Saturday, May 31, 2008

Fox in the Hen House


Retirement is often a battle between you and your advisor. Can you guess who is winning?

The success you have in preparing for retirement will depend on whether you or your advisor wins control over your investment accounts. Recent studies have made it extremely clear that you will need to grow your savings to supplement your government retirement income. For those fortunate enough to have a defined benefit pension, the battle is for maximum happiness versus a tight budget. For those without a defined benefit pension the battle will be for a reasonable standard of living versus dependency on others.

For many investors, they believe they have acted prudently, hired an advisor who will assist them, and worked diligently to save their money. Many will realize far too late that the fox is in the henhouse!

While there are a growing number of advisors who put the client first, the overall trend is still very disappointing. Most advisors put themselves first, their employer second and the client third. What proof do I have for such a bold statement? Recently there have been a number of surveys completed by reliable sources that suggest the industry in Canada charges the highest Mutual Fund expense ratios (MER) in the industrialized world. In fact, Alia McMullen in the Financial Post on Friday May 30th, does a good job of outlining the issues. Her articles is supported by the Rotman International Centre for Pension Management which has raised the alarm that MER’s may rob Canadians of the ability to fund their retirement years.

The issue of excessive MERs have been addressed ad nauseum in Canada but with little tangible results. So advisors work for companies that charge high MERs , what can they do you may ask yourself? Well, for starters they can reduce the damage instead of compounding the matter. However many put themselves first and sell products with the highest fees they can get when cheaper options would benefit the client. The sale of expensive deferred sales charge (DSC) funds makes the problem worse for investors but makes the advisor wealthier. The question I have yet to hear an answer to is “how does the investor benefit from purchasing expensive DSC style funds”. The obvious answer seems to be that they benefit by having a very, very happy advisor and fund company. There appears to be no tangible benefit to the client. I realize the advisor needs to earn a living, but not at the expense of the client.

The product selection between Canada and the U.S. shows how a closed shop in Canada allows for the sale of substantially more DSC funds in Canada versus the comparable U.S. per centage. Instead, Americans purchase a much higher percentage of Index funds. Would it surprise you to know Canadian advisors also have access to the same options but consistently choose higher cost alternatives?

What can you do? Have a strongly worded conversation with your advisor about any funds sold to you via the DSC option. Ask how you benefit by being locked into one specific family of funds by penalties outlined in the DSC schedule? Then ask the advisor how he/she was compensated and if it differs with the DSC versus say a front end loaded fund. The smart investor hires an advisor to work "for you" NOT "with you". You can hire better friends cheaper so do not be fooled into thinking you are part of a team approach. It all starts and ends with your money!
Watching your retirement slip away......
Sois Mike

Sunday, May 25, 2008

SCORPION AND THE FROG




Many of you may be familiar with the fable of the frog and the scorpion. It is a story that holds a number of parallels with the investment relationship you may have with your broker or advisor.

The story is poignant as I have recently seen a number of cases where Investors react with disbelief when they are informed that the DSC on their funds was neither necessary nor advisable. Their immediate thought is that there is a misunderstanding because their advisor would never inflate the cost of their investments by selecting the more expensive sales option. In fact, I try to explain that the advisor actually cannot help themselves. Hence the fable.

The fable involves a scorpion asking a frog for a ride on the frog's back so the scorpion can cross the stream. The frog at first declines, fearing the scorpion would sting him and he would die. The scorpion argues, quite logically, that if it stung the frog, the scorpion too would drown. Seeing the logic the frog agrees to swim the scorpion across the stream. But halfway across the scorpion stings the frog! As the frog feels his muscles begin to convulse he asks the all important question,WHY? As the scorpion struggles in the water he says he could not stop himself even if it meant he lost his life. Why, because I am a scorpion!



