Saturday, July 9, 2011


Is the Truth Good Enough? I think not!

One of the great challenges for all investors (and especially DIY investors) is determining what information you should accept as truthful and valid. All information is provided from a specific perspective by the source of the information. This blog is no exception!
The easiest part of the process may be determining if information is factually true. If I say “the ETF symbol XIU is a broad based Canadian Equity fund with a MER of 0.17%”, you can determine if that is true quite easily by checking the iShares site or better yet, by reading the prospectus for XIU. Of course, other information can be more challenging to validate. If I stated “the XIU was the most liquid Canadian Equity ETF” or “the lowest cost EFT”, that would require you to do a little more research (it is not the lowest cost but is arguably the most liquid Canadian Equity ETF based upon the liquidity of the underlying securities and daily trade volumes).

OK, if we assume you accept my comments on XIU as being accurate; you then need to ask yourself “why would I believe this blog or any argument it may present with respect to the information provided?” It may be that you have validated the accuracy of previous blogs or it may be that you have checked for confirmation from another source you trust. The important thing is that you do not just assume the information is correct or the correct information is being presented in a proper context. For example, if I stated “you should always buy XIU for your portfolio because it is the most liquid Canadian Equity ETF” then I am using accurate liquidity information to support an improper suggestion. Strong liquidity is not a compelling argument on its own for you to select an ETF for your portfolio.

Ask yourself some critical questions: what association or affiliation does the blogger (Mike) have with iShares? Does he sell the security for profit? Does he own shares in iShares parent company? Is he trying to induce you to pay for advice by providing some basic facts to build trust with you? Is he an amateur “wannabe” advisor playing on the internet from his basement apartment? (In the interests of full disclosure: I do not sell or recommend any securities and carry no license to do so, I do not own shares of iShares parent company {I do own some units of XIU in my portfolio}, I do not solicit clients via my blog, I have a BA from UWO with a major in economics, hold a FMA designation from the Canadian Securities Institute and have 27 years experience working with major Canadian financial institutions.)

Assuming we can accept that I have no obvious conflict of interest in making the above comments about XIU and that I have sufficient experience to suggest the data is likely correct; the challenge becomes determining why I shared the comments and whether I am might be unknowingly passing along inaccurate assumptions. Given the above disclosures, my motives are likely somewhat more pure than an industry originated blog. Given my experience I should know what is accurate and what data is not trustworthy.....right?
The investment world, more so than most others, is filled with people who write with conviction about investments that they do not understand. Most advisors do not read a prospectus before selling a fund or stock offering. Information that is passed along is second, third, and often fourth hand by the time it reaches an investor. An analyst might work for a major bank and recommend stock “” for a portfolio. The analyst then shares the report with the senior executives who decide to pass the recommendation to the company’s advisors. The advisors then receive a “hot sheet” with a number of analyst recommendations, including In order to support the recommendation a small sales blurb is included with the hot sheet and this is what the advisor reads. The advisor is looking to make a sale so they approach clients with the recommendation, often pretending to have researched the stock and determined that it is the most suitable for the investor. The challenge for the investor is that the motives and skill of the analyst, bank brokerage executives and the advisor are all built into the risk of the investment. If we lift the hood on the whole process and peer inside we might see the following:

The bank is trying to win business from as a securities advisor, commercial lender, or corporate banker. They approach the analyst and suggest a strong recommendation might help our sales pitch. The analyst reviews the company, and not finding any major problems and knowing the banks business plans; the analyst uses some extra positive adjectives to ramp up excitement about ABC stock as an investment. The bank executives love the report and strongly suggest the advisors jump on this opportunity as supported by the analyst report. The advisor, looking for a security to sell, reads the sales blurb from the tip sheet and feels comfortable selling the securities of ABC because a top analyst has recommended the firm and the tip sheet sounds very positive on the future of ABC. The investor is overwhelmed by the opportunity as described by the advisor, recommended by the bank, and supported by a respected analyst. The analyst has a CFA designation and plenty of experience. The bank executives see no obvious problems with ABC and benefit from accepting the analyst report and adding their full support to the recommendation. The advisor trusts the firm he works for and feels the analyst must have done the hard research before making such a positive recommendation. The analyst gains positive stature and a reputation for being dependable from his companies senior executives. The executives get a positive reception from the management of ABC when they suggest their services to ABC at a significant revenue gain for the bank. The advisor gets a positive story they can sell to investors about a stock the investor will likely buy thus generating commissions for the advisor. Nobody lied to anybody. No factually incorrect statements will be made to anybody. Everybody feels good and has benefited..... With one exception. The investor has bought a mediocre stock based upon marketing hype that is not supported by ABC’s relative strength as an investment. While nothing is “wrong” with ABC, it is just not the best option the investor could have bought. There is no way for the investor to know what motives were behind the recommendation and it is difficult to point to other securities you might have bought a year or two after the fact when ABC has lagged the market by a few per cent. It might even have gained in value versus the book value.
Solution: So, “buyers beware” is the key when investors receive advice from ANYBODY! Check multiple sources. How many analysts are following ABC and how many of those rate ABC as a strong buying opportunity? Ask the advisor the right questions: have you read the full analysis yourself, what are the key risks outlined, is your bank soliciting business or doing business with ABC and how did you confirm that, what other securities did you consider and why is ABC a better choice, why do I need another stock in my portfolio and why this sector of the market at this point in the business cycle?
As my good friend Joe always says.....”It is good to trust but safer to not trust”! That translates to “trust but always verify” when you are an investor!

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