Tuesday, January 24, 2012


The current investment climate is about as bad as it gets when you look back over an extended time period. Canadian investors have watched as equities vary between days of terror (huge market drops) and days of despair (slow death via multiple days of small declines). The odd good day or week in the markets seems to just tease us for what might have been had we invested in the 90’s instead of this century! Even the old standby, the Money Market Fund, has proven to be neither safe nor profitable. We lamented the lost decade for equities from 2000 to 2010, and then started the new decade with negative equity markets for 2011.
So what can we do and what should we do!
1-      We CAN stop adding to the problems by making poor decisions about our investment strategy. The typical investor in a MF or ETF Index fund will make significantly less than the fund itself over the course of a typical year. That is because investors jump in and out of the equities market based upon the current emotions they are feeling. Studies show that this undisciplined approach will cost investors up to 4% less return than a mutual fund would make on average. Professionals do NOT jump in and out of the markets based upon emotions. They follow an Investment policy Statement (IPS) that outlines the minimum and maximum percentages of equity that MUST be held in the portfolio. For those that wondered about the definition of “rebalancing” a portfolio; that is the term used for bringing a portfolio in line with its IPS guidelines. Without an IPS you CANNOT rebalance your portfolio!

2-      We CAN stop pretending that the folks who make a good living managing investments have an ability to predict what stocks will go up or down next week or next year. Professionals can help you select stocks which have good balance sheets and good management in place. They can also help you ensure your portfolio is well diversified. Other than that, professional stock traders are of little use unless they can provide insider information (which in general is illegal). In 2011 the consensus forecast of investment managers in Canada was for stocks to outperform bonds and commodities. It will come as no shock that a) they were wrong, and b) they have made the same forecast for 2012. In fairness.....they eventually will be correct just based on the law of averages!

3-      We CAN reduce the fees we pay. With investor returns at historic lows we cannot continue to give a guaranteed 2-2.5% return to investment salespeople. If markets were to provide you with the 4%-5% returns we expect in the near future, a fee of 2.25% would be 45-55% of your total investment return. In years where markets drop, like 2011, the fee just increases your losses. If you negotiated a fee of 1.25% you would be giving up only 25% of the same return forecast! If you used ETF Index funds you could reduce the fee drain to a fee of .25% and have only a 6% fee drain.
While markets are certainly tough it does not mean we cannot do better. A little effort, some simple strategies and a calm demeanour can go a long way to lessening the pain of being an investor today!
If you need an IPS then ask an independent (non-selling) firm to customize one for you!


Monday, January 23, 2012

Well, it was another year of frustration for “real investors”. By “real investor” I mean those of us who trade without access to inside information and who cannot augment our returns through hidden fees or commissions. While we will lick our wounds and carry on, we should also track where the smart “professionals” were focused in 2011 to see where we missed the boat.

Consensus Forecasting for 2011: The “professionals” forecast the market performances every year and then a “consensus report” is tabulated to allow us to peak under the curtain and see what active traders are doing to beat the markets. The asset class forecasts were very clear that security performance in 2011 would see returns ranked as follows:

-          Equity stocks would be the best performing asset class

-          Commodities would be the second best performing class of assets, and

-          Bonds would trail the above classes and provide weak performance

Based upon the forecast, you would overweight equities, diversify with commodities, and minimize your bond holdings.Let’s see how well the smart money did in forecasting 2011.

-          Equity returns in Canada ( TSX broad market total return index) -8.71% and if you choose to look just at the blue chip TSX 60 returns were -9.08%

-          Commodities as measured by the Auspice Broad Commodity Index was 1.78% to the positive side

-          Bonds as measured by the Dex Bond Universe was up 9.7%

Wow, the smartest guys on the street managed to show an amazing dyslexia of returns! They used thousands of analysts to crank out the research math and got everything backwards! In fairness however, the forecasts were great for revenues at the brokerage firms as investors traded heavily into the markets based upon the forecasts. By the end of the investment rich RRSP seasons investors had bid up the equity markets and the research looked great. However, once all the suckers....um, investors were fully invested, the professionals did a quick sprint to the exits, leaving the retail investors holding a smelly mess of equities. The TSX dropped from the lofty mid 12,000’s to the more realistic low 11,000’s. Unfortunately, those who followed the advice in late February and early March can only wish they had lost 8 or 9%! In fact many will see 15-20% drops with their RRSP investment money.
So, how did a conservative indexer do in this type of market? If the pro’s got it wrong we can only assume the indexers got creamed! Our conservative 50/50 balanced model would have received the returns of a typical mix of ETFs somewhat like the following: 

