Minesh, a client, had a couple of crores of rupees invested in financial assets like bonds, mutual funds, and shares. But around two-thirds of his investment kitty was invested in a residential flat whose value had grown manifold over a decade.
As Minesh was nearing retirement, he wanted to consolidate his investments. He wished to know whether he should sell the property and invest the proceeds in financial assets.
As I reviewed the facts shared by Minesh, it became clear that selling the flat made sense for a variety of reasons. One, Minesh would find it hard to manage the property after retirement as he was currently using his employer’s corporate resources to manage it. Two, the concentration risk from having two-third of the kitty in a single asset would be reduced. Three, investing the sales proceeds in a balanced fund would provide diversification without sacrificing consolidation and also allow a tax-friendly systematic withdrawal plan. Four, he had brought forward long-term capital loss from another transaction that he could set off against the substantial capital gains that would accrue on the sale of the property, reducing the capital gains tax outgo significantly.
However, there was a conflict of interest in rendering this advice. Our fee structure was based on percentage of assets under advice which did not include real estate assets. If Minesh sold real estate and invested the proceeds in a balanced fund, our fee would triple.
The investment advisory regulations that govern us require us to disclose such conflicts of interest to clients. My instinct said clients would be aware of such conflicts of interest but would value the advice when presented along with transparent disclosures.
But those were early days in our investment advisory practice, and I was worried that Minesh may disregard our advice because of the inherent conflict of interest. In any case, we had no choice but to follow the regulations. We disclosed the conflict of interest to Minesh and reiterated that we had tried to remain objective while providing the advice. We listed out the detailed reasoning behind the recommendation to sell the residential property. Minesh listened patiently, asked many questions, and finally decided to follow our recommendation.
Sometime later I asked Minesh about the impact that conflict of interest disclosure had on his decision making. He confirmed that the inherent conflict of interest was very much there on his mind. He found the presentation with the upfront disclosure of conflict of interest very transparent and professional. Far from dissuading him from acting on our recommendation, the transparent disclosure had spurred him to value the recommendation even more.
We have got similar responses from all clients in similar situations whether it be advising clients to obtain an education loan rather than redeem earmarked mutual funds for the higher education of their children, or invest unexpected surpluses in financial instruments rather than use them to prepay a loan.
Far from being a hindrance to our practice, transparent disclosure of conflict of interest is a powerful tool that has helped us build long-term trust with clients. These disclosure requirements, which are baked into the investment advisor regulations, are also assisting the young but fast-growing investment advisory profession gain clients’ trust.
Disclosure: I am the chairperson of the Association of Registered Investment Advisers (ARIA), a Section 8, not-for-profit company formed to promote investor interests by elevating the standards of the investment advisory profession. ARIA interacts with the regulator to seek direction and guidance and optimisation of the regulatory architecture of our profession to promote investor interests.
Fee-Only Investment Advisors LLP
A SEBI-registered investment advisor