Advisors are trained that they are "hunters" who live off the results of their sales efforts. They work hard to find customers and get the assets transferred to their firms. As hunters, the expression is that you "eat what you kill". That translates to you earn the income you generate. More is always better and as a great hunter they have earned the income. They begin to believe that you are lucky to have somebody like them advising you. Surely they deserve to make top level income for the hard work and effort they put into investing your money. As the hunter mentality sets in they are praised by their employer for increasing revenue and achieving ever higher revenue goals. But if they fail to make the goals, they are just average hunters, no longer a part of the elite circle of top producers.

The problem is that the advisor lives in the world of the scorpion. They do not charge the highest fees to hurt the client, they charge the highest fees to maintain their position in their organization. The client becomes a means to an end and that end is to maximize revenue. How do they sleep knowing they have charged so high a fee? They sleep like babies! Their can be no guilt or shame in a scorpion acting like a scorpion!

So, the next logical question is why do investors keep letting the scorpions hitch a ride? I guess we wouldn't if we knew they had the stingers. How do you protect yourself from being a frog?

Try telling your advisor straight up that you do not want any DSC commissions charged to your purchases. In fact, tell your advisor you will pay them a flat pre-negotiated fee or move to a new advisor. If you belong to a group that has access to salaried advisors take a good hard look at the benefits of an advisor who is not commission driven. Your advisor will tell you to avoid salaried advisors as they are not up to the calibre he is. Indeed, those salaried advisors are not worthy of being called hunters!

Fighting fees.....soismike
p.s. The he and she are interchangable. Scorpions come in both sexes.

Friday, May 16, 2008

SIMPLY TOO COMPLEX

Most portfolios are simply too complex. Unfortunately many investors are guilty of thinking complexity is a good thing! ITS NOT. having a portfolio that has exotic products can almost always ensure the portfolio has excessive fees. Even getting past that fee hurdle, the complexities of investing will generally subtract from performance not add to it.
I find that Ken Hawkins of Second Opinion Investor Services generally is the writer that best puts his fingers on the key issues and does it in a way we can all understand.......so here's Ken from his latest Investopedia article.
soismike

Many investors find themselves with a portfolio that is too complicated to understand, hard to manage and difficult to change. In fact, some investors' portfolios contain so many mutual fund and principal protected notes (PPN) that they match the complexity of billion dollar pension plans, but without the expertise and resources required to manage them properly. Individual investors, especially those who invest in mutual funds, should strive for simplicity in portfolio construction. Koichi Kawana, a designer of botanical gardens, says "Simplicity means the achievement of maximum effect with minimum means." This could also be applied to an investment portfolio. See the link for the rest of the article.

http://www.investopedia.com/articles/basics/08/simplify-investing.asp?Page=1

Sunday, May 11, 2008

THE MEAN CAN BE VICIOUS

FUND RETURNS, REVISION VERSUS REVERSION OR THE VICIOUS TRUTH ABOUT THE MEAN

Did you ever wonder why that hot fund you bought is suddenly a dog? The fact that it has happened so frequently makes you start to think the market is personally trying to make you the world’s worst investor. You can relax, there is a good chance it’s not you that is the problem.

When you look at Mutual Fund advertising you can begin to understand the primary reason why investors almost inevitably buy the wrong funds at the wrong time. The reason of course, is that you do not really buy mutual funds; somebody sells them to you. Whether you read about the fund in the paper, saw the marketing at your bank, or had it recommended by your advisor, there is a good chance the seed was planted through a sophisticated marketing program.

That most marketing programs promote yesterday’s success is not important to the marketing machine; they need “outstanding returns” to put in big bold letters above the tiny warning about past returns not guaranteeing future returns. In fact, the warning should state that past returns are likely to foretell a weaker return in the future. Mutual fund companies know it, the advertising companies know it, and your sales person knows it! It’s really basic mathematics!

