I have written several times in the past about financial products selling agents not acting in the best interest of their clients. This is most prevalent among banks and institutional financial product distributors either Insurance products, mutual funds or any other financial instruments. As I mentioned earlier also, most of the Financial Advisors are acting only for their personal benefits and none of them are bothered about the financial wellbeing of their clients. Be careful about your Bank's Relationship Managers, Insurance Agents or any other financial product selling intermediaries. Even if you don't have time or expertise in investing, try to learn and take right decisions or take investment advices from reliable, knowledgeable and service minded persons.
Note: I am not against financial products selling intermediaries but I am against their mind setting and motive to make money at the expenses of others
Best Regards
Prakash Nair
A comprehensive empirical research study has proved that financial advisors in America have made clients worse off. It would be interesting if a similar study be undertaken in India.
This is the first time that a comprehensive study has proved that financial advisors do not align themselves with clients' interests. It would be interesting to note what the situation would be like in
Financial advisors fail to take the best interest of clients while giving advice, and in some cases make clients worse off, a recent academic paper has concluded. More pertinently, the paper said that advisors encourage returns-chasing behaviour and push for actively managed funds that have higher fees, even if the client starts with a well-diversified, low-fee portfolio. While we do know that sometimes fiduciary duty is lacking and most advisors look after their own interest, the same has rarely been documented and proved in a scientific manner in convincing fashion. In the research paper titled, "The Market For Financial Advice: An Audit Study," Sendhil Mullainathan, Markus Noeth and Antoinette Schoar have concluded that "advisors fail to de-bias their clients and often reinforce biases that are in their interests". In other words, financial advisors do not look after the best interests of their clients. While this academic study is confined to the United States, one wonders what is situation in India.
The researchers audited clients in the Boston area and studied individual portfolios and their advisors. The paper said "(advisors) are unwilling to lean against biases that help them further their own economic interest, e.g. maximise fees. We find that in some cases the advice even pushes clients towards funds with higher expected fees with little change in portfolio diversification and thus would reduce the expected returns on their portfolios." The paper also said that average advisers were much more likely to recommend actively managed funds (49.7% of the cases) versus index funds (only 7.3% of the cases).
It is pertinent to note that an index fund is supposedly one of the soundest instruments anybody can buy in the US with a long-term horizon, "were almost never mentioned by the advisers." Index funds outperform actively managed funds, due to the lower fee component. However, advisors don't seem interested in selling them to consumers as it earns them less income. Sometimes, advisors even churned well-designed portfolios. In the sample universe of clients conducted, the researchers found out that if a client had an index portfolio, advisors suggested changing portfolio in 85.4% of the cases.
It is discomfiting to hear that advisors try to change or modify the existing portfolios, especially when it has an index fund in it. The paper said, "Actively managed funds were recommended especially frequently to clients who came in with an index fund portfolio (61.0% of the time) or just cash investments (75.0% of the time)." An advisor is more likely to advise an actively managed fund, as the fee component is much higher than a passively managed fund.
In some cases, the financial advisor faces pressure to do business and increase sales. So he/she is more likely to mis-sell, even if a client's portfolio is well-balanced and does not need modification. The paper notes, "These results show that even though the meeting between the client and adviser is also a sales situation, advisers are willing to go against the (revealed) preferences of the client and suggest changes away from the current strategy in the majority of cases." They will even butter up clients by acknowledging their good choice only to change the portfolio later on.
This brings us to one important facet of the investment advisory business—fees. Most advisors are only interested in churning clients' portfolios, as it nets them more fees, or advise funds with high fees as we just wrote. The paper said, "Overall, advisers seem to support strategies that result in more transactions and higher management fees." In India, this would usually mean commission-based advisors as—more the churning there is, the higher the fees. However, it doesn't stop here. It was found out that advisors were not forthcoming or honest when it comes to fees. This is a startling revelation. For example whenever pressed about the fees, rather than be honest, they would downplay it or use it differently, to put the fees they earn in good light. For instance, they would say "This fund has 3% fee but that is not much above industry average." This is another form of mis-selling, which we normally see in India.
The failure of the industry and a large chunk of financial advisors to provide fiduciary duty to clients, in an honest manner have resulted in even genuine advisors facing difficulty in finding business. The paper cited, "Advisers who are interested in providing better advice might be unable to gain a market share if biased retail investors are unable to differentiate good from bad advice."
The definition of advisors used in the study was: a person working in a bank, retail investment firm or their own independent operation, focusing on the lower end of the retail segment. Most of them are paid on commission based on the fees and volumes that they generate, and only a small subset of the advisers are independent and would be paid based on capital under management.
Source : MLF
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