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Best kept secret about KYC – Investment Executive

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Until the client-focused reforms (CFRs), little attention was paid to this topic except when it was too late: at trial or in a regulatory investigation or enforcement matter.

Why is the client’s investment knowledge/sophistication an important criterion impacting both a judge’s and regulator’s decision on suitability? Here is the reason: judges and regulators will seek to determine whether the investment risk was accepted by the client, and for that to have happened, the client must have understood the investment and its risks.

The client’s understanding and thus acceptance of investment risk is determined by assessing both or either of the following:

  1. Did the client have the sophistication to understand the investment risk?
  2. Was the product explained to the client at their level of sophistication/investment knowledge? There is an inverse relationship here: the explanation needs to be more detailed and simpler for less sophisticated clients than for more sophisticated clients.

Either way, the judge and the regulator will assess the client’s investment knowledge as well as their understanding of the product’s risks.

Don’t get me wrong: risk profile also plays into the suitability determination. But that is not the topic of this article, especially since risk profile has received loads of attention and is much more obvious.

What most advisors don’t know is that judges devote pages upon pages in their written reasons in suitability cases analyzing the evidence of client investment knowledge and, therefore, the client’s ability to understand the risks of the investments.

Invariably, inexperienced lawyers representing sophisticated clients make the mistake of alleging that the client is unsophisticated. I have been involved in many cases, and there are many that have also gone to trial, where the judge doesn’t buy the argument and the client loses.

However, there are also cases in which the client is unsophisticated and asserts the risks were never explained. While the advisor may have explained the risks, there is no paper trail, so the judge has to make a credibility call. As professionals, this is not a good place for advisors to find themselves.

A dispute on the issue of sophistication leads to considerable time and mountains of money in the form of legal fees spent by both sides, through the litigation process and through the trial, proving (by the client’s lawyer) or disproving (by the advisor/dealer lawyer) a client’s alleged unsophistication and lack of understanding of the product risks.

It all comes down to evidence — and, without a paper trail, who is believed.

If advisors realized in advance both the costs and risks associated with their lack of evidence of client sophistication, they would give this KYC item more attention.

This lack of appreciation is not advisors’ fault, however. Until Dec. 31, 2021, client investment knowledge received little regulatory attention. There is now a reference in the CFRs (NI 31-103, s. 13.2(2)(c)(iv)) in the context of the registrant’s obligation under suitability determination to collect sufficient information of the “client’s investment knowledge.” Furthermore, the companion policy (31-103CP, s. 13.2), includes guidance for advisors:

  • The need for clear language describing the meaning of the different levels of sophistication (and different levels of other criteria) on the KYC form is required, especially for unsophisticated clients completing their own KYC forms.
  • If clients give instructions to an advisor that are “unclear or give inconsistent responses to KYC questions,” the advisor should make further inquiries of the client, with particular attention to “less sophisticated clients.”
  • Perhaps most helpful is the companion policy’s list of what should be examined to determine a client’s investment knowledge, including the following four criteria:
  1. Understanding of financial markets
  2. Understanding the relative risk and limitations of various types of investments available
  3. Understanding of how the level of risk taken affects potential returns
  4. Client’s awareness and previous experiences with finances and investments
  • There is a suggestion that advisors “may” use questionnaires to determine a client’s investment knowledge, but advisors should “always” make further inquiries if a client’s KYC information appears to be inconsistent with their apparent level of investment knowledge and experience, while also indicating a willingness to accept a high level of risk.

An example of this would be if Jessie and Johnny, both age 60, are unsophisticated but know they should be saving more to support their retirement, so they tell the advisor to invest in high-risk products, hoping for high returns. This presents a red flag for the advisor, who has assessed Jessie and Johnny as unsophisticated and sees the risk of them losing money they cannot afford to lose. The clients have shown both a lack of understanding of the markets and a lack of appreciation of their own risk capacity. The advisor cannot just take their instructions but must explain to the clients that they cannot afford to take these risks and instead tell them what indeed is suitable for them.

Now that you understand what is required from a regulatory standpoint, and the attention judges pay to this topic, the hard work begins with the open-ended questions and active listening skills to ensure you collect the evidence in a paper trail of this (and every) KYC item to satisfy both judge and regulator. Ask yourself, What can I ask each client to flush out each of the four criteria?

I invite you to send me the questions you think should and can be asked to flush out the four criteria (ebessner@babinbessnerspry.com). I will take your suggestions and add my own recommendations to prepare a second article drilling down the specific questions to ask clients.

Remember not to get distracted by questions that flush out risk profile — we can do that in another article. Just send me questions associated with assessing client sophistication and knowledge. I look forward to hearing from you.

