The principal-agent relationship in financial advisory refers to a fiduciary arrangement in which the agent (wealth manager) acts on behalf of the principal (investor), avoiding conflicts of interest while receiving appropriate compensation.
In a fee-only model, the investor directly compensates the wealth manager with a transparent fee, aligning the advisor's interests with those of the client. In contrast, commission-based advisory means that the wealth manager receives commissions from product manufacturers based on the investor's purchases. Commissions deducted from investments can lead to potential conflicts of interest.
The fundamental difference is based on trust and shared interests. Commission-based advisory violates the principal-agent relationship because the wealth manager acts as an agent for the product manufacturer rather than the investor. This dynamic undermines investor trust because the advisor may prioritize products that pay higher commissions over the investor's best interests A fee-only model fosters genuine trust by ensuring that the wealth manager's advice is objective, increasing transparency, and protecting the investor's financial well-being.
Factors Driving Growth
Several factors have contributed to the growing adoption of fee-only financial advisory services in India, reflecting changing investor expectations. The introduction of direct mutual fund plans has caused investors to question the value of investing in more expensive regular plans. They are now looking for more cost-effective financial guidance. Further, SEBI's unambiguous fee-only advisory guidelines encourage professionalism and transparency in financial services by differentiating between commission-based advisors, also referred to as distributors, and comprehensive, independent advisors.
Wealth managers have long been trusted by Indian investors, including the ultra-wealthy. But in 2008, a leading institution unveiled a novel fee-only advisory model that defied expectations and showed that advisory services could flourish without conflicts of interest. This move established a precedent, inspiring others to follow suit.
Although investor awareness has increased, adoption remains low, with fewer than 1% of advisors licensed to provide fee-only services. Nonetheless, this indicates a gradual shift in the way investors value unbiased and transparent financial advice.
The fee-only model promotes transparency by aligning the wealth manager's interests with those of the investor, as per the principal-agent relationship. It ensures investor-focused decision-making by prioritizing optimal asset allocation, which accounts for more than 90% of return variability.
Additionally, it allows for unbiased product selection and protects investors from market distractions, resulting in a trust-based advisory framework. In India's changing financial landscape, this model emphasizes the importance of transparency and professionalism in meeting investors' growing demand for unbiased financial advice.
Simplifying complex financial concepts and emphasizing the benefits of unbiased, transparent advisory services can help to foster trust.
Challenges and Opportunities
Regulatory and technological advancements are driving the shift to fee-only financial advisory in India, but some recent regulatory changes pose challenges.
SEBI's position that mutual funds oversee commission-based wealth managers (mutual fund distributors) is problematic. Many mutual funds rely heavily on distributors, who have in recent years pushed for a higher share of the management fees charged by the mutual fund to the investor from the norm of 50% to going up to as high as 80%. Expecting mutual funds to regulate distributors undermines the integrity of the fee-only advisory model, as commission-based managers frequently give advice that contradicts regulatory principles.
Furthermore, SEBI's recent approval for fee-only advisors to offer commission-based products outside of its purview undermines investor trust. When investors put their trust in an advisor, they expect conflict-free, comprehensive advice rather than compartmentalized guidance that could lead to biases. On the technological front, social media presents numerous opportunities for awareness and education. Fee-only advisors with significant resources can use these platforms to differentiate their services and promote the advantages of unbiased, investor-aligned financial advice, bridging the knowledge gap between commission-driven and fee-only advisory models.
Fee-only advisors in India face numerous challenges, including regulatory hurdles. SEBI's current stance seeks to balance financial inclusion and advisory, but it unintentionally supports the distribution industry's dominance due to its widespread reach throughout the country. This short-term approach prioritizes accessibility, but it exposes investors to market fluctuations without proper awareness.
India's severe lack of financial literacy exacerbates the situation. Campaigns like Mutual Funds Sahi Hai encourage investment but fail to educate investors on key distinctions like equity versus debt. As a result, retail investors are frequently unprepared for market downturns, causing financial stress during periods of low returns. To address these challenges, fee-only advisors must prioritize investor education via awareness campaigns and social media. Simplifying complex financial concepts and emphasizing the benefits of unbiased, transparent advisory services can help to foster trust. Collaboration with educational institutions and workshops can improve financial literacy, allowing investors to make more informed decisions and embrace the fee-only model
About the Author
Ashish Khetan is the Founder of Serenity Wealth, a SEBI-registered fee-only investment advisory firm based in Mumbai. With nearly 30 years of experience in wealth management and financial services, he specializes in business development, wealth management, and business strategy. During his distinguished career at Kotak Wealth Management, he served as Chief Operating Officer and Practice Head for Family Office and Estate Planning. A graduate of Delhi University with Masters in Finance from the Department of Financial Studies (DFS), Ashish is committed to transparency and fostering trust in wealth management.
