Why SEBI could kill off Fixed-Fee-Only Fin Planning & Jack Bogle’s legacy

If an individual Fixed-Fee-Only RIA engages with a client with a net worth of Rs 40 cr, then the RIA may have to live at below the official poverty line! SEBI RIA Avinash Luthria explains why SEBI's new RIA regulations on the anvil can do more harm than good

image of a man standing before broken tiles representative of the broken SEBI's proposed regulations that could kill off fee only financial planning and Jack Bogle's legacy

Published: January 26, 2020 at 11:05 am

Last Updated on

SEBI is trying to kill the Indore-type-RIAs. But instead, SEBI is most likely going to kill Fixed-Fee-Only Financial Planning and the Boglehead approach to investing. SEBI RIA Avinash Luthria explains why and how it will affect you, the retail investor.

Avinash Luthria is Fee-Only Financial Planner & SEBI Registered Investment Adviser (RIA) at Fiduciaries.in; He was previously a Private Equity & Venture Capital investor for 12 years and has a flagship-course MBA in Finance from IIM Bangalore; He writes about Financial Planning & Investing in Business Standard, Mint, MoneyControl, The Ken, VCCircle etc. The full list is available here: https://fiduciaries.in/articles/. Views expressed here are of the author and do not necessarily reflect the views of FreeFinCal

‘Indore-Type-RIAs’ is a term that has emerged to refer to a large number of fraudulent operations, many of them are SEBI Registered Investment Advisors (RIAs) and others pretend to be RIAs but are not. A majority of them are based in Indore (there are also legitimate RIAs based in Indore) and many are also based in other cities all across India. These Indore-Type-RIAs have been cheating investors out of a significant amount of money. SEBI is right in worrying about this and is trying to stop this.

SEBI constituted a ‘Working Group’ of industry participants to propose changes in regulations to stop the Indore-Type-RIAs. The ‘Working Group’ mainly consisted of a powerful lobby of (a) Distributors (b) Percentage-of-AUA (Assets Under Advisory) RIAs and (c) others including those that are both Distributors and Percentage-of-AUA RIAs and enablers of such groups. Such a Working Group naturally resulted in proposed regulations that will help that powerful lobby; drive most Fixed-Fee-Only Financial Planners & RIAs out of the profession and hence hurt investors. Since this lobby is extremely powerful, it is very likely that these proposed regulations will get implemented.

There are several destructive aspects of the proposed regulations but let’s stay focused on the most destructive aspect. Let’s look at (a) how it most likely kills Fixed-Fee-Only Financial Planning and the Boglehead approach to investment advice; (b) how this will impact you and (c) what you can do about it.

1 How SEBI is most likely going to kill Fixed-Fee-Only Financial Planning

Fixed-Fee-Only Financial Planning and all excluding the last name in Freefincal list of fee-only planners ) is a simplistic term to describe RIAs who are Financial Planners who minimize conflict of interest by charging clients based on the number of hours of effort that they put in. This is like how a doctor or a lawyer charge their clients. Doctors and lawyers don’t charge you more just because you have a higher net worth. They charge you based on the number of hours of effort that they put in. Since the Fixed-Fee-Only Financial Planning approach is still nascent in India, most such RIAs currently charge all clients the same fees and put in a roughly similar amount of effort for all clients. Such Financial Planners do not charge clients a percentage of the client’s Assets Under Advisory (AUA). SEBI is yet to carefully define AUA so, for now, you can think of it as roughly similar to the client’s net worth (i.e. a total of all assets minus total of all liabilities).

Fixed-Fee-Financial Planners’ fees are approximately the hourly fee of that RIA multiplied by the fixed number of hours of effort by the RIA. The hourly fee of the RIA is usually a function of the experience and qualifications of the RIA. Some RIAs have an approach that involves 5 hours of effort with new clients while other RIAs have an approach that involves 20 hours of effort with new clients. There is a tendency for clients with a higher net worth to gravitate to the 20-hour approach and clients with a lower net worth to gravitate towards the 5-hour approach, but this is largely the client’s choice. Clients may or may not continue the engagement beyond the first year. During subsequent years, the hours of effort that RIA puts in is roughly half and hence the fees are also roughly half (for a more detailed description, see ‘How should you select a Registered Investment Adviser (RIA) to engage with?‘.

