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Financial advisors' skin in the game

Should financial advisors be required to prove to investors that they follow their own advice?

Financial advisors' skin in the game

In his book Skin in the Game, Nassim Nicholas Taleb has some interesting advice for investment advisors. "Don't tell me what to do, just show me your portfolio," he says to those who are in the business of trying to advise others about what to invest in. This is a very straightforward way of having skin in the game. A literal implementation of this would be an investment advisor who will not say a word about what you should do with your investments. Instead, he will simply maintain a public record of his own portfolio. If you trust the advisors' judgement, you will copy his portfolio. This would mean perfect skin in the game for the advisor. If you lose money following his advice, then he will also lose a similar proportion of his investments. By the same principle, an investment manager for a mutual fund or a portfolio management scheme should invest only in the scheme he is running and nowhere else.

Is this workable? Is this a serious proposition, or is it just a rhetorical question? Well I've been effectively (although for the most part, not formally) an investment advisor for a quarter of a century, so perhaps, I can answer this based on my own experience. I feel that Taleb's basic point is correct and everyone who gives investment advice should be transparent with their own investments. For most of my working life--in fact, till just a few months back--I've been a mutual fund investor while being a media person who specialises in giving advice on mutual funds. My mutual fund investments were always along the line that I advised, although always confidential.

However, last year, when Value Research's premium Stock Advisor service was launched, I became an investment advisor in the formal, legal sense as well. Subsequently, I aligned my personal investment portfolio to precisely what Value Research Stock Advisor recommends and obviously, this was published on the valueresearchstocks.com website as well. I must confess that in the beginning, this felt a little uncomfortable, a sort of a loss of privacy. However, it's eventually mentally and ethically freeing, to align my own interests exactly to that of my customers and walk the talk. When it came out, reading Taleb's book certainly helped sharpen my ideas about why anyone who issues advice must also follow it and be seen to do so.

Of course, the exact approach that Taleb recommends is too limiting. Any investment advisor would need to give advice to customers whose investment needs and profile are different from his own. I could be a well-settled professional in my 40s, while I'm giving advice to everyone from a young professional who has just started working to a 75-year-old retiree whose savings are falling short. What I do for myself will have little bearing on what I advise to these particular people. However, the transparency principle still holds true. It will benefit the overall relationship and enhance trust if the advisor declares his own interests openly.

On this issue, the situation with Indian mutual fund managers is quite strange. Statutorily, they are required to declare their investments and asset size. However, almost all AMCs do this in a manner that seems designed to make it as difficult as possible to discover this information. This is puzzling! I think that it should be a point of pride to say that your fund managers invest only in the AMC's own funds. Even the AMC's surplus money should be invested only in it's own funds. It is possible that fund managers don't like it be known how much they are worth, rather than where they are invested. This is a fair point. As a mutual fund investor, there is no need for me to know whether the fund manager is worth Rs 1 crore or Rs 100 crore or Rs 1000 crore. However, I would like to know whether he has the courage of his convictions to be invested in his own funds.

As for other financial intermediaries, like fund distributors and advisors, and the high officials of the banks and their 'relationship managers' who chase you day and night to invest, it will definitely help investors to know if they put their money where their mouth is.