Five Questions to Ask Your Financial Advisor

After the abolition of entry loads, we present a five-point checklist of questions that mutual fund investors must pose to their advisors and distributors.
By Vicky Mehta |  10-09-09 | 
 
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About the Author
Vicky Mehta is a Senior Research Analyst with Morningstar. He would like to hear from you, but he cannot provide individual-portfolio or financial-planning advice.

With entry loads on mutual fund investments being abolished, the investor-distributor relationship has been redefined. Investors, who until now were only habituated to signing cheques for the investment amount, are now required to compensate distributors as well.

Distributors on their part need to justify the compensation, in terms of the services they will offer. Clearly, both investors and distributors will take a while to come to terms with the new scenario. In light of the same, we present a five-point checklist of questions that mutual fund investors must pose to their advisors and distributors.

1. What is the basis for the recommendations?

Investors must quiz advisors/distributors about the recommendations made by them. It is vital for investors to understand how the advisor arrives at his recommendations. If the advisor claims to conduct in-house research, he should be questioned about the process. If the advisor relies on external sources, then the latter’s credibility should be verified. Figuring out how the advisor forms his recommendations will aid investors in evaluating the quality of service on offer.

2. What is the fund’s track record and pedigree?

The importance of seeking detailed information about the recommended funds cannot be overstated. For instance, if an equity fund is being considered, investors should be unambiguously aware of how the fund has performed over various time frames on both the risk and return parameters. The fund’s showing vis-à-vis comparable peers and its benchmark index must be studied. Investors must also seek information about the fund’s pedigree i.e. the fund house it belongs to. The quality of investment processes followed by the fund house will have a telling impact on the fund’s performance.

3. What role will the fund play in the portfolio?

Ideally, a mutual fund should have a distinct part to play in the investor’s portfolio; in other words, investments should not be made on a stand-alone basis. The fund’s nature (its investment proposition) will determine the role it plays. For instance, a diversified equity fund with a track record of stable performances can feature as a core holding and lend stability to the portfolio.

Conversely, a thematic fund (offering a high risk–high return investment proposition) equipped to provide a fillip to the portfolio can be an apt ancillary holding. Investors must find out from their advisors what role every fund in their portfolio is intended to play. This in turn will aid them objectively evaluate the funds’ performance.

4. What are the terms of engagement?

In the new investment regime, investors are required to compensate distributors for services rendered. Hence, they would do well to seek clarity from the advisor on the terms of engagement. Simply put, the services that the advisor will provide and the time frame for which he will be engaged should be explicitly defined and agreed upon. Also, investors must enquire if value-add tools like portfolio and fund trackers will form part of the offering.

5. What is the advisor's compensation from various fund houses?

Advisors are now obligated to reveal the compensation offered to them by various fund houses. Investors should exercise their right to access this information. There might be a case for raising a red flag, if only funds backed by the most benevolent compensations are being recommended by the advisor. In such a scenario, investors must probe further to find out why other funds have failed to make the grade. This exercise can impart a degree of transparency to the investor-advisor relationship.

In conclusion, while the regulator has done his bit to further the investor’s cause, the onus to make the most of the scenario lies with the investor.

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