Due to a combination of these factors, Fixed-Fee-Financial Planners currently typically charge between Rs 15,000 and Rs 35,000 during the first year of the engagement (‘First-year Fees’) and between Rs 8,000 and Rs 15,000 in subsequent years of the engagement (for brevity ’Renewal Fees’).

SEBI’s proposed regulations limit the total AUA of all clients of an individual RIA, put together, to Rs 40 cr. I am a Fixed-Fee-Only Financial Planner & RIA and I follow a 20-hour approach that attracts relatively higher net worth individuals. For me, this would mean engaging with just one client with a net worth of Rs 40 cr will ensure that I cannot engage with any other client. And since currently all clients that choose to renew the engagement pay Renewal Fees of Rs 15,000 per annum, this would mean an upper limit on my total revenue of Rs 15,000 per year. Or if I engage with two clients each having a net worth of Rs 20 cr, then I could engage with a total of only two clients. Again, with each client currently paying Renewal Fees of Rs 15,000 per annum, this would mean an upper limit on my total revenue of Rs 30,000 per year! This is not a typo. This is in the ballpark of how India officially defines the ‘poverty line. So, if an individual RIA engaged with a client that has a net worth of Rs 40 cr, then (even absurdly assuming that the RIA has zero business costs), the RIA should live below the official poverty line! This is how SEBI is likely to kill Fixed-Fee-Only Financial Planning.

Other such individual RIAs also have some proportion of clients with a relatively high net worth. But let’s assume that to mitigate the impact of the proposed regulations, another individual RIA (let’s call him ‘X’) is forced to terminate the engagement with any client that has a net worth of more than Rs 3 crore. Let’s say that after rebuilding his profession in this manner, X now has clients with an average net worth of Rs 2 crore. To visualize this, visualize a 60-year old retired couple with a net worth of Rs 2 cr and no pension. Their net worth allows them to spend Rs 55,000 per month including to cover rent, health insurance etc. So, you would not call them rich. Let’s call such a couple ‘Y’. The Rs 40 cr AUA upper limit would let X engage with only 20 such renewal clients. Let’s say that X’s Renewal Fees are Rs 8,000 per annum. Do remember that X is engaged with clients with a budget of Rs 55,000 per month in retirement. So, X wants to provide value-for-money and hence X has to offer a low-priced service. X would earn revenue of Rs 8,000 per annum multiplied by 20 which is Rs 1.6 lakhs per year. Even absurdly assuming that X has zero business costs, this is clearly unviable!

SEBI’s proposed regulations dictate that if an individual RIA would like to engage with more than this number of clients, then the individual RIA should re-register as a company (or Limited Liability Partnership) within 6-months. This involves (a) the RIA taking Rs 50 lakhs of the RIA’s personal net worth and investing it into a company and the RIA cannot use this money even in case of a personal emergency (b) the RIA paying SEBI higher fees of Rs 1 lakh per year and (c) the RIA incurring lakhs of costs per year in additional compliance costs of a company.

Some Fixed-Fee-Only Financial Planners will not be able to spare Rs 50 lakhs from their personal net worth. And they will be forced to exit the profession (See Melvin Joseph’s quote about this in an article in Business Standard.