In statistics it is referred to as “reversion to mean”. That basic statistical rule suggests that over time the returns on markets, securities and funds will move toward the average. If a fund had a great 2007 then there is a great chance it will have a sub par 2008. If the fund had a great 2006 and 2007 then there is still a great chance it will have a sub par 2008. Knowing this basic rule, it would seem that promoting a poorly performing fund is just as likely, if not more likely, to produce superior results in 2008.

If you need proof Just look at the world’s indexes by country. Hong Kong was the top country in 1991,92 and 93 and just as you and I figured it out it went to last place in 1994. In 1994 Japan was number one and in 95,96 and 97 it was in last place. In 1999 it was back to first place. The U.S. was last in 1993 and second best in 1995,97 and 98 but careful because as you jumped in 98 the U.S. was headed for last in 2003,04 and 05. If you followed the industry marketing you jump in at the end of the bull and you sell out in frustration at the bottom of the bear market. The fund companies and advisors however take their cut in good and bad markets so they were not hurt nearly as bad as you.

What does the smart money do? The smart money is often called contrarian because it refuses to chase last year’s winners. The smart money also avoids the bubble stocks because they invest on sound fundamentals, not on marketing noise. Retail customers however invest by listening to the marketing campaigns. If everybody is getting into energy then I better call my advisor and get some energy stock. If everybody is buying REITS I better get some too. If everybody is buying Nortel I better get some too. To make the urge to chase hot securities seem legitimate you have the marketing supported by buy side analysis and seemingly independent sourses like Business News Network and the national papers with buy side articles telling you the top securities every week, month and quarter. How can all these folks be wrong?

Reversion to mean is vicious because it is relentless. What goes up does indeed come down and most often it does so shortly after you bought it. The smart money leads on the way up and the suckers follow as the security turns negative. Unfortunately in the security markets, retail investors are often played as the suckers.

How do you beat this cruel reality of the markets. You have two choices. You can find a great contrarian manager and hope their returns do not revert to the mean, or you can buy the indexes and accept the mean returns as a fair return on your equities. The indexes of course are not exciting, but they are cheap to own . Best of all in a well diversified portfolio you can accept the markets random emotional turmoil without wondering if you are the smart money or the sucker.

A lot of good will happen if you stop chasing last year’s winner and just accept that reversion to mean will balance your returns over time. You can play the market but you cannot beat the market by looking in your rear view mirror.
soismike

Tuesday, May 6, 2008

fee"dumb" 55

FEE-DUMB 55


WHEN IT COMES TO FINANCIAL PRODUCTS, TRUTH IN ADVERTISING IS A SPEED BUMP THAT RARELY SLOWS THE MARKETING MACHINE!

LET’S LOOK ATA FEW OF THE GREATEST MARKETING PROGRAMS IN FINANCIAL HISTORY! IN A PREVIOUS RANT WE DISSED THE CURRENT MARKETING SLOGANS OF THE BIG BANKS BUT WE DID NOT LOOK BACK AT SOME OF THE BIGGEST WINNERS IN CANADIAN HISTORY!

“FEE-DUMB 55”: AN INNOVATIVE PROGRAM OF MUTUAL FUND AND SEGREGATED FUND SALES DESIGNED TO ENSURE YOUR ADVISOR IS INDEPENDENTLY WEALTHY BY THE TIME THEY ARE 55 YEARS OF AGE!

The real cool part about this marketing program is the fact that it was the type of marketing that would naturally appeal to people nearing retirement; and yet that is the segment that it could do the least to assist. Unless you suddenly win a lottery at age 45, you will be hard pressed to find freedom from financial worry at age 55.

In fact this advertising should have been focused on graduating students who, depending on student loans, might be able to survive the high fee mutual fund market and retire at age 55. In fact a student who graduated at 20 and put $1,000./yr in an RRSP earning 6% would have a not very significant $125,000 to retire on at age 55. That is actually less than $50,000 in today’s dollars. So if you wanted to retire at 55 and visited your high fee sales person at age 40 you better be a mega income earner or have a great pension plan before you arrive.

