Killing the Small Advisor

First they came for the Stock Brokers, and I did not speak out –

Because I was not a Stock Broker

Then they came for the Portfolio Managers, and I did not speak out –

Because I was not a Portfolio Manager

Then they came for the Advisers, and I did not speak out –

Because I was not a Adviser

Then they came for me, the Investor – and there was no one left to speak for me

With due apologies to  Martin Niemöller

SEBI was instituted to safeguard the interest of investors, but the way its acting in recent times makes one wonder if there will be any investor left to safeguard at the end. 

Like any other professions out there, the financial services industry has seen a large number of bad apples. In an effort to remove those bad apples, SEBI is in recent times trying to implement the policy of kill a fly with a cannon. 

While there have been a lot of good moves in terms of regulation with respect to Stock Brokers, the high level of compliance costs and the falling revenues from transactions has meant that brokerage industry is now dominated by a handful of companies with the capital to survive. A small broker with limited abilities stands no chance today.

Portfolio Management Service (PMS) is a unique concept that is not found elsewhere in the world of finance. This was before the arrival of the Alternative Investment Funds the poor man’s alternative to Mutual Funds.

Today, with a Net-worth Requirement of 5 Crores, minimum investment of 50 Lakhs, the concept is essentially dead especially considering that your tax liability is far higher than with Mutual Funds. I wrote about this here 

The small investors who were once serviced by small stock brokers are today advised by either a Registered Investment Advisor or a Mutual Fund Agent. 

SEBI has now floated a Consultation Paper on Review of Regulatory Framework for Investment Advisers. 

Before we get into the paper, let’s try to understand what a Registered Investment Advisor {RIA} can do and cannot do. A RIA can advice his clients for a fee on creating personalised Portfolios using mix of Equity,  Debt and Funds, Asset Allocation and provide Financial Planning services.

What he cannot do is offer execution or directly manage the monies of clients or sell products where he shall receive a commission for his efforts. Of course, the rules are for those who follow and as I wrote in my post, SEBI is sleeping while the regulations are openly flouted

Today and even tomorrow, all it requires for one to sell intra-day tips is a database of phone numbers. Most of them I doubt even go through the registration process that SEBI has put in place let alone adhere to them.

The number of RIA’s that offer Financial Planning is barely a handful in number with most RIA licenses being used to offer Portfolio Advisory which is more simpler and easy to sell. But portfolio’s are not designed with regard to one’s own risk temperament nor is there advice on how much of one’s assets should be invested in what kind of allocation. 

Both of these fall into the bracket of a financial planner who places a lot of time and effort to understand your requirements, get a hold on your limitations and plan the most optimal investment portfolio that suits both your goals and yet doesn’t require to take more risks than what you can bear.

Portfolio Advisory on the other hand doesn’t require a deeper understanding of the client’s financial abilities or even his risk temperament. The advisor is offering a portfolio which is sold on a certain attribute and one that is designed for the do-it-yourself investor who understands the market.

RIA unfortunately clubs both of them in the same bracket even though the type of clients they are different with different set of requirements. Since RIA’s who are individuals are prohibited from providing execution services (Corporate entities can offer execution facilities under a separate company and while this is not to be compulsory, we all know how this works)

A while back, SEBI raised the minimum net-worth requirement for Mutual Funds from 10 Crores to 50 Crores. Next it raised the net-worth requirement of PMS from 2 Crores to 5 Crores. Through this consultation paper, SEBI wishes to raise the Net-worth to 50 Lakhs. While its 10 Lakhs for Individuals with clients lower than 150, given the prices that client can bear, 150 clients with its attendant costs {Office Space, at least 1 employee, etc} means that you barely break-even at 150.

SEBI’s recent thought process seems to be that if you are Rich, you won’t pull wool over people’s eyes. The reason I say this is because Net-worth is basically a deposit that is kept at your end and one that can at best provide you a risk free return. It does nothing to benefit either your working requirement (since you cannot use it to buy assets that depreciate) or the client.

When we try to analyze securities, we try to look for companies that have a Return on Capital Employed greater than 20%. Here, your capital of 50 Lakhs will be basically offering a return of 7%. Since this cannot be used for setting up a new office or employing others, basically this is a dead investment. This is true even in case of PMS or Mutual Funds.  

To add to the misery, the Consultation paper requires some serious investment and monitoring to ensure that in case of a dispute, you are in the clear. SEBI is attempting to do by asking for all conversations to be recorded. This is already happening at the stock broker level and is not new, but adds another layer of cost especially since these records have to be saved for 3 years. While cloud has ensured cheaper storage space, it’s still an additional cost not to talk about ensuring that these files remain secure since it impacts clients privacy.

What is also interesting, though this is not a new requirement is the primacy given to a degree. While we have no standardized way to test the aptitude of an advisor, exams like CFA / CMT and CFP have been recognized worldwide as a good way to filter out candidates. The NISM exam is really a very low hanging fruit and one that can be cleared easily by even those without a deep understanding of finance. 

A person should not be too honest. Straight trees are cut first and honest people are screwed first

Chanakya

SEBI seems to reckon that if you are honest you should be Rich. Given the lack of financial literacy in India, we want more qualified Individuals to embrace the world of advice but by overreaching, SEBI may end up doing the very opposite of what it has set out to do – help the small investor.

Lack of good Investment Advisors is already resulting in mis-selling of products that are not suitable for the investor but yield a good commission to the seller. By enforcing very high standards, SEBI will essentially kill the ecosystem that has just started to blossom. I doubt this is SEBI’s intention though.