But let’s focus on the sub-set of Fixed-Fee-Only Financial Planners that will be able to spare Rs 50 lakh as the price to continue in this profession. Such RIAs will have to now or later pass on these cost to the clients. RIAs with a high revenue will be able to spread this additional fixed cost over a large revenue base and may increase their fees by 25%. RIAs with a low revenue will be forced to spread this additional fixed cost over a small revenue base and increase fees by around 100+%. So, Fixed-Fee-Only Financial Planners will have to increase their fees by 25-100+%. Some clients (e.g. Y) will not be able to afford these higher fees. So, the set of potential clients will reduce. Other clients may be able to afford it but will be paying 25-100+% extra and will not get any additional value for it. Many such Fixed-Fee-Only Financial Planners will also make losses for several years.

Finally, SEBI has proposed that such Fixed-Fee-Only RIAs should go from having a personal net worth of Rs 1 lakh to investing Rs 50 lakh into a company. A year or two later, SEBI could increase this to Rs 1 crore (this is similar to how SEBI recently increase the minimum net worth for PMS management companies from Rs 2 crore to Rs 5 crore). So even a Fixed-Fee-Only RIAs who can afford to spare Rs 50 lakh (as the price to continue in this profession) would hesitate before becoming a corporate RIA. Once he puts the Rs 50 lakh into the company, it will be much harder for him to exit the profession and he will be trapped. So, he may be better off leaving the profession as soon as the proposed regulations become effective.

In summary, the losers will be Fixed-Fee-Only Financial Planners and their clients/investors and indirectly other investors also, but we will get to that. The winners will be the lobby that was listed earlier.

2 How SEBI is most likely going to kill the Boglehead approach to investment advice in India

Democracy depends on Capitalism and Capitalism depends on Democracy. Similarly, the Boglehead approach to investment advice depends on Fixed-Fee-Only Financial Planning. And Fixed-Fee-Only Financial Planning will depend on the Boglehead approach to investing. Since Fixed-Fee-Only Financial Planning is still nascent in India, this link is not apparent. But it is very apparent in the US and it will become more apparent in India also.

The Boglehead approach to investing focuses on diversifying and minimizing investment costs. This video and article, The mature approach to personal finance, provides my simplistic summary of the Boglehead approach to investing in the Indian context (Note: My approach is more risk-averse than Jack Bogle’s approach.

But we need not go into that nuance here). And these articles in Business Standard and FreeFinCal –This will change the way you invest: S&P Index Versus Active Funds report . provide a rationale for index funds that are at the heart of the Boglehead approach.

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There are 11 RIAs who are both a part of the FreeFinCal list of Fixed-Fee-Only  Financial Planners and are also a part of Fee-Only-India. Of these 11 RIAs, 4 RIAs recommend index funds to varying degrees. Example A: I was the first RIA and currently the only RIA to recommend only index funds in the Boglehead approach to index funds both for Equity MFs and Debt MFs (there may be others who claim that they can generate alpha using index funds but that is just active investing while disguising it as passive investing). Example B: Within Equity MFs, Swapnil Kendhe tries to recommend only Equity index funds to clients. Example C: SR Srinivasan explains both index funds and active funds to clients and helps them pick between the two. So, 36% (4 out of 11) of these RIAs recommend index funds to varying degrees. I expect that in a few years, more than half of these RIAs will primarily recommend index funds.

The Boglehead approach to investment advice is based on minimizing fees. The Fixed-Fee-Only Financial Planning approach to investment advice is based on minimizing fees and minimizing conflict of interest. The Boglehead approach to investment advice depends on Fixed-Fee-Only Financials planners to champion it (more so now that India has gone from one MF that focuses on index funds to zero MFs that focus on index funds). And Fixed-Fee-Only Financial Planners will depend more and more on index funds to deliver value to clients. The reason is that Fixed-Fee-Only Financial Planners gravitate away from the lie that they can help a client beat the market. So, one of the primary ways for a Fixed-Fee-Only Financial Planner to deliver value to the client is to minimize investment costs. On the other hand, the entire business model of the high Percentage-of-AUA Financial Planner (e.g. who charges 0.5+% of AUA each year) rests on the lie that they can help a client beat the market. The high Percentage-of-AUA Financial Planner’s pitch is that the RIAs high fees are compensated for by the high alpha that the RIA will generate. So, the high Percentage-of-AUA Financial Planner’s pitch is the opposite of the Boglehead approach to investing.

