One of the hottest topics under discussion in India, as well as many parts of the world, surrounds the issue around distribution and the customer, and the need to ensure that the customer does not get a raw deal.
Advice that the customer pays for himself or herself, without the perceived conflicts that come with distribution of products with embedded commission, seems the magic formula to ensure the best possible outcome for all.
However, is this magic formula the only solution that can work, particularly in the Indian context? Let us examine it through a few different prisms and see if the formula passes the test or whether there is need for a re think.
Penetration rates remain in single digits for most market-linked products even after more than two decades of these products being in existence. Multiple factors can possibly explain this, but the most common sense reasons seem to be lack of trust, comfort levels with flexibility in return, and a complete understanding of what makes these products tick.
Most would agree that the need to ensure that this penetration reaches a healthier level must be a primary goal, with the secondary being to maximize the number of people invested in the right asset classes, given their financial goals. Advisory services to this day, remains a niche segment, and probably needs a certain level of understanding level at the customer end, to be meaningful.
In a country, where awareness levels remain low, such an approach may not solve the penetration objective. If that were the case, can distribution in an execution mode only, provide the answer? Probably not completely, given that gaining the customers trust and improving his understanding levels needs a quantum of relevant information to be given, which must be allowed within the ambit of the execution service to make it useful.
Conflict of Interest
Very often, conflict of interest between the distributor’s commercial imperatives and the customer’s need is cited as the main issue that needs to be sorted out. Advice that the customer pays for directly is unbiased and, therefore, free from this conflict of interest. But does advice become suitable for the customer only because it is unbiased? I would argue that advice or distribution to be really workable for the investor, must be well researched, appropriate to the customer’s financial situation and needs, and executed efficiently. Mere lack of bias is clearly not enough.
On the other hand, distribution execution services coupled with relevant information, that enables the customer to make the correct decision, may actually help his interests more. Obviously, the conflict of interest issue remains, but maybe a better solution for this would be to enforce complete disclosure of all interests, including commissions received, if distribution execution is the service being offered, as opposed to seeing customer paid advice as the only recipe that works.
Another area of concern is the relatively high cost of products, with embedded commissions. Whilst direct plans are cheaper, and therefore more customer friendly, the saving in costs in many cases, are outweighed by the benefits of information and execution services.
In many developed markets, the concept of multiple share classes exist. In simple terms, it is the offering of the same product with a variety of cost structures, which ensure that irrespective of the diversity of the customer or distributor base, there is a cost structure that comes close to being appropriate for most types of customer-distributor relationships. The current model in India with only two classes - costs available for all customers, and the cost available to the customer who has a high level of awareness and execution capability and comes direct, needs a rethink.
If we adopt a model based on the multiple share class, we will possibly see a decline in costs for most customers, as they can then choose lower cost structures as their needs and awareness evolve. Distributors will also prefer this, as it will give them flexibility to price their services depending on the level and quantum of execution and/or advice involved.
The last bastion remains the after sales conundrum. Critics of the embedded commission model argue that commissions continue to remain, many years after the initial transaction, although the service levels have changed. Advocates argue that there is a cost attached to making sure the customer stays invested, remains updated, and most importantly remains wedded to his or her financial goals. The truth probably lies in between. Moreover, just like multiple share class type models address the cost issue, they also in many ways can address the after sales aspect as well, as mature relationships can transition to lower cost structures that reflect the maintenance need and cost more accurately.
In conclusion, there is no black and white answer to the ongoing debate, but as seen above, there are many ways one can address the issue, by thinking laterally, and creating a common ground. Most importantly, a middle path ensures we continue to succeed in the most important objective – increasing the penetration of market-linked products in Indian households, and helping them in their journey towards financial prosperity.
This post initially appeared in the India Markets Observer 2017 where you can read the perspectives and views of other experts too. It is available to all for FREE. All you need is a minute to register.
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The views are personal and not necessary those of the organization the author represents.