Disclosing conflict of interest builds trust

I explained the conflict: if Sukanya sold real estate and invested in financial products, our fee, a percentage of assets under advice (excluding real estate), would rise

Our client, Sukanya, holds a Chief Executive Officer (CEO) position in a large firm. She requested a review meeting with us. Sukanya resides in an apartment she owns. She has an impressive net worth with investments in mutual funds, a substantial sum in her Employee Provident Fund account, and an additional apartment valued at a few crore. As her children’s educational goals were approaching, she was contemplating selling the investment property to partly meet those goals.
 

The investment property constituted approximately 40 per cent of her investment portfolio. Selling it would result in a significant shift in her asset allocation. The review meeting aimed to discuss this proposal.
 

Such discussions are familiar to us, as many of our clients have substantial investments in real estate. I listened to Sukanya in detail. I began by clearly disclosing that we had a conflict of interest while advising her on this matter. According to the terms of our investment advisory agreement, the fee we charge is a percentage of Assets under Advice (AUA), which excludes real estate. If she sold the property and invested the proceeds in financial assets, our fee would increase substantially.  
 

Once certain that she understood this conflict of interest, I presented to her the pros and cons of selling the investment property, and the reasons for our recommendation to sell it. She took time to mull over the decision before deciding to follow our recommendation. She later informed me that a significant factor in her decision was the transparent disclosure of our conflict of interest in making the recommendation. “I was fully aware of your conflict of interest anyway, but the transparent disclosure along with the detailed reasoning for the recommendation made it very credible for me,” she said.
 

A similar conflict of interest arises when a client with surplus funds approaches an investment adviser (IA) to seek the latter’s recommendation on whether to invest the surplus (in which case the IA’s fee goes up) or repay an outstanding loan (no impact on the IA’s fee).
 

We have discovered that a transparent disclosure of the conflict of interest, along with detailed reasoning for any recommendation, strengthens clients’ trust. Full disclosure of conflict of interest is mandated by the IA Regulations, and is, in any case, the correct professional thing to do.
 

We sometimes refer our clients to an insurance intermediary (to purchase suitable insurance products) or to a law firm for complicated estate planning. The referral doesn’t benefit us in any way but is made solely to fulfil the client’s needs. Most clients have a firmly embedded perception that the referrer receives a commission. In all referral cases, we make a straightforward written declaration that we derived no benefit from the reference. We find that client trust in us increases when we reiterate this unequivocal “no conflict” statement.
 

When recommending a shift from a debt to an equity fund, we remind clients that this is a “no-conflict” recommendation for us since our fee remains the same whether they stay in a debt fund or move to an equity fund. Again, this adds credibility to our recommendations.
 

Truth be told, conflict of interest can never be entirely eliminated. The fundamental conflict for IAs (of receiving commissions from financial product providers) has been eliminated by regulations. The transparent and professional handling of the remaining conflicts of interest is a fantastic tool and opportunity for IAs to build trust with investors. As for investors, they would benefit from dealing with IAs who handle such conflicts in a professional manner.

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The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; Twitter: @harshroongta