So, killing Fixed-Fee-Only Financial Planning will effectively kill the Boglehead approach to investment advice in India.

3 How the proposed regulations will hurt you

3.1. Among Financial Planners that are RIAs, the proportion of Fixed-Fee-Only Financial Planners will reduce from around 10% (around 20-30 people, across India) to less than 5% (less than 10-15 people, across India). And the proportion of Percentage-of-AUA Financial Planners will go up from around 90% to around 95+%. Nobel prize winner William Sharpe said that “It is all too easy for a client to underestimate the impact of financial advisory fees on expendable retirement income. A fee of 1% of total assets each year may seem small, but this can reduce spendable lifetime retirement income by as much as 20%”. I have written about this in detail in How the financial services industry aims to take 1% of your wealth each year — The battle for 1% p.a. will determine whether you will survive retirement’ ( https://freefincal.com/financial-services-industry-fees/ ). Further, a percentage of AUA approach magnifies the conflict of interest. For example, I have not heard of a percentage of AUA adviser that recommends prepaying a home loan (because this would reduce their AUA and hence their fees). So, the degree of conflict of interest will increase. This will either hurt you or some close relative / close friend of yours.

3.2. Direct Plans of MFs and the RIA regulations were created at roughly the same time because they support and enable each other. Kill one and you partially kill the other. The proposed regulations are also watering down the definition of an RIA. The proposed regulations allow individual Distributors to choose to register as RIAs and mention on their website that they are RIAs even though they earn an annual commission on the investments of 100% of their clients (this is currently already true for corporate RIAs). Such an individual Distributor who is also registered as an individual RIA could even have a commission-driven AUA of Rs 1,000+ cr. Hence this may prove to be the first step in the MF industry’s attack against Direct Plans of MFs, which they hate (I have written about this in an article in The Ken, ‘Two-headed Goliath – Mutual Funds and their Distributors. If you are sceptical about the existence of such a powerful lobby that works to enrich itself and harm investors, then Exhibit A is the book ‘How Fund Managers are making you Rich’ in which the author, Pravin Palande,  talks about a meeting between Ajit Dayal, the founder of Quantum MF, and senior management at other MFs where “[Ajit] Dayal…called the mutual fund industry a den of thieves”. Exhibit B is the quote on Quantum MF’s website which mentions that a large MF Distributor told Quantum MF, which used to offer only Direct Plans of MF: In this industry even elephants dance to our tune; you are an ant – what can you do?

3.3. One Melvin Joseph would have vaccinated thousands of investors against the Indore-Type-RIAs. The proposed regulations will not drive Melvin Joseph out of the profession, but it will drive the next 100, Melvin Josephs, out of the profession. This will put at least one lakh people at risk of being cheated by the Indore-Type-RIAs. Indore-Type-RIAs operate outside of the law. They do not care about the regulations. So, the proposed regulations are unlikely to stop the Indore-Type-RIAs and will instead leave at least one lakh people at risk of being cheated by the Indore-Type-RIAs.

4 What you can do to stop it

If you think these proposed regulations should be stopped/changed, then send the following email (or a modified version of it) to SEBI ( sebiria@sebi.gov.in ) latest by January 30, 2020, i.e. the coming Thursday. If you have already emailed SEBI about this, then please ignore this.

