Wednesday, March 10, 2010

Ask your wealth manager for money back.

A few months ago, I said I wanted to be a mutual fund agent because it was a great life. I change my mind – I want to be a wealth manager instead. Mutual fund agents are limited to earning commissions on just mutual funds, and thanks to SEBI, those are now in the realm of sane amounts. Wealth managers on the other hand, have whole suite of commission eating opportunities – real estate funds, private equity funds, structured products, and if nothing else, the erstwhile ULIP, which was created for everyone except the end customer to make money. It really is a phenomenal life. You don’t really need to make any investment decision and if the client does lose money, you can conveniently blame the fund manager, because you never handled the money in the first place. You appear smart and sophisticated because you can apparently do “asset allocation” and “risk management”, people trust you because they think you know how to evaluate products, when in reality, you are pushing high commission products down people’s throats.

Do you know what the highest selling products in the wealth management market have been?
ULIPS, for one, because distributors are earning as much as 50% of the premium in commissions, entirely upfront. Private equity funds are another market favourite. They can lock-in capital for 3 years, and pay the distributor a hefty 3-4% commission upfront. Why make 1% in trail on an equity mutual fund, when you can sell a client a more exotic product that pays you four times the fees, all upfront?

Even worse, individual investors don’t realize the curse of commissions, because there are no entry loads and wealth managers claim to be product neutral. The reality is murkier. Because a fund house has to pay a distributor commission, he has to charge you higher fees, so there is enough for everyone to eat. The reason equity funds in the US charge 0.75% to 1% while Indian funds charge 2% is not because Indian funds are adding twice the value – it’s because in India, a fund manager has to feed the distributor to survive. The total fee an equity mutual fund manager earns is around 2%, typically paid every quarter. Of this, even after the change in SEBI regulation, the fund house has to pay as much as 1.5% of the fee as commission to the distributor, most of it upfront. The fund manager, at the end, is left with a meagre 0.5%. Moreover, the fund manager is paying the distributor before he earns most of his fees, only to have the distributor convince the client to buy another fund in six months. Besides the atrocious principle that a distributor is earning more than the individual managing the money, the practice is driving fund managers bankrupt. No wonder most AMCs in India are unprofitable. Worse, it’s killing innovation in the investment market because a fund house’s only incentive is to create long lock-in products that can pay the highest commission – think ELSS or tax-saver schemes.

There is a solution to the problem, a drastic one, but one that investors should think about. Wealth manager should be happy with the advisory fees they are charging, and if they aren’t charging advisory fees, they should start charging them. They should then tell the customer exactly what commission they are earning from each product they are selling, and REFUND the whole commission back to the client. A client will see the commission wealth managers earn and the incentives they actually have, and a wealth manager will truly be product neutral. The customer will pay less investment management fees because he doesn’t have to bear the cost of the distributor, and will pay the wealth manager an advisory fee he deserves. The net results – clients will pay for the services they need and investment professionals for the value they actually add, not the bargaining power they have as middlemen. If a client doesn’t need advice they won’t pay for it, and if a wealth manager cannot give advice, he won’t get paid for it. Simple.

End clients are the only ones who can clean the asset management system of the corruption of commissions, ultimately for their own benefit. Maybe then I won’t see clients who have had wealth managers invest them in 95 different mutual funds (and this is not an exaggeration) or 70-year old retirees who have been sold private equity funds by their investment advisor. Maybe then, we will see a growth in what is right now a very small breed of wealth managers who refuse all commissions and are happy just giving advice. And maybe then, the fund managers of the world will design great investment products, rather than great commission generators.

The next time you talk to your wealth manager, tell him to show you a statement of exactly what commissions he has earned. There is enough competition in this market that you, the end client, can get with the question. And if your wealth manager doesn’t agree, find a wealth manager who will, because they exist. Pay the right fees and do all of us a favour – go, ask for cash back.


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