In fact this campaign may single-handedly disappoint more Canadians than any in history. Retiring at 55 is not possible for most of us and even less possible if you have been paying 2.5% MERs!

Another great financial marketing scheme is being played our as we speak! Manulife is turning investing on its head with Income Plus! We can understand that a lot of blood has rushed to the investors head! How else do you explain an investment that is sold as a “guarantee” that will help you sleep at night; but has so many confusing twists and turns that it can keep you up at night just trying to figure out the odds you can ever reset and make a profit above what you put in!
At the end of the day one of the most common warnings comes to mind: if it is too complicated for investors to understand then the person selling it is making a huge commission. As with most “guaranteed” products, you pay a huge price to avoid an unlikely future loss over the life of the investment.

These two marketing schemes stand out as great examples of marketing to the unlikely dream on the one hand and the unlikely fear on the other! Greed that you can find a quick easy way to retire early and fear that the market will suddenly crash just as you retire! Both fear and greed can cause investors to look past fees and the skeptic might even think the ads count on that!

Let me know what marketing scheme is catching your eye these days!

Friday, May 2, 2008

Put Your Advisor on a Diet

Diversification Drift: The Diabetic Portfolio Syndrome

Imagine if you will a person on a strict diet who is working in a candy shop! Moderation is the key, and every day they remind themselves to be disciplined! It can’t be easy and inevitably most will fall off the wagon!
Well advisors can fall into the same trap! They know that equities need to be constrained to reduce the risk in your portfolio, but gosh they are hard to resist. They just look so good with a gooey analyst buy rating spread over the top!

The key to every great portfolio is to get the asset mix right! Nobody even argues that fact any more as history has proven the impact of asset allocation on portfolio volatility. Asset allocation is the primary reason why good advisors start with a financial plan. From the plan you can determine the rate of return needed by a client, and from that you can build an asset allocation model. In fact almost every investor can dig up an old account set-up and find an asset allocation model they received from their advisor long ago!
I challenge you to do so, and when you find it if you are over-weighted in equities please send me a nickel…..forgive me, I will have to write quickly as I am expecting a deluge of coin soon and might be retiring by the end of the week!

So why does it happen? Why would advisors increase the riskiest component of a portfolio above the agreed to targets! Well, advisors are only human. They are bombarded daily with equity recommendations from their bosses, their research departments, BNN, the newspapers and even from clients looking for the next Google! Combine that with the sugar high of big fat commissions and trailer fees and it is a wonder investors ever even know what a bond is! Equities are the sizzle; bonds are the roughage.

Slowly but insidiously, the equity component rises in the portfolio. Fortunately rebalancing should prevent the damage from being too severe or long lasting. Alas, rebalancing is a lot like exercise. It might be good for you, but somehow it keeps getting pushed to the bottom of the “to-do list”. That same old account set-up you found may well list the rebalancing schedule that hasn’t happened and the semi-annual face to face meeting that was not deemed necessary. All these non-events contribute to allowing the equity assets to become the fat kid of the asset class!

Probably my favourite ongoing example of equity drift occurs when I look at an E. J. statement. The statement lists the target for every asset class in the account;and beside that percentage is the actual weighting in the portfolio. It is amazing that clients don’t seem to rebel at the discrepancy from what the E.J. statement recommends and what the advisor actually has them holding!
Now I am sure not every E.J. Advisor is recommending clients be over-weighted in equities and it is probably just my small sample that distorts the fine work they do. I will say the E.J. statements at least show the recommended asset weighting which is more than many of the big brokers do!

So what is an investor to do? Put your advisor on an equity diet. And like any good dietician, have them check in for a semi-annual review to ensure they have not bulked up by nibbling on too many IPO’s or equity buffets. It may be your advisors diet, but the impact of too many equities will damage your portfolio long before your advisor shows any symptoms!

SOISMike
p.s. Beware structured notes which claim to be roughage but are filled with sugary equities and laced with fees!