The subject of the email: Email subject: Feedback on Consultation Paper on Review of Regulatory Framework for Investment Advisers (IA)

Body of the email:

“Name of entity/person/intermediary/organization: <Type your full name here>

Page No. 16 Para No 3.5.2.6: Suggestion: For individual IAs, the proposed cap of Rs 40 cr AUA across all clients and the proposed cap on the number of clients of 150 should be deleted. Instead, the revenue should be capped at Rs 1 crore p.a (increasing with inflation). Rationale: These two caps are unviable. The cap of Rs 40 cr AUA across all clients indirectly limits individual IAs to around 10-20 clients each paying average fees of around Rs 20,000 p.a. which is total revenue of Rs 2-4 lakhs p.a. also unviable. This will drive a majority of individual IAs out of the profession. This will force clients to engage with corporate IAs that charge a high percentage of AUA and it will also reduce the choice that clients have. The profit after tax of the individual IA will be less than half of the revenue, so the suggested Revenue cap of Rs 1 crore is indirectly a cap of Rs 50 lakhs on the profit of an individual IA.”

5 The rationale for the proposed solution

SEBI’s regulations on the anvil propose a cap of Percentage-of-AUA fees at 2.5% per annum. So, if there is a client with a net worth of Rs 40 cr, SEBI is implicitly saying that it does not object to an RIA charging such a client 2.5% p.a. of Rs 40 cr which is Rs 1 cr per annum. As described earlier, a Fixed-Fee-Only Financial Planner may earn a revenue of Rs 15,000 p.a. from such a client. And since such an individual RIA would be allowed to have only one client, this would be such an individual RIAs total revenue across all clients for the year. Even if this Rs 40 cr of AUA was spread across 20 clients, a Fixed-Fee-Only Financial Planner may earn total revenue of only Rs 1.6 lakhs p.a.  across all client during a year. The suggestion is that SEBI explicitly caps the revenue of an individual RIA at Rs 1 cr p.a. instead of going about this in a roundabout way and as a side-effect, driving Fixed-Fee-Only Financial Planners out of the profession.

6 Conclusion

It is ironic that SEBI’s attempt at killing the Indore-Type-RIAs is most likely going to kill the Fixed-Fee-Only RIAs who have the least conflict of interest; the most transparent fee structure; and relatively the lowest fees. SEBI’s Working Group most likely did not consist of any Fixed-Fee-Only RIAs (SEBI typically discloses the report of the Working Group and the names of the members but in this case, SEBI did not disclose either so we cannot be sure). Hence, SEBI did not think through how its proposed regulations would hurt Fixed-Fee-Only Financial Planners and clients/investors. Hopefully, several readers writing to SEBI may stop this destructive proposed regulation. Thank you for making time for this.

I had earlier discussed the importance of minimising fees on an investment journey: How the financial services industry aims to take 1% of your wealth each year — The battle for 1% p.a. will determine whether you will survive retirement’. Fixed fee-financial planning (as opposed to Percentage-of-AUA fees) can help the client significantly on costs over a typical investment journey lasting 2-3 decades.

In a tribute to Jack Bogle, I had written “I think the closest that Indian investors ever came to getting a Jack Bogle was C B Bhave (former Chairman of SEBI). Will these proposed regulations kill Jack Bogle’s legacy (the Boglehead approach to investment advice) and leave one lakh investors unprotected to fend for themselves against Indore-Type-RIAs?

Postscript: I have further described the Boglehead approach to investing in India in an episode of the ‘Paisa Vaisa’ podcast, which was recorded a couple of months back but will most likely be released on January 27, 2020 morning. At that point, it will be available via the Google Podcasts app etc and at YouTube

Avinash Luthria is Fee-Only Financial Planner & SEBI Registered Investment Adviser (RIA) at Fiduciaries.in; He was previously a Private Equity & Venture Capital investor for 12 years and has a flagship-course MBA in Finance from IIM Bangalore; He writes about Financial Planning & Investing in Business Standard, Mint, MoneyControl, The Ken, VCCircle etc. The full list is available here: https://fiduciaries.in/articles/. Views expressed here are of the author and do not necessarily reflect the views of FreeFinCal

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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3 Comments

  1. Whether you call SEBI or MF industry or Distributor, one thing is common. There is NO sense of service, No ethics etc., just want to make money.
    I have exited this business couple of years back.
    providing free service to known people.

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