Some RIAs and research analysts are exiting Smallcase

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  1. Michael Gonsalves

    Michael Gonsalves Member Staff Member

    Jun 26, 2016
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    Past performance matters, particularly if you are a doctor, engineer or even a scientist. It is no different for those involved in markets and trading, including registered investment advisers (RIAs) and research analysts. But market regulator Securities and Exchange Board of India begs to differ. It has barred RIAs and research analysts from showcasing their track record. And investment platform Smallcase has only made matters worse for them.

    Some advisers and analysts have decided to hang up their boots and end their association with Smallcase, which is backed by stockbroker Zerodha, to be on the safer side of regulations.

    The 5 April Sebi circular seeks to enforce stricter compliance with an advertisement code, which effectively prohibits RIAs and research analysts from any sort of advertising “that may influence investment decisions of any investor or prospective investor". It also prohibits “any promise or guarantee of assured or risk free return to the investors". Besides, any reference to the past performance of registered advisers and analysts. This rule on past performance is what has raised their hackles. And that is where Smallcase enters the picture.

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    Graphic: Mint
    The Smallcase angle
    Smallcase is a platform that allows advisers and analysts to curate and offer a number of ready-made portfolios of stocks or exchange-traded funds (ETFs) that, according to the firm’s website, track a theme, strategy or objective. People could invest in any portfolio of their choice for a fee. There was no restriction on the number of portfolios that advisers and analysts could offer. The themes ranged from green energy to digital inclusion to electric mobility, while investment strategies included growth, momentum and ESG (Environmental, Social and Governnance).

    Things were going just fine until the market regulator came up with the advertisement code on past performance. It ruffled quite a few feathers. “On the one hand, Sebi is saying we cannot show our past performance, and, on the other hand, the performance of Smallcase managers is displayed by default," said Narasinga Rao, a registered investment advisor and portfolio manager of Sampadha. said. Rao put his Smallcase account on pause immediately after the advertising code was enforced. "We want to stay away from this as long as there is no clarity." To be sure, there is no option to hide the past performance in the Smallcase platform.

    “There is no other way to prove our credibility other than to show our performance. We will have to shut shop if we cannot show our past track record," said Kushank Kamal Poddar, a Smallcase manager who is still active on the platform.

    Some financial experts, meanwhile, say that RIAs and research analysts are themselves to blame for this situation. Many of them tried to manipulate the system by showing misleading performances to gullible clients. There was also a lack of a standardized way of measuring past performance. These factors, said the experts, nudged the market regulator to bar them from advertising their past performance.

    Naveen Fernandes, chairman of BSE Administration and Surveillance Ltd, which acts as the supervisory body for RIAs, said that investment advisors are not supposed to show past performance as they need to take into account the needs and risks of each person and accordingly create a personalized portfolio. “If somebody is offering the same portfolio for everyone and showing past performance, that is clearly a violation of Sebi regulations for RIAs."

    Responding to a query from Mint, Smallcase said, “We don’t use or highlight past performance of SEBI registered RA/RIAs listed on the platform in any of its advertisements. The platform provides an information tool on the website that can be accessed by the users to check the actual returns of recommendations by RA/RIAs in different time periods. The tool works on publicly disclosed logic available on the website and uses the actual recommendations issued by RA/RIAs on the platform (which is also available on the website to download). Any user can calculate and cross-check the displayed information using this data."

    RA is short for research analysts.

    Different rules
    Meanwhile, not everybody is enthused by Smallcase’s actions. “The issue of showing past performance can be a contentious one. It is an enforcement issue. Regulators like Sebi often impose restrictions on RIAs to ensure that investors don’t solely rely on past performance, which may not guarantee future results. Smallcase, on the other hand, might have a different interpretation or approach to compliance," said Sumit Agarwal, Regstreet Law, and a former Sebi officer.

    Some investment advisors Mint spoke to also pointed out that while Sebi allows research analysts to offer model portfolios for free, the same is not allowed for portfolio managers operating under the license of an investment advisor. “This is a clear regulatory arbitrage that the regulators need to remove," said an adviser, who did not want to be identified since he is not authorized to comment on regulatory issues.

    Such disparities are one of the reasons why many RIAs think this career does not make sense any more.

    “Disparity, if any, can lead to frustration among RIAs who may feel it’s unfair competition. It’s crucial for regulatory authorities and platforms like Smallcase to have a clear dialogue to address these concerns and ensure a level playing field for all participants in the financial industry. It’s a nuanced issue, and finding a balanced solution is essential for investor protection and industry fairness," said Agarwal.

    Yet, there is also ambiguity on whether research analysts can sell model portfolios. This, after Sebi passed a settlement order against Amit Mohan Jeswani, then a research analyst, for allegedly running a model portfolio. In the order passed against Jeswani, Sebi said that “the Applicant was selling model portfolio products to his clients/prospective clients which is against the defined responsibility of a Research Analyst as mentioned in RA Regulations and professional standards of Research Analyst." After the order, Smallcase allowed research analysts to select stocks in the basket without assigning any specific weights. To be sure, analysts can share portfolio weights on Smallcase if they wanted.

    However, in informal guidance shared by Sebi to LGT Wealth in April 2023, the regulator said “making a recommendation in respect to a basket comprising more than one security to the clients, shall also be covered within the defined regulation" of Research Analysts regulations. It is uncertain whether Sebi allows research analysts to recommend a portfolio comprising a basket of stocks with different weights for each security.