Friday, May 25, 2012

One Small Step For Investors, One Small Set Back for Investors Group

The sudden announcement that Investors Group will lower MERs (the hidden fee an investor pays every year to hold a firms mutual funds) on two thirds of their funds is a victory for retail investors (that’s you if you own IC funds). The fees are being reduced by approximately 0.4% to 0.5% per year. In short you will save approximately $450.00 every year for each $100,000.00 in IG funds you own! Given IG has approximately $60 billion in funds it manages, and using the two thirds ratio, that means Canadian investors will see annual fees drop by a collective $180 million dollars annually!

As a backgrounder, IG is extremely large in the Canadian Fund industry and has been known historically for charging MERs that were relatively high compared to their peers. In fact, IG is a primary reason why fund fees in Canada are deemed the highest in the developed world! Given the size of IG you would have expected an economy of scale advantage that would have enabled the firm to be a low cost provider in Canada. Instead, Investors Group took the approach that Canadian investors are fee tolerant and either did not care or did not react to very high fees. In short, small uninformed investors are ripe for being fleeced on fees. In fairness to IG, that seems to have been a smart bet over the past couple of decades. IG has built a huge business by being everywhere with a horde of well trained sales people. The sales pitch has been slick and having sales people coming into investors homes has built a huge base of goodwill and trust. Almost every Canadian town has a ball team, hockey team, or soccer team sponsored by the local IG office. In fact, IG has been to fund companies as Tim Horton’s has been to coffee shops.....that is if Tim’s charged $3.00 for a double double!

Investors Group has always downplayed fees and promoted the softer benefits of having a financial plan and a trusted hand to guide investors. At the same time, however, IG has kept fees high across the board. If investors try to leave IG they often find themselves having to pay thousands in penalties that the investor did not really understand. By selling large quantities of funds with Deferred Sales Charges (DSC or Back-end Loads) IG has reaped a windfall of profits even as dissatisfied investors have left. Which brings us to the crux of the matter for Investors Group: Investors have been paying the penalties, albeