Why investors refuse to pay Investors will pay a fee to financial advisers only if the latter can deliver a good performance

One question that refuses to go away is whether investors should pay a fee for investment advice. The proposed new advisory regime, which has been implemented in many other countries, asks advisers to seek fees from investors. The commission paid by producers, such as insurance companies and mutual funds, is being phased off to ensure that advisers do not push unsuitable products to investors. My interaction with banks, broking houses and independent advisers indicates that most of them will choose to remain distributors. Most are not confident of earning adequate fees from investors to replace commissions.      There are three primary reasons why investors are unwilling to pay a fee. First, the risks in a financial product would mean varying rates of return, including a negative return in bad years. The advisers who cannot offer meaningful asset allocation strategies to deal with risk are seen as not adding any value. Second, the services of the adviser seem easily replicable. They are unwilling to pay for expertise when they don't perceive it. Third, several advisers, including some large institutions, pass on their commissions to investors. This practice, though explicitly banned by the code of conduct and ethics, is widely prevalent. Investors are used to being paid for making an investment and would like this arrangement to continue. The issue needs effective policing and penalties.      It is not as if fee is not paid by anyone in the market. There are financial planners of repute, who earn through fees and disclose it as being their only source of income. Then there are those who earn both fees and commissions. Some banks and broking houses charge a fee and debit clients who miss the fine print in the agreement. Alert clients may fight to end this unless they see value in it. The reality, though, is that in a competitive market with mixed practices, advisers fear losing customers if they ask for a fee. Even if they choose to stay out when the Sebi (Investment Advisor) Regulations, 2013, come into force, financial advisers are aware that they have to make a switch at some point in the future. How can they make the transition?      They need to showcase the value they add. If one considers the data on mutual fund assets, three trends are obvious. First, investors buy funds in a rising market and quit in a bear phase. Second, they chase performance and buy into past winners. Third, they opt for new fund offers with no track record. None of these three buying strategies is likely to have made any money, and poor product choice is at the root of investor dissatisfaction. Since distributor push is also partly responsible for these choices, investors do not trust the financial advisers to recommend the right products. In order to charge a fee, advisers should demonstrate expertise in choosing products, be willing to dissuade the investor from buying past winners and NFOs blindly, help them sell losing products, and discourage investing during market peaks.      The sad reality is that today most professionals are unable to demonstrate that their recommendations are based on solid research. Too few advisers have invested in research and most lean heavily on inputs provided by free research that may be generic or focus on the basics. Advisers should publish newsletters, research reports, or studies that demonstrate expertise in analysing a product for its risk, return and performance. To make a case for a fee, independent and rigorous research from investment advisers should be available.      Investors do not perceive any expertise if advisers scurry for cover when they are asked a technical question about the markets or products. The vast majority that has earned commissions from selling insurance and mutual fund products still leans on producers to pay for their learning, seeks short-cuts and sound bites, and prefers 'practical' training that translates loosely into sales tips. The employees of banks and broking houses struggle with hiring and employee quality when relationship managers fall short on knowledge and technical competence. Those with CA CFP or CFA degrees are the first movers in the fee-based model, and each one of them vouches for holding out knowledge as the key to asking for a fee. If customers do not see serious investment in knowledge, they are unlikely to oblige with a fee.      Ideally, advisers should combine prod ucts to construct portfolios that deliver returns within a defined range at a lev el of risk acceptable to the client. The fee is to enable such portfolio perform ance. A fund manager earns a fee for se lecting securities, showcasing perform ance and beating benchmarks. An ad viser should earn a fee for allocating as sets, selecting products, showcasing per formance and delivering for the investor' goals. Without making the investment to get there, advisers may not be able to seek a return in the form of fees. That is the tough transition. Investors and reg ulators have only made it tougher.