Advisers, not funds, can pick ‘suitable’ products To avoid misselling, mutual funds need to create simple, well-defined products so that advisers can choose them as per the specific needs of investors, One of the issues that was raised involved selling suitable solutions to the investor. The argument was that pushing of products has hurt investors and there is rampant misselling. What we need, instead, are products that are sold only after ensuring they are appropriate for the investor. This is a valid point, but my submission is that the problem of suitability cannot be solved by the mutual fund industry. It is a problem that needs the attention of a skilled and competent adviser. Fund managers cannot, and should not, do the job of an adviser. Consider a simple need to save for the education of a child. This need is common, holds high emotional appeal, and is attractive for a service provider to tap into. How does one create a solution that is suitable for this need? The investor has to first set aside regular savings for this goal. Then, an estimate of the return on investment is required. Given the amount needed for higher education, and the sum that the investor is capable of saving, the desired rate at which the investment should grow has to be estimated. The investor can achieve this rate through various means. From buying a house, which can be sold 18 years later when the child goes to school, to buying gold on every birthday, to investing systematically in an equity fund, or opening a recurring deposit account, the investor has various choices to reach the desired destination. However, not all choices may be suitable. The capacity to save and the ability to take risks may vary. A combination of various choices, which is asset allocation, is arrived at. This depends not just on achieving the desired rate of return, but also on how much time is left before the child gets to college, and how much risk the investor is willing to bear without being flustered and worried. Assume that the investor decides to invest in a combination of a PPF account, equity fund SIPs, debt fund SIPs and gold. Next, he has to choose the specific productsto invest in. These choices need to be reviewed to ensure that they are working well and are generating the desired return at the specified risk. As the goals of the investor draw near, the allocation has to be modified. While a higher investment in equity seemed a good decision with 18 years to achieve the goal, the invested amount has to be shifted to debt as the time to realise the money draws closer. If growth is the objective in early years, capital protection is the objective in later years. My argument is that the above process, which represents the tasks a financial adviser will perform in order to meet the specific needs of an investor, cannot be replicated by a mutual fund. Let us assume that a mutual fund or even an insurance company offers a product called a children’s education fund. What this product will typically do is combine equity and debt in a portfolio and offer it as a ‘solution’. A Ulip will add insurance to it. Some may add a bit of gold to the solution. However, it may still not be a ‘suitable’ product. An investor with a younger child needs more equity for growth, and an investor with an older child needs more debt for capital preservation. The amount of suitable equity depends on the time available with the investor, and the risk he is willing to bear. There is a unique combination that needs modification over time for each investor. The fund cannot find a feasible way to ensure that a standard product is ‘suitable’ for all investors who buy it at various points in time. If the fund offers equity and debt funds, an adviser can pick among the best and modify the proportions according to the investor’s need. All hybrid products and ‘solutions’ are bad ideas from funds trying to do the adviser’s job. It is a poor substitute for selecting the best equity and debt funds across fund houses. However, when we compel a fund to do what it structurally cannot, we face more problems. These hybrid funds or ‘solutions’ give themselves flexibility to modify the allocation. They do this to ensure that their returns look good and attracts investors. They increase the equity portion when equity markets are doing well, and increase debt when debt does well. Some of them have the flexibility of being fully invested in equity or debt. All these ‘flexibilities’ make it tough to compare funds in this category and evaluate their performance. For example, how would you compare balanced funds, which have allocations ranging from 65-85% in equity? If you choose one based on its current portfolio composition, what if the manager modifies it? A fund will always be managed with an eye on the expected performance of the markets, while an investor will need attention to his own specific situation. A mutual fund’s primary task is to showcase its ability to create various portfolios of securities, selected through a thorough process of research and managed skilfully at a low cost. Their core job is to beat benchmarks and compete with similar peers to remain at the top of the pack. It is the job of the adviser to go through the process of suitability and select the right funds that serve the purpose of the investor. Funds should compete for the adviser’s attention with their performance track record and the adviser should be able to choose the best funds in a given category, and modify the combination of debt and equity based on what the investor needs. This is reason that placing the onus of creating ‘suitable’ products on the doorstep of mutual funds is completely wrong. A very risky sectoral fund, which invests in just 10 stocks may also be ‘suitable’ for a specific investor, whom the adviser has to hunt down. Mutual funds need to create more and more such well-defined, simple products that advisers can confidently select and use. Instead of doing this, pushing mutual funds towards simplistic solutions is harmful—for funds, advisers and investors.
Posted on: Mon, 01 Jul 2013 04:57:58 +0000
Trending Topics
Recently Viewed Topics
© 2015