Yesterday we looked at the reasons why a financial adviser could well be a necessity.
This post looks at the different types of entities offering their services.
MUTUAL FUND DISTRIBUTOR (MFD)
Mutual fund distributors are registered with the Association of Mutual Funds in India and are required to abide by AMFI guidelines and code of ethics. AMFI issues a license known as AMFI Registration Number, or ARN, which permits distributors to sell mutual funds. This license is valid for a period of three years. You can search the AMFI website to see if the distributor’s license is still valid; you can also check here if the distributor’s license has been suspended for any wrongdoing.
Distributors earnings are tied to the amount of assets invested through them. For instance, if you invest Rs 10 lakh in an equity fund, a distributor who has opted for full-trail model could earn Rs 10,000 a year, assuming a trail commission of 1%. This commission is paid by the asset management company from the total expenses charged to the fund. If your money grows to Rs 15 lakh in three years, the distributors income will grow proportionately. On Rs 15 lakh, the distributor would make Rs 15,000 a year. Similarly, if your fund value decreases, commissions go down.
While it is in the distributor’s interest to make sure the funds they recommend perform well, some may sell schemes which offer higher commissions or help them qualify for prizes/junkets. Always ask your distributor the rationale behind a recommendation.
A few distributors also charge investors a fee on top of receiving commissions.
MFDs are required to pass a basic NISM Mutual Fund Distributors Examination VA Examination. Some distributors might have additional certifications offered by institutions like NISM, Bombay Stock Exchange, National Stock Exchange, Financial Planning Standards Board of India, or FPSB, and American Academy of Financial Management India. But they are not required by regulations.
Though not mandatory, distributors may even have CFP certification which is a rigorous test on personal finance administered by FPSB India.
REGISTERED INVESTMENT ADVISER (RIA)
These advisers are registered with Securities and Exchange Board of India. RIAs are held to onerous rules as compared to mutual fund distributors. However, this does not necessarily mean that MFDs are not qualified to offer sound advice. There are many distributors who are equally qualified as RIAs but have chosen not to register with SEBI due to ambiguity on the direction of RIA regulations. Holding a RIA license is the business call of an adviser.
RIAs will charge an ongoing fee for their services. Usually, the RIA will charge you a flat fee for preparing your initial financial plan and an ongoing service fee. Here are the two types of fees which most RIAs charge:
- Percentage of assets: This fee is similar to the trail commission discussed above. The only difference is that in this case it is directly collected from you and not the fund company. The percentage of fee depends on the size of assets. Generally, it is 1% of assets initially and goes down as your corpus increases.
- Flat fee: A fixed fee on an annual or quarterly basis as agreed upon by you and the adviser.
RIAs will prepare your financial plan after understanding your goals and financial situation. Some RIAs also hold ARN licenses through a family member or separate entity. They might charge you a fee and implement your financial plan through the ARN license of the family member by offering you regular plans. Regular plans carry 0.50%-1% higher total expense ratio (depending on the fund category) which eat into your returns. Ideally, RIAs should offer you direct plans since they are already charging you an ongoing fee.
The decision to implement the plan through the RIA is up to you. You may choose to execute it on your own. However, many investors prefer to implement the plan through the RIA.
To become RIA, a person must have a post graduate degree in finance related topics or a graduate in any discipline with five years experience in financial sector. Additionally, he/she has to pass these two exams (Level 1 and Level 2) conducted by NISM. In lieu of these two certifications, the person can pass CFP as well.
There are some RIAs who are purely fee only advisers. Fee-only advisors charge you a fee and are not compensated by fund houses for the products they recommend. But they are few and far between. Lately, many RIAs are transitioning towards moving their client assets from regular to direct plans. There are around 922 RIAs in India. You can find their information here.
NATIONAL DISTRIBUTORS and BANKS
Many national distributors like NJ India, Prudent, IIFL Wealth, Bajaj Capital, Karvy, including banks operate as mutual fund distributors.
Over the years, banks have become dominant players in mutual fund distribution. You must have been approached by your bank relationship manager to start a SIP or buy a unit linked insurance policy. Bank sales executives are issued Employee Unique Identification Number, a seven-digit unique alpha numeric number, by AMFI for recommending mutual funds. Make sure you ask for this EUIN and note it down. This will help you trace the person in case you have been mis-sold a mutual fund and the executive has quit his job.
We would advise you to exercise caution while dealing with bank relationship managers as you might end up with a product which does not suit you. Banks have a white list of products to recommend. If you bank with ABC Bank and if the bank also has an asset management business, chances are that the RM would sell you schemes of ABC Mutual Fund. Banks would give priority to their own brand. There’s nothing wrong with it. But you need to see if ABC Mutual Fund has a good track record and suits your goals.
Similar to mutual fund distributors, majority of national distributors and banks operate on commission driven models. They are offered commissions by mutual fund companies from the annual fund expenses. Thus, their revenues are tied to the quantum of assets under advisory.
