The Covid-19 case for better-trained wealth managers
By Miren Lodha
The market swings set off by the Covid-19 pandemic reiterate the need for appropriate and adequate training of wealth managers – both in theoretical principles and concepts, and their application – as much as any global crisis to have hit us.
To wit, the past quarter has seen major economies contract, with little clarity on when recovery will set in. In view of the mounting risks, CRISIL has forecast India’s gross domestic product to contract 5% this fiscal.
Nevertheless, with central banks around the world opening liquidity taps to combat the economic fallout of the pandemic, equities have bounced back after the initial panic. The S&P BSE Sensex TRI and the Nifty 50 TRI have recovered 40.24% and 41.31%, respectively, as on August 21, from the lows they hit on April 3.
Interestingly, participation by retail investors, many of them first-time investors, in the stock markets has surged since April.
Yet, data released by the Association of Mutual Funds in India shows open-end equity mutual funds logged net outflow of Rs 2,480 crore in July, their first net outflow in over a year.
Counterintuitive as it is, this trend is typical of the stock market – negative events trigger volatility and panic-selling, while bull markets see irrational exuberance. And while some investors are nimble enough or plain lucky to get the timing right, many tend to burn their fingers for lack of proper guidance and investment strategy.
The logical course for small investors, therefore would be to stay put in safe hands, such as those of mutual fund managers, amid the pandemic-induced crisis.
In India, well-trained wealth managers become all the more important for at least three reasons.
First, the country’s financial services market is highly under-penetrated, though the past decade has seen a gradual rise of the retail investor and a visible shift in household savings from physical to financial assets, led by campaigns such as ‘Mutual Fund Sahi Hai’. Effective handholding by wealth managers remains a need as most of these investors lack the wherewithal and expertise to take informed decisions on their own.
Second, unlike in the past when the wealth management business was run largely based on relationships, today, thanks to increasing awareness, financial education and inclusion, and easier access to technology, investors are better informed about markets and investment products, and need sharper insights on risks and opportunities alike.
And third, wealth management itself has become increasingly complex over the years, with a bewildering array of financial products.
Spotting risks and opportunities
Among other things, a good wealth manager must stress the need to follow a well-defined investment roadmap and have a focused approach in selecting products suited to an individual’s risk profile and financial goals.
A common mistake investors make is to invest solely on the basis of past performance. For instance, belying popular belief, many investors saw their debt mutual fund investments lose as much as 10-15% value overnight during some negative credit events in the last 18 months. Clearly, no one had warned them about the credit risk in the underlying portfolios.
Thus, monitoring risks pertaining to concentration, asset quality and liquidity is just as important as tracking performance – and in both fixed-income and equity investments. Two funds may hold the same stock, but their liquidity could vary based on the quantum held by each. Even if it is a highly liquid stock, a fund holding a very large quantity of it compared with the daily trading volume may find it difficult to liquidate its holding when the need arises.
Theory and experience
CRISIL’s experience shows that the three portfolio-based risks – concentration, asset quality and liquidity – are interlinked.
For instance, in the recent past, when some prominent infrastructure and non-banking financial companies either defaulted or had their credit ratings downgraded, their papers not only eroded investor wealth but also turned illiquid. And since the credit events triggered large-scale redemptions from mutual funds that held these papers, the fund managers were forced to sell other, liquid papers to meet the redemption pressure. This left them with illiquid securities in their portfolios. This deterioration in asset quality and liquidity had a domino effect on the portfolio’s concentration, too, heightening the underlying risk.
CRISIL Mutual Fund Ranking, has, in fact, been emphasising the importance of using a blend of net asset value and portfolio-based parameters for nearly two decades now. This is based on the unique insights on Indian market conditions gleaned through nearly three decades of evaluating investment products. Notably, CRISIL anticipated and began tracking liquidity as a risk in liquid funds way back in 2006-07, before the 2008 liquidity crisis broke out.
Ensuring ethical standards
On its part, the Securities and Exchange Board of India has also been addressing the problem of mis-selling by tightening guidelines and introducing measures such as a reduction in the expense ratios of mutual funds and cap on the maximum fees that investment advisors can charge their clients.
In a consultative paper on its draft guidelines on this, the market regulator has enumerated the various complaints made against investment advisors. The charges range from offering “assured returns” and charging exorbitant fees “with false promises of handsome returns” to mis-selling “without adhering to the risk profile of the client”, non-disclosure of complete service fees/charges and “extracting money in the name of various charges”.
While the regulator has proposed measures to address these issues, the onus is equally on wealth management firms to curb mis-selling by their relationship managers.
This underlines the need for high-quality training programmes for wealth managers. CRISIL’s recently launched Wealth Manager Certification Programme (https://www.crisil.com/en/home/crisil-1academy/wealth-management-certification.html), for one, seeks to fill the gaps by training wealth managers to help their clients take more informed decisions aligned to their risk tolerance, return expectations and financial goals.
