Due Diligence. Are you dealing with an advisor or a distributor?

When you buy shares of a company in the secondary market, you do it through a stock broker; when you buy insurance or pension products, you go through an agent. These intermediaries work for the brokerages or commission they earn, either from investors or from the company whose products are sold through them. Things are simple in these segments.

But once you get into mutual fund investing, the confusion begins. The person through whom you have been buying and selling mutual funds, who calls himself/herself independent financial advisor, wealth advisor, etc., might be just an agent earning commission from the fund house. This is true of online mutual fund platforms as well.

If your requirement stops short of buying and selling mutual funds, you can continue to deal with your friendly agent who calls himself an advisor and throws in some advice on various funds, as an aside.

But if you need comprehensive guidance on structuring your portfolio according to your goals and want your investments to be mapped to your risk profile, then you need the real ‘investment advisor’.

The distributors’ fraternity and the regulator, the Securities and Exchange Board of India (SEBI), have been on the warpath over the last five years over the distinction between investment advisers and distributors.

SEBI wanted distributors to stop styling themselves as advisers and giving ‘incidental advice’ to investors, since such advice is not regulated. The regulator had also been telling investment advisers to earn only advisory fee from their clients and not take commission from mutual fund AMCs since that leads to conflict of interest wherein the advisor sells only those schemes and plans where the commission is higher.

The distributors have been arguing that the Indian investor is not mature enough to choose schemes himself and needs to be advised. Advisers say that since investors in India are reluctant to pay for advice, they should be allowed to earn commission from AMCs. SEBI once again buckled to the distributor lobby in December 2016, allowing status quo to be maintained — that is, mutual fund distributors can continue to give advice that is ‘incidental’ to their main business, and advisers can earn commission from fund AMCs, albeit through subsidiary companies.

But back to the primary question, how to make out if you are being served by an investment adviser or a mutual fund distributor?

If the advice given to you is directed at the product that is being sold to you instead of taking into account your overall investment need and profile, it is likely that you are dealing with a distributor who has styled himself as an advisor.

When you deal with an investment advisor, he will look at your entire portfolio, your financial goals and risk profile while giving you advice.

Another test is through the fee that is charged from you. A distributor, who earns his revenue from the commission, will not ask for any advisory fee. But financial advisors registered with SEBI will ask you to pay a fee for the advice they give. You might have to write a separate cheque as advisory fee if you are dealing with an investment advisor.

You must also be ready to reveal the details of all your assets and liabilities and your propensity to take risk, if you are dealing with an adviser. Such disclosures are not required when you are transacting with a mutual fund distributor.

If you decide that you need your entire investment portfolio overhauled, you need to approach an investment advisor registered with SEBI. The regulator has laid down strict guidelines on the way these advisers go about their jobs, the documents they maintain and the disclosures they make to ensure investor protection.

The advisor will initially seek information from you such as your age, investment objectives, including time horizon, income details, existing investments and assets and risk tolerance and liabilities. With these details the advisor will assess your capacity and willingness to absorb losses.

All investment advice given by the advisor will be matched to this risk profile and the justification for every product recommendation has to be documented.

If the investment advisor is also earning any consideration or compensation, in any form, on the advice given to the client, through any of his associate or subsidiary companies, it has to be disclosed to the investor. The advisor should maintain an arm’s length relation with such subsidiaries.

Any other material information or fact that might compromise the objectivity or independence of the advice should also be revealed to the client.

Besides the basic records of the client’s profile, the advisor has to maintain a record of investment advice provided, along with the rationale for arriving at the investment decision, duly signed and dated.

These records need to be maintained for a minimum period of five years and have to be audited yearly and are open to inspection from SEBI. There are also formal channels through which investor grievances can be addressed.

The choice is, however, yours, whether you want to just buy and sell through your mutual fund distributor or whether you want more comprehensive advice. There are around 658 investment advisers registered with SEBI and the list is available on http://www.sebi.gov.in.

If you do not think that your investment portfolio requires a financial advisor or if you think that you want to learn the art of investing yourself, it might be a better idea to buy direct plans of mutual funds from the fund houses. The saving on distributor commission can amount to a substantial gain when compounded over the long term.