money Matters, an RIA firm.
