Is your wealth advisor truly aligned?

Role of an Advisor

Simply put, the role of an advisor is to give advice which is in the best interest of their client (i.e. you). No other consideration should matter, except what is right for you. And if there are any other considerations, those should be disclosed upfront so that you can weigh the pros & cons clearly. Let us examine what those considerations are, and how each of the 3 cohorts fare on them.

The considerations which impact your advisor, and therefore, their advice.

How do they earn?

There must be an economic alignment of interest between you & your advisor. The advisor is expected to protect your interests, so it is absolutely imperative that you are the only one protecting their economic interest. Hence, only you should pay them for their advice. No one else.

When you have a commission-based relationship with your advisor: these advisors earn from the products or services you buy through them. The product/service provider pays them a commission. Since the commissions vary from product to product (or from service to service), there is always a likelihood that the advice gets influenced by the amount of commission they earn. For example — Equity mutual funds command a higher rate of commission than debt mutual funds (about 2 times). Within the category of equity mutual fund, small & mid-cap equity mutual funds have a higher element of commission. Hence, there is always a likelihood that your advisor nudges you to do more equity (than what you should) and within equity, allocate more towards mid & small cap funds.

When you have a fee-based relationship with your advisor: these advisors earn from you, by way of a negotiated fee. As per the law of the land, if they have a fee-based relationship with you, they cannot earn from anyone else.

Firms falling under Cohort 1 fail to pass this very important test. Whereas, firms falling under Cohort 2 (provided you have negotiated a fee-based relationship) & Cohort 3 pass the test. Logically speaking, there is no incentive for them to nudge you into buying products or services which are not in your best interest. But is this alone adequate? What if the ecosystem in which your advisor operates is conflicted or distracted by other considerations?

The eco-system: what is the organisation structure? How focused is the leadership team?

There must also be an alignment between the organisation’s (and its leadership’s) interest and yours. If the organisation has multiple businesses, and hence multiple lines of revenue, it is naturally in the organisation’s interest that you also become a customer of these businesses, even though it might not be in your interest. The leadership’s focus is also naturally divided, as they must do justice to every business.

Firms falling under Cohort 2 have at-least two lines of businesses – clients who sign up for a commission-based relationship and those who sign-up for fee-based relationship. Your relationship manager will also have both types of clients. The commission-based business will have its own set of priorities, very different from the fee-based business, which can impact the organisation’s product selection decisions. Usually, the commission-based business has a dominant share of total revenue of the organisation. It is useful to ask the %age share and also understand the reasons why the fee-based business has a smaller share. Is it a conscious decision of the leadership to focus more on building the commission-based advisory business?

Besides, such firms might have other lines of businesses. For example: in-house investment products & services, which then competes with other similar products & services in the market. While your relationship manager is technically aligned since you are paying a fee, if the firm he/she represents has in-house products/services, there will be both a structural and commercial bias towards in-house products/services. Even if a better (or cheaper) product/service might exist outside, your relationship manager will be either constrained and/or incentivised to nudge you towards in-house products/services.

Firms falling under Cohort 3 have a single line of business which is fee-based advisory. So the only product they have on offer is ‘advisory’ and the only source of revenue is the fee you pay them. Hence, they are driven only by what is in your interest and wherever the best product, service, solution, platform exists — they should put those in front of you. You can be rest assured that their advice is not beholden to any other consideration.

However, there are just a handful of such firms.

Why so? What Explains the Skew?

• Investor awareness: There is a general lack of awareness about the conflicts of interest and how those conflicts can impact the quality of advice.
• Reluctance in paying for advice: Further, as explained earlier, many believe that in the commission model, they are getting advice for free. Hence, when a firm asks for a fee, there is reluctance.
• Compliances: The compliances for the fee-model, as prescribed by SEBI, are quite stringent. By comparison, the compliances for the commission-model are much lighter. As a matter of fact, the regulator, as of now, does not even recognise the commission model as a legitimate business to dispense advice. SEBI (the regulator) prohibits them from giving holistic advice.
• Lack of resources: Building investor awareness requires a lot of resources to be invested with no guarantees of near-term rewards. This requires people not just with a high degree of conviction but also access to deep pockets.

At Serenity, we are fully convinced about the future of Cohort 3 and look at the current skew as an opportunity. We have been steadily building our advisory practice and will continue to do so.