05th Sep 2012

Distributors have been keen to understand what role AMFI played in the wide consultations that SEBI held before it announced its decision on the direct share class. As we tried to get some answers to this question, what emerged is that perhaps what started off as a suggestion for a lower cost advisor share class unfortunately got transformed into a low cost direct share class.

SEBI has made three major statements in August : (1) that it believes incentivising good behaviour is a better way than simply mandating it - which is why it came up with the 30 bps carrot for small town penetration, (2) that it wants to promote direct investments, and (3) that it wants to promote advice and therefore has announced its advisor regulations.

If SEBI understands that incentivising is the best way to get desirable behaviour - what is the message it is sending out? Is it pushing Indian investors towards a do-it-yourself culture or is it pushing them towards a new breed of investment advisors that it is keen to create in the country? The share class instrument could so easily have been used to actually incentivise investors to seek good advice rather than go it alone, merely because its cheaper. We suggest a tweak in the share class decision that can actually help drive better intermediary and investor behaviour.

What was AMFI's role during SEBI's consultations on the direct share class ?

In all of the noise surrounding SEBI's decision to impose a lower TER direct share class, two questions that kept getting asked by distributors were :

1. What did AMFI do during the consultative process that SEBI undertook before announcing its decisions on Aug 16th? Was AMFI supportive of the current direct share class? Did it remain a silent spectator when the consultations were being held?

2. What role did AMC CEOs (3), AMFI CEO (1) and the lone distribution representative (1) play in discussions within SEBI's MF advisory panel, when the issue of the direct share class was actually discussed? After all, they were 5 members among them - could they not have sensitised the rest of the panel about the implications of a lower cost direct share class on distributors?

The questions are being asked by a distribution community that wants to know whether AMCs have tacitly been supporting the introduction of a lower TER direct share class - whether this is part of a larger plan to build an independent direct distribution model. Over the last few days, we spoke with a number of AMC CEOs who are on AMFI's Board and some of the members of the SEBI MF advisory panel to get some clarity on their contributions during the consultative phase prior to the SEBI decision. Here is what we have been able to gather :

1. The entire consultative process that SEBI embarked on actually began when AMFI sent a detailed note to SEBI on steps that it recommended for enhancing market penetration, revitalising distribution and improving financial viability of AMCs. A number of AMFI's recommendations - on revitalising distribution and improving AMC financials - have actually been implemented by SEBI, after its consultative process. There was no recommendation for a lower cost direct share class in all of AMFI's wish list.

2. AMFI had recommended introduction of multiple share classes - with a provision for two lower cost TER structures - institutional plans which will be offered for only large transactions, and an advisor share class which will be offered by advisors who wish to build a fee-based model and would therefore sell zero commission products. There doesn't seem to have been any mention of a direct share class at a lower TER which would be offered by AMCs

3. During the consultative process that SEBI engaged in during June and July 2012, several large distributors supported the idea of an advisor share class, as a means to encourage the growth of a fee-based advisory model, which can co-exist with the current distribution model.



4. On the subject of multiple share classes, it appears that SEBI decided against so many share classes and was in favour of only two - distributor share class and direct share class. This proposal was in fact tabled by SEBI for the MF advisory panel to deliberate. From what we understand, the proposal seems to have been very briefly discussed at the Advisory Panel. Some of the AMC CEOs, we understand, raised an objection to this proposal and did highlight that it could impact distributors. It appears that these concerns were set aside as the move was perceived as investor friendly and therefore approved by the Advisory Panel.

5. When the minutes of the Advisory Panel's meeting were circulated to all AMCs and to AMFI, the AMFI Board met and formally decided to oppose a lower cost direct share class.

6. It appears that SEBI went ahead with its desire to create this lower cost direct share class as it remains convinced about the move being investor friendly and fair on the do-it-yourself investor, who does not seek inputs from a distributor.

Which way should SEBI push investors - towards direct or towards advice?

A thought that struck me during all these conversations is this : what should SEBI be really promoting : direct or advice? Instead of SEBI clearing stating that it wishes to promote direct investments, shouldn't it encourage investors to seek professional advice? Isn't that a better form of investor protection?