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FPIs pump in Rs 8,600 crore in September; pace of investment slows – Economic Times

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After infusing more than Rs 51,000 crore last month, foreign investors have slowed down the pace of equity buying in India in September so far, as they invested a little over Rs 8,600 crore, on sharp depreciation in rupee. Going forward, Foreign Portfolio Investors (FPIs) are unlikely to buy aggressively amid rising dollar, VK Vijayakumar, Chief Investment Strategist at , said.

Indication of further rate hike by the US Federal Reserve, fears of a recession, depreciating rupee and continued tensions in Russia and Ukraine will affect FPI flows, Basant Maheshwari, smallcase manager and Co-founder, Basant Maheshwari Wealth Advisers LLP, said.

The latest inflow comes following a net investment of Rs 51,200 crore in August and nearly Rs 5,000 crore in July, data with depositories showed.

FPIs turned net buyers in July after nine straight months of net outflows, which started in October last year. Between October 2021 till June 2022, they sold Rs 2.46 lakh crore in the Indian equity markets.

According to the data, FPIs have bought equity to the tune of Rs 8,638 crore during September 1-23.

However, FPI activity has turned highly volatile with alternate bouts of buying and selling. They have sold on seven occasions in this month so far. In fact, in the last two trading sessions, they have pulled out Rs 2,500 crore from the Indian equity markets.

Vijayakumar has attributed increased FPI selling in recent days to rising dollar and rising bond yields in the US.

In addition, the 75 basis points (bps) rate hike by the US Fed for the third consecutive time to control rising inflation and the surging dollar have impacted FPI buying, Wealth Advisers LLP’s Maheshwari said.

“The US Fed’s hawkish tone on interest rates and the fear of a global recession fuelled pessimism among investors,” Shrikant Chouhan, Head – Equity Research (Retail), Kotak Securities, said.

Foreign investors have been slowing down their equity buying in India since September. The scenario turned adverse after a hotter-than-expected inflation report dashed hopes that the US Fed would scale down its rate hikes in the coming months.

The August US inflation edged 0.1 per cent higher from the preceding month to 8.3 per cent. Compared to one year ago, it eased as it was 8.5 per cent previously.

The aggressive stance of the central bank chair, which made it apparent that the Fed will once again go for another 75 bps hike for the fourth consecutive time in its next meeting as well, dented sentiments and turned investors risk averse towards emerging markets like India, Himanshu Srivastava, Associate Director – Manager Research, Morningstar India, said.

Also, currency movement is another factor that FPIs track very closely as it has a significant impact on the returns that they make on their investments in any country. Therefore, the outflows tend to accelerate in a scenario of rapid currency depreciation.

The sharp depreciation in Rupee as it touched all-time low of Rs 81.09 against the dollar does not augur well for foreign investments, he added.

“With the dollar index above 111 and the US 10-year bond yield above 3.7 per cent FPIs are unlikely to buy aggressively, going forward. The situation will change if the dollar index and US bond yields decline,” Vijayakumar said.

In addition, foreign investors have pumped in Rs 5,903 crore in the debt market during the month under review.

Apart from India, FPI flows were positive for Indonesia and Philippines, on the other hand, South Korea, Taiwan and Thailand witnessed outflows during the period under review.

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Top 3 investment bets for millennials to beat market volatility and make money – Economic Times

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There is a thrill for many to do things that are so-called out of the ordinary. As mentioned in the first part of this story, millennials are the impatient investor class who are all up to ignore the stereotypes, bet even on riskier investments.

On that note, in the first part we talked about three new-age investments that go beyond the ordinary for the millennials or the digital natives. To know more about millennials and more about the investment options, you can read the first part here:
Top 3 new-age investment bets for millennials looking to take risk and earn big

Nonetheless, it is never bad to be cautious. A roller coaster ride is fun at the amusement parks but when it comes to using the hard-earned money, no one will be keen to lose their savings. It is often said volatility is the daily crux of the market. Experts also opine it can be a motivation to capitalize on the imbalances.

“Volatility is the ghost that haunts you only if you look at it. The best way to avoid volatility is to ignore it; don’t trade into a market when there’s euphoria or out of it when there’s panic. Instead, constrict and hold a diversified portfolio for the long term, or better still, a mutual fund, which isolates individuals from volatility shocks,” Utkarsh Sinha, managing director at boutique investment bank firm Bexley Advisors said.