Cdn Equity
US Equity


Well, it was definitely a tough year; however staying diversified reduced the damage significantly. Even if investors reduced the risk by splitting the fixed income between short and long duration bonds (50% XBB and 50% XSB), the overall return would be -0.3% for the year 2011.
Obviously the higher the Canadian equity component or the EAFE equity component, the worse the overall portfolio performance. For those active traders that jumped on the gold bandwagon the entry point was a challenge. On the whole XGD (the gold ETF) was down 14% and the much recommended emerging markets saw a decline of 16.4% as measured by the emerging market index. So, if you followed the professionals you were heavy equities, heavy emerging markets, heavy gold and light weight bonds. If you followed your Investment Policy Strategy as a conservative investor you retained your capital! Thank goodness I am a dull investor with a conservative IPS!


Monday, January 9, 2012

Part Two: Why Mutaul Funds are like Popcorn.....Explaining The Fee Gap

Mutual Fund Fees: Part Two     
In part one we discussed the position put forward by Fund Companies and Advisor/salespeople that the Management Expense Ratios in Canada represent fair value for investors. The logic they use does not hold water when you break down the component parts of the MER between investment management, sales channel expense, and the “advise” component.  As we showed in the previous blog, the portion that is reasonably assigned to “advice” seems to be far too high. In an efficient world we have shown that a typical Canadian Mutual Fund with an MER of 2.4% per year would have approximately 1.2% available to cover the advice cost. In fact, the fund companies generally pay a “trailer fee” to sales people to cover the cost of the annual advice component of the fee. That trailer can vary between 0.5% and 1% per year. This would suggest an average advice fee of .75%. This suggests that there is another fee component that we are not accounting for?
Formula: MER = investment management expense + sales channel expense + advice fee + ?
                2.4%= .7% + .5% + .75% +?
                ? = 2.4% -.7% -.5% - .75% = 0.45%
Where does the mysterious 0.45% go? In fact, on the typical mutual fund with a 0.5% trailer the mysterious “?” factor is 0.95%. In effect, we can surmise that Canadians are paying an extra half to one per cent on mutual funds after all reasonable fees have been accounted for. Who gets the extra fee?
Alternative Scenario: Mutual Funds in Canada are priced to reflect what an uninformed investor can be convinced to pay. The mutual fund industry and the “advisor” industry have set up an ideal world for the exploitation of investors. The key components are as follows:
Ø  A closed market where prices can be set by a few large companies.
Ø  Self regulatory oversight where the same companies can dominate the rule making process
Ø  A sales channel that can act to keep the investor unaware of low cost alternatives
Ø  An uninformed Government that can be manipulated to support the ongoing deception
For those that think this is about a big “conspiracy theory”, let me assure you it is not. Conspiracies are too complex and the details would eventually leak out. Instead this is about a combination of ignorance, laziness, and business strategy.
Ignorance & Laziness:  Most of us slowly and almost unwittingly enter the world of investing. Our first investment need is often an RRSP or TFSA account. Investors are typically directed to their bank or “advisor” to teach them how to manage their investments.  Often young adults will learn important skills from their parents; however the financial world has changed so fast that we do not have a pool of knowledgeable parents to educate the young investors. The educational system does not teach money management and, in truth, most investors are unaware of the problems and thus of the need to become educated. Investors are focused on their jobs, family, and day to day life. The path of least resistance is to be a part of the current system and use the bank or fund company sales channel. This is a combination of laziness ( not getting ourselves educated about investing) and ignorance (not knowing the current process is a problem).
Governments are also a part of the ignorance problem. Rather than regulating the investment process the governments have chosen to allow the industries to regulate their selves. These “SRO’s” include the Investment Funds Institute of Canada (IFIC) and the Investment Dealers Association “IDA” whom have morphed the regulatory duties into the Investment Regulatory Organization of Canada (IIROC). In short, those who profit the most from unfair fees are the group the government allows to set their own rules and standards. The result of this has been a government who does not protect investors and who then actually looks to the industry SRO to provide guidance to the government on industry policy. An example of this collusion was the decision by the government of Ontario to exempt fund companies from disclosing the HST paid on mutual funds. The only possible purpose in doing so was to hide any information that could allow investors to determine their monthly fund fees. The government bought into the bizarre suggestion to exclude the information from statements and the industry benefits at the expense of the investor.

Currently we are seeing an even more egregious example of an industry run amok as the various levels of governments defer “investor education” programs to committees dominated by executives of financial firms who sell funds. Most people who understand the industry are left to shake their heads and mutter about the “wolf guarding the henhouse”. As for the government, they appear to be happy to defer to the industry in a way very similar to how the average investor defers to the mutual fund sales status quo. Governments are not being so much duplicitous as they are being ignorant and lazy. Why look for problems and solutions if investors are not making waves.
Business Strategy: The fund executives are in the business to make profits for investment firms who employ them. Period! They are not in the business of providing advice, education, or regulatory oversight. Their business strategy, however, necessitates that they control the advice, education and regulatory processes that impact the fund industry. Their strategy has been to control the process from start to finish and create a closed loop.  The industry controls the production of funds, the regulatory oversight, the distribution of funds, investor education, provides guidance on government policy decisions and sets the pricing of all services to the investor. It is a great business model and one that generates massive surplus profits for the fund industry.
On the Street Impact: The impact of the strategy is felt directly by the investor. While most investors are not aware of the strategy they are very aware of the impact it has had on investors.
-          Canadians pay the highest fund fees in the world
-          Canadians deal with “advisors” who are in fact licensed sales people and have no legal duty to put the client’s interests before their own. In actual practice advisor/salespeople clearly prioritize their own benefits ahead of their clients. For proof look only as far as the next point.
-          Over 80% of mutual fund sales people are NOT LICENSED to sell competing products such as low cost index funds that trade on the TSX. These funds are amongst the top performing funds every year and cost as little as a tenth of the cost of equivalent mutual funds.
-          Canadians buy a significant portion of their mutual funds with deferred sales charges. These charges are being banned in a number of countries (Britain, Australia) and are rarely sold in the U.S. where investors are much quicker to sue an advisor over improper advice. These fees are designed to lock an investor into a single mutual fund company for up to seven years with little or no corresponding benefit to the investor.
-          Canadians have no binding complaint process that allows for arbitration of investor complaints with multi-billion dollar financial firms. If a firm does not pay up the individual investor faces the daunting task of suing a firm that has the top securities lawyers on speed dial.
-          Canadian mutual fund statements and disclosures are amongst the worst in the world. Investors are not provided with monthly cost of fund fees, personal rates of investment return, nor proper benchmarking information.
-          Risk ranking of various mutual funds has been left to each individual fund company. In fact, the same fund can be rated at a different risk level by two different distributors at the same time. The acceptable risk rankings have no basis in quantitative analysis and thus are at best useless and at worst dangerous.
The above are only a few of the negative impacts we can attribute to the business strategy of Canada’s large fund firms. However, as any fund executive will tell you....it’s not personal, it’s just business!
As Canadians struggle to build their retirement nest eggs it should be clear that at least part of the problem for investors is the significant skimming of retirement funds by mutual fund companies and so-called advisers. In the real world the cost of the additional and excessive fund fee is reflected in delayed retirements, eroding retirement portfolios, improper retirement planning advice, and a general sense that the average Canadian cannot seem to get ahead.
Perhaps this is part of the issues that pushed some people to Occupy Wall Street! Add in the bank strategies on increasing consumer debt, excessive credit card fees, excessive chequing account fees and you begin to see a pattern of skimming that leaves the 99% with little to cover basic living expenses. Of course ignorance and laziness are somewhat self induced so we can solve these issues ourselves. However the solution will have to start at the ballot box because currently the fund firms hold all the trump cards!
Wow, that sounded more political than I intended! This blog does not take political stands but fortunately (or unfortunately in this case) all political parties currently bow to the financial firms with equal deference.
Sois mike