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The Peril of Product Diversity

In mutual funds, product diversity helps sellers but is always harmful to the interests of the investors.

Last week, at the mutual fund industry's annual conference in Mumbai, one of the sessions was on 'product positioning as a game changer for the industry'. As one of the speakers in this session, I spoke on product positioning in the context of 'income segmentation, demographics, geography and risk appetite'. However, expressing any opinion on this entire business--of fine-tuning investment products to different kinds of investors--puts me in a quandary. That's because my opinion is very simple, and runs contrary to the received wisdom in this matter. Very little, almost none, product differentiation is needed for mutual fund or other retail investment products.

This is not the received wisdom. It's almost a cornerstone of thinking about all kinds of products that since different types of customers have different needs, it's axiomatic that they will need different types of products to fulfil their needs. This thinking comes naturally to those selling consumer products and extends itself to financial products itself. It appears self-evident that products are fine-tuned to customers' needs must serve them better. However, this is a fallacy, let's see why.

Take a moment and think about this phrase, which was the topic on which I was to speak: Product design, differentiation and positioning from the perspective of income segmentation, demographics, geography and risk appetite. After reading these sixteen words, if a passerby were to be asked whether product differentiation was a good thing or a bad thing, what would that person say? They would say that product differentiation, whose ostensible goal is to create different product suited for different customers, is a good thing. That message is implicit in the phrase. That message is wrong. It's wrong because it is anti-investor. The idea--and the thinking that goes into it--is part of the problem, and not part of the solution.

This belief of mine is the result of two decades of interacting with small investors practically every day. I've learned that all legitimate investing needs of individual investors can be taken care of by no more than four or five types of mutual funds. This is true regardless of 'income segmentation, demographics, geography and risk appetite'. It's always possible to create arguments that people of different types need different types of investment products. However, the increase of complexity has always done more harm than any imagines benefits.

Moreover, I firmly believe that an increased variety of products obfuscates the real issues that investors should pay attention to it. The only situation that is beneficial to investors is if every fund company (or other financial product/service provider) has a small number of simple and similar funds. Only then can the investor choose based on the things that matter. These are, one, investment performance, and two, service quality. Differentiated products means products that cannot be compared with each other.

This brings us to the real reason why product differentiation exists at all. It is the seller's way of guarding against being compared to other products. While I don't care if sellers of rice or water are claiming 'advanced features' to pretend they are not selling a commodity, it matters if the same is done with financial products. Product differentiation is generally a deliberate attempt to pretend that intrinsic characteristics like investment performance are not important, or are less important than bells and whistles.

It's easy to say that customers should guard against this, they certainly should. However, that's not always possible, especially because to do so, they have to think their way through a sophisticated effort to (mis)guide their decisions. Ultimately, it's the regulators' responsibility to ensure that needless product differentiation is prevented. Are SEBI, IRDA and RBI up to the task?