The economy too is at a volatile juncture with slower-than-expected growth recovery and galloping inflation. For stocks, the plausibility of earnings growth is diluting and valuation is said to trade below the long-term average. So, what could be better than to have some safe options even during a volatile period, enjoy the thrills of new-age investments and still achieve the monetary goals?

Girirajan Murugan, the chief executive officer at FundsIndia, lists more instruments that will help millennials to avoid some volatility:

InvIT – Infrastructure Investment Trust

This involves a trust channeling investments from individuals/institutions toward infrastructure projects. In a developing country like ours, the demand for good infrastructure is huge and perennial, in my opinion, Murugan said, adding that an investment in an InvIT with a good management will be a fruitful investment for the long term.

However, most infrastructure projects are subject to government regulations and interference. Change in the political space could affect such investments. Lack of choices to choose from is a severe disadvantage. Being a budding avenue, the participation in this investment is comparatively low. This means that selling them in the current market could be difficult. However, if the market for this type of investment takes off, then this concern will be void.

REIT – Real Estate Investment Trust

Similar to InvITs, REITs pool resources to invest in real estate assets. “Real estate investment has not lost its flair even today, despite being a conventional investment. That’s exactly why I’d like to call this a “grandfather-approved investment,” Murugan said.

By enabling part ownership, REIT has made real estate more accessible for all sections of people. REIT investments buy you ownership to the property in question, proportionate to the investment made. The income from this asset shall also follow the same proportion.

There are 2 categories of REIT – tradable and non-tradable. Some non-tradable REITs disclose the share values only after 18 months. Non-tradable REITs also carry the disadvantage of less liquidity.

ESG (Environmental, Social and Governance) Investing

In this mode, the investment is directed toward the development of businesses that toil for the betterment of the world. One can either invest through readily available ESG Mutual Funds, or they can identify the right companies and invest in their stocks.

“As far as ESG investing is concerned, it’s a thumbs up from me, and I say this from an ethical standpoint. The reason is that a good planet and a harmonious society are something we can’t survive without. When it boils down to it, man will eventually be forced to choose survival over profitability. If you choose to do it for the purpose, rather than for profitability, this may be one of your best investments,” Murugan said.

ESG assets are on track to exceed $53 trillion by 2025 and represent more than a third of the $140.5 trillion in projected total assets under management (AuM), according to Bloomberg Intelligence.

Bexley Advisors’ Sinha said millennials are at the best point of their lives currently to invest, as they have the bulk of their lives ahead of them. With these options explained, the millennials perhaps have better insight on the options available. Remember how we introduced the generations in the first part of the story and talked about an angry young man from Bollywood? Well, keep the swag and invest with prudence.

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How rising interest rates impact insurers' investment decisions – Canadian Underwriter

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Recent interest rate hikes aimed at curbing inflation, and the potential for more rate hikes next year, has the insurance industry keeping an eye on its investment returns.

But while the transition from a low-interest-rate environment to a higher-rate environment will create short-term challenges, it also creates a long-term opportunity, noted Gord Dowhan, CFO at Wawanesa Insurance in a recent Canadian Underwriter interview.

“Over time…higher interest rates can create an opportunity for us to increase our yield moving forward,” Dowhan said. “As bonds mature, it gives us the opportunity to invest at a higher rate.

“You’ve seen this experience in Europe and elsewhere, where they were at zero percent and negative interest-rate environments in some cases. Having higher rates is healthier than being in that environment [of extremely low or negative interest rates], and there’s definitely an opportunity for us to pick up yield and investment returns within our investment portfolio as those instruments mature.”

For an insurer’s portfolio, Dowhan noted a rising interest rate environment makes certain investment instruments more attractive. And his firm has some of these in place, including preferred shares, limited recourse capital notes, and floating-rate or variable-rate debt.

“We’re also looking at real estate and infrastructure investments. From a rate-reset, preferred-share perspective, this gives us the opportunity to increase our yield; the dividend yield resets regularly based on five-year government bond yields,” he said.

“In a rising rate environment, this gives us an opportunity to increase our returns. Floating-rate, or variable-rate, debt has become increasingly attractive as rates rise. We’ve invested in and will continue to invest in floating-rate debt and look for opportunities to grow our portfolio there.”

What’s more, Dowhan said that during high inflationary periods, real estate and infrastructure tend to outperform other asset classes.

“The underlying instruments within these products, leases and other revenues that produce revenue streams linked to inflation, is one reason why they typically outperform other asset classes during periods of high inflation,” he told CU. “So, opportunities exist for us to enhance our yield in the long term and continue to deliver value for our policyholders.”

This article is excepted from one that appeared in the August-September issue of Canadian Underwriter. Feature image by iStock.com/porcorex

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