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Mis-selling takes place in almost every aspect of our lives. The "maximum retail price (MRP)" tag on goods has been abused for years. Airlines advertise attractive prices of as low as Rs 500 for an air ticket, not disclosing the substantial tax that gets added. Showrooms advertise "50%" discount sales but prefix "up to" in small print.
But nowhere is mis-selling as rampant and as potentially harmful as is in the financial services sector. I was recently surprised to hear an elderly relative lamenting the sharp fall in midand small-cap stocks. Surprised, because at this stage of his life, he should not have exposure to these risky segments. But evidently his financial advisor didn't think so. He had suggested a new fund offering (NFO) of a midcap focused fund last year. Its NAV has dropped by almost 50% in 2008.
This is a classic case of mis-selling. A senior citizen, whose portfolio should comprise safe assets that provide regular income, was advised to put money in a risk-laden mid-cap fund. The reason must have been relatively higher commissions (up to 4-5%) which an advisor earns for selling NFOs. Clients are advised to sell off existing funds, even though they have been doing well, and invest the proceeds in NFOs.
Mis-selling also happens when fund houses launch new schemes with fancy names. In some cases, the names hardly have anything to do with the fund's investment objective. Then there is the common misconception that a new fund with an NAV of Rs 10 is cheaper than an existing one which unscrupulous brokers misuse to the hilt.
Investors also get lured by announcements of large dividends. What they don't realise is that after the dividend payment, the NAV falls by that much. Dividend is your own money coming back to you so it doesn't make any difference to your returns.
What an investor needs is not important. What an advisor wants to sell gains precedence. Who loses in the bargain? The investor, of course, who gets something he didn't want or need.
Investors have been mis-sold funds for decades. Before the assured returns schemes were disallowed by Sebi, many equity funds were floated with assurances of "double" or "triple" the money in a few years. Brokers aggressively pushed funds that paid high commissions and ignored those that didn't.
When you invest Rs 100 in an equity fund through a broker, only Rs 97.75 gets invested. Where does the balance Rs 2.25 go? That is the "entry load" of investing in the fund. The money is usually spent on marketing and distribution expenses. However, according to a new rule made this year by Sebi, direct investments in mutual funds will not be charged any entry load. Quantum AMC pioneered this concept of "direct to investor" and "no entry loads" in India.
While this model reduces the cost for investors as also the chances of misselling, a long-term solution could be a variable fee-based model. The investor pays a fee to the advisor for the services rendered rather than route the payment through a fund or insurance company. This would make the transaction transparent and the intermediary more accountable. If the investor is not happy, he can switch his advisor.
Devendra Nevgi is CEO & CIO, Quantum Mutual Fund. He can be reached at devendra@quantumamc.com