Now that it has announced the advisor regulations, shouldn't it provide a fillip for this new breed of registered advisors? There is a simple tweak to this share class issue that could have been so much better - and perhaps fair on all :

1. The lower cost share class should be labelled as advisor share class. Only SEBI registered investment advisors will have access to this share class. When investors understand that this lower cost product is available only from SEBI registered investment advisors, there will be a greater willingness to pay for advice. In this manner, SEBI can actually promote and encourage a fee-based advisory model to work alongside the current distribution model. If an investor knows he can get this lower cost product directly from the AMC anyway, his willingness to pay for advice will definitely reduce.

2. Distributors and AMCs will not be able to sell the advisor share class - as they are not SEBI registered investment advisors. This will automatically provide a level playing field between AMCs and their distributors - which does not exist today under the new direct share class arrangement.

3. The chances of the advisor share class being abused are minimal as anybody who becomes a SEBI registered investment advisor will automatically have to abide by the stringent sales process and documentation requirements that come with it. The lower cost product will therefore be offered only after genuine advice has been offered and documented.

SEBI's new mantra seems to be incentivise desirable behaviour rather than mandate it. That is why it offered the additional upto 30 bps carrot to AMCs to embark on a much larger scale small town penetration drive, and the size of the carrot will depend on the level of penetration achieved. This has automatically got AMCs thinking far sharper about small towns than they possibly did in the past.

In exactly the same vein, shouldn't SEBI be encouraging distributors to embrace a more desirable behaviour rather than putting a fear of direct into them ? If SEBI is really keen to see the birth of a vibrant fee-based advisory model in the country, it should actually provide an incentive to distributors to want to become advisors. A good way to start is by providing them exclusive access to a lower cost share class. If the regular share class is priced at 2.5% p.a., let the advisor share class be priced considerably lower - say at 1.25% p.a. Advisors can then ask their clients for an AuM linked fee of 0.75% to 1% p.a. - and still give their clients a better deal in overall cost terms. Investors will get the benefit of good advice and all the protection that comes with advisors being regulated - and this will still cost them less or equal to what they would pay had they not gone to a registered advisor.

We Indians are very value conscious and go instinctively for a "good deal". When an investor knows that he can get good advice from a regulated entity, and that it would cost him the same or perhaps less than what he would have got from elsewhere or by going direct (and therefore that the advice didn't cost him extra money), he is automatically incentivised to go towards an advisor. If the same investor knew however that this product is available at the same low cost directly from an AMC, his quest for the "good deal" will perhaps take him to the advisor for advice and then to the AMC for execution - thus short-changing the advisor in the process.

To conclude

SEBI really needs to think hard about which direction it is pushing Indian investors : towards good advice or towards a do-it-yourself model. How confident is SEBI that Indian investors are now sufficiently well informed and experienced in market investments - and thus able to take their own decisions, without too much of advice or guidance? Conversely, how cognizant is SEBI about the fact that lack of financial awareness is the biggest issue it faces and therefore promotion of an advisory model is a very key priority for SEBI - as it addresses the central issue of investor protection far better than any disclosure norms ever will.

How confident is SEBI that value conscious Indians will not flock towards the direct share class driven primarily by the cost advantage - which is immediately visible - and thus deprive themselves of good advice - which becomes visible only over time? If we really understand the value consciousness of Indians and we really want to promote a breed of regulated advisors, shouldn't SEBI be finding solutions that push investors towards advisors? Shouldn't distributors be given a workable business model to make them migrate towards an advisory model? Shouldn't SEBI offer distributors a carrot to embrace the advisory model in the same way as it is giving a carrot to AMCs to embrace small towns?

If SEBI is really serious about its stated belief that the spread of the advisory profession - which has no conflict of interest - is indeed in the best long term interests of the investors it seeks to protect, then it needs to ask itself a hard question : how exactly is it incentivising entrepreneurs and professionals to become advisors in a country where fees for advice is still at a very nascent stage?

What do you think? Is our suggestion of a low cost share class that is available only to registered advisors a step in the right direction? Will this help create an advisory profession that SEBI clearly desires to see? Are Indian investors better off being incentivised to go direct or to seek the services of a registered investment advisor? Share your thoughts with the industry by posting your comments in the box below - its YOUR forum !