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The traditional view in the MF industry - in India and across the world - is that we expect AMCs to produce a diverse range of products across different asset classes - each with a clear, well defined mandate - the narrower / sharper, the better. It then becomes the advisor's job to decide which product to offer to which customer in what circumstances. The role of the product and the role of advice have traditionally been seen as distinct, with little or no overlap.
As the world experiences increasing volatility and as market cycles get shorter and less predictable, questions are being raised worldwide whether retail investors are actually being adequately served well enough. Do small investors, who may not have access to wealth managers, get the benefit of advice about when to buy and when to sell and when to invest in which asset class? Are retail investors getting adequate advice or is advice available only to affluent investors? If retail investors are not getting access to good advice (as it may not be remunerative for an advisor to individually advice small investors), is there merit in embedding advice within the mutual fund product itself?
If advice can be embedded in the product, all you need is a distribution function to reach the product to the investor. After that, the product will continue doing its job, without the need for frequent advisory inputs. What are the kinds of products which have advice embedded in them and how do they work? Lets consider a few popular examples in the Indian context and then look at other products that are popular in developed markets, but are yet to catch fancy here.
Asset allocation funds / multi-asset funds
These are hybrid funds that invest across different asset classes. In India we have a number of asset allocation funds that invest across different combinations of equity, debt and gold. By sticking to a mandate of auto-rebalancing at daily/weekly/monthly intervals, these products automatically perform the critical function of rebalancing investor portfolios to maintain the stated asset allocation. Rebalancing has the effect of buying low and selling high, as we all know.
Valuation based asset allocation funds
We have a few P/E ratio based funds in our market. These funds have a pre-defined algorithm that specifies the proportion to be invested in equity and debt, at various levels of market P/E. As the market P/E levels keep increasing, the proportion invested in equity will automatically keep reducing and as market P/E levels keep falling, the proportion of equity investment in the fund will keep rising. Here again, the fund effectively executes a buy low - sell high mandate, without allowing investors' emotions to come into play, which often stall re-balancing efforts of many advisors.
Dynamic funds
We have a few funds in our market where the fund managers are given a mandate to move between 65% - 100% in equity, based on their own parameters. This is a departure from a strict algorithm based product, where there is no discretion given to the fund manager.
On the fixed income side, the entire set of dynamic bond funds are in a sense embedded advice products, as the funds give mandates to the respective managers to arrive at a balance between a duration strategy and an accrual strategy, depending on market conditions and their outlook. The investor and distributor are not expected to move from short term funds to income funds and back based on rapidly changing market outlooks - that mandate is given to the manager of a dynamic bond fund. The advisory element is in this sense, embedded within the product.
Multi-manager funds
A product category that has achieved significant traction in developed markets, but has not caught the fancy of our market is multi-manager funds. Typically, one of the key roles of an advisor is fund research, fund selection and monitoring performance of funds on an ongoing basis, in order to help investors decide whether to remain invested in a fund or switch, based on performance and other parameters. This level of expertise is often not available to many retail investors, whose portfolios may not be reviewed periodically to weed out underperformers and substitute with better performers. A multi-manager fund of funds comes into the picture here.
An AMC that offers a multi manager product will put together a team that does the fund research and monitoring jobs as its main function and will accordingly decide which funds to remain invested in and which to move out of, in order to deliver alpha to investors. An investor who buys a multi-manager equity fund, is thus assured that there is an expert team that is scanning all available equity funds in the market - whether from that AMC or from its competitors - and is taking decisions on the best equity funds to invest in, from time to time. Once the investor buys a multi-manager fund of funds, he does not take any further decisions on which should be the underlying schemes that this fund should invest in - that job is handed over to the fund manager of the fund of funds product.
Multi manager funds add an element of incremental cost - which in India is capped at 0.75% p.a. Now, with the advent of the direct share class, this incremental cost can be considered as an offset against commissions that the distributor would get for his services - and on an overall cost basis, some investors may now find multi manager fund of funds more relevant and appealing. Multi manager equity funds in India have also historically suffered from a taxation anomaly, where they could not get the capital gains tax concessions that are accorded to normal equity funds.
Internationally, the biggest driver for multi manager funds is not a direct proposition, but actually distributors who willingly recommend multi manager products to their retail / small clients. As compliance requirements relating to product suitability and advice get tighter in several countries, advisors are finding it more challenging to actually prove product suitability and prove regular portfolio monitoring for all clients - especially retail clients who may not be remunerative enough to offer ongoing advice and portfolio monitoring. Advisors are, in such cases, clearly distinguishing the products they offer to different customer segments. Smaller clients are offered multi manager products - which are embedded advice products - where the advisor is effectively absolved from the responsibility of regular portfolio monitoring. Advisors then focus their personal time on the higher value clients, who either pay for advice, or whose transactions are large enough for commissions to cover the advisors' costs.
Target date funds / life stage funds
All the embedded advice products we've discussed so far deal with either timing decisions on asset classes or fund selection within an asset class. Both these functions are critical aspects of an investment advisor's job. There is another set of products that attempts to offer embedded financial planning advice, to those who cannot access a qualified financial planner. These products are known as target date funds or life stages funds.
A financial planner would normally recommend higher equity allocations for investors whose goals are several years away, and would progressively shift towards a more cautious asset allocation as the goal approaches, in order to ensure more portfolio stability closer to when the money is actually required for the goal that it was being saved for. This is exactly what a target date fund does. If an investor is planning for his daughter's higher education in the year 2020 and is also planning for his retirement in the year 2030, he can invest in two target date funds - 2020 and 2030. The 2020 target date fund will progressively start increasing its debt allocation and cutting down equity allocation say 3-4 years before 2020 ie from 2016 onwards. By 2019, the fund will be practically a debt and liquid fund with little or no equity exposure. This will be achieved through annual changes in the equity-debt-liquid allocations within the fund. At the same time, the same investor's investment in the 2030 fund - where he is saving up from retirement, will continue to have relatively high allocations to equity, even in 2020, as the target date is still 10 years away. This fund will start cutting down equity exposure progressively towards zero in the 3-4 years prior to the target date of 2030. In this manner, an investor can have multiple target date funds running at the same time, with each fund carrying out suitable changes in the debt and equity mix, not as a consequence of a market view, but based on the proximity of the target date. This therefore can effectively become a personalised portfolio for the investor, which promises to adjust his asset allocation according to his own unique target dates for his personal financial goals.
Any investor can come into a 2030 fund at any point of time - with the full knowledge that the fund will keep moving its asset allocation in sync with its target date.
To conclude
One can argue that embedded advice products can never be as effective as a good advisor, who will take into account all the unique circumstances of an investor and then recommend appropriate strategies and products to the investor. However, one must also recognise that all investors do not have access to good quality advisors - perhaps because their portfolios are too small to interest good advisors and they themselves are reluctant to pay fees to advisors willing to help them for a fee. It is in these circumstances that embedded advice products come into the picture. Are investors better off with no advice and plain vanilla products or are the interests of such retail investors better served with embedded advice products? From a distributor's point of view, are you better off recommending embedded advice "fill it - shut it - forget it" type of products to your smaller clients and do a proper asset allocation and regular reviews only for your larger clients? As product suitability norms become increasingly more demanding in our market, just as they have become in developed markets, are distributors better off considering embedded advice products for that set of clients whose portfolios they will not be able to regularly monitor? These are issues that will increasingly become relevant in our country - just as they have become in developed markets.
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