This is a reproduction of an email I sent out this morning to the venerable Securities and Exchange Board of India (SEBI) attempting an explanation of why I think they are barking up the wrong tree – dangerously – when it comes to imparting (much-needed) financial literacy in India.

Sirs,

This refers to the news item reported at http://cafemutual.com/news/industry/8913-either-charge-a-fee-on-financial-advice-or-get-commission-on-mf-distribution and specifically to the para that reads:

Quote (numbering added for readability)

New proposed rules for MF distributors

  1. MF distributors can only talk about mutual fund schemes.
  2. Distributors cannot provide financial planning services to their investors which involves risk profiling, financial goal setting, and so on.
  3. Distributors will have to disclose the commission they earned.
  4. Distributors will have to clearly explain to their clients why a product is suitable for them.

Endquote

At the outset, let me confirm that I am in complete agreement with the proposition that a mutual fund distributor (MFD) should get a commission on the distribution activity while NOT charging a fee for financial advice.

In our own practice we do NOT charge our clients any fee and our sole income is via commission on mutual fund distribution.

I would like to submit that while item 3 is acceptable, items 2 and 4 are directly in opposition to each other and both assume a level of financial literacy on the part of the investor that is frankly absent in the general investing public.

Financial advice, I submit, is a concomitant part of the distribution activity and in the real world cannot be reasonably separated.

As a distributor I cannot explain why a (mutual fund) product is suitable to a specific investor without an understanding of that investor’s risk profile, financial goals etc. To essay an explanation of a product’s suitability only in general terms defeats the whole purpose of the exercise which is to ensure that an investor is aware of the risks entailed in investing in a particular product, risks which may be specific to that investor’s situation and needs, rather than merely product-specific.

To illustrate, a fixed maturity plan may satisfy the investor’s requirement of a low-to-moderate risk investment but may fail the investor’s specific liquidity requirement. Unless, as a distributor, I am aware of these conflicting requirements in that investor’s specific situation I will not be able to do justice to the requirement “to clearly explain to their clients why a product is suitable“.

Further, in our practice we have become acutely aware that to many of our clients both new and old, we serve as a source of education on investing in general and mutual funds in particular. Clients do not want us to “only talk about mutual fund schemes” as they are looking for education, guidance and reassurance about investing and about mutual funds and one cannot reasonably fulfil that role without talking at least by way of reference about other investment vehicles. One is not ‘selling’ the other vehicles but comparisons are inevitable (and indeed necessary).

Financial literacy in our country is abysmal and even well-educated and intelligent clients view investing as an esoteric and arcane discipline that is beyond their understanding. It should be (but is not) taught at least at college level as an essential life skill. Given this general lack of financial literacy, MFDs are often the first point at which people even start thinking of investing and to bar us from imparting this literacy is both senseless and dangerous.

And the only effective way to impart this literacy is to work with clients on such areas as risk profiling, financial goal setting and financial planning. A blanket ban on MFDs assisting in such areas is, I repeat, senseless and dangerous (to the investor).

Instead, I would submit that the ban be on charging for financial advice, not on providing it. If you want to provide advice AND charge for it, don’t distribute. If you want to distribute, some level of providing advice is essential and necessary, don’t penalise it.

Best regards,