Know your customers - if they are yours!
Debashis Basu | 27 February 2014

In a piece written for this paper about a month ago, I had pointed out that risk profiling (which is now being sought to be made mandatory by the market regulator) is a pseudo-rational idea. But why should mutual fund companies and regulators embrace it? There are several reasons but the main one is another shocker: neither the regulator nor the fund companies are in touch with their core constituency – the saver – and so simply don’t know how irrelevant, or even harmful, risk profiling is on the ground. It seems hard to believe that mutual funds don’t know their investors. After all, equity mutual funds are supposed to be retail financial products. Well, think again.

About six years ago, I was discussing an idea with the head of an asset management company, which involved communicating to its customers every fortnight. After about 10 minutes he cut me short with a polite interjection: “But we cannot do it because we don’t have the data. We don’t know who our investors are.” He said it in a matter-of-fact tone. I was taken aback. Noticing my bewilderment, he explained that all its customer contact was outsourced to a major foreign bank as part of a global tie-up. Sending annual reports to them? The foreign bank does it. Handling redemption requests? The same. Know Your Customer is a standard part of the regulatory process in India, so filling KYC forms, of course, was being done. But this fund company did not know its customers in the real sense of the word.

Nothing has changed since then. Surely many fund companies are “communicating” to their investors directly and have the customer data now. But does it mean they really know their customers? I recall, on one occasion, a former chairman of the Securities and Exchange Board of India (Sebi) asked the marketing head of a mutual fund company, how do you acquire customers? The fund official replied breezily, “through distributors”, thereby walking into a trap. The chairman pressed: “So then, they are the customers of the distributors, not yours.” The fund official hesitated, and was forced to agree, realising the faux pas a little too late. Mutual fund unitholders are not customers of fund companies; they are the customers of large distributors. Indeed, hypothetically speaking, a powerful distributor like HDFC Bank can persuade its customer to redeem his HDFC Mutual Fund scheme and put the money into the scheme of another fund company!

A few months ago, a colleague invested some money in a mutual fund company that has been performing exceptionally well for over a decade. A knowledgeable distributor, a regular attendee of our literacy seminars, came to the office and got the KYC form filled. The form was dauntingly detailed and asked for all kinds of personal data including an email address. It has been four months now, but my colleague has not got either an SMS or an email or a call from the fund company. KYC was carried out but the fund company didn’t really want to know its customer.

In contrast, if you buy a washing machine, you would go through a distributor too. But most reputed manufacturers ensure that an engineer visits your place to check the installation and a service quality team calls (which is independent from the sales team) enquires about your experience.

Mutual funds are another matter. The fund distributor I mentioned earlier dropped by the other day and shared with my colleague his view of the market, his experiences of fund managers and other customers. All that was very enlightening for my colleague; he certainly knows whose customer he really is. This is the reality of Know Your Customer in the mutual fund business.

What applies to fund companies also applies to stock exchanges and Sebi. They don’t know the psychology and the pains of the savers. If Sebi knew what was happening on the ground – or cared about it – we would have had a different kind of regulation. If Sebi cared about how advice was sought and delivered, we would not have the mumbo jumbo of risk profiling, imported from the US and getting a pride of place in India, even though it has no scientific basis.

A few months ago, Sebi issued a diktat to fund companies on how they should regulate distributors — all in the interests of customers. Since fund companies don’t even know their customers, can they possibly play an effective role in protecting them? Also, distributors are their agents; in technology businesses such humble agents are called “partners”, which reflects that it’s a close business relationship. Surely you don’t expect a partner to regulate another partner.

For simple, sensible and effective regulation, it is essential to bridge the gap between exchanges and stock investors, Sebi and savers, mutual funds and their customers. Today, nobody is in direct touch with investors. There is no feedback mechanism for regulators and market players. It can’t be done through advertisements, travelling vans, sponsoring trains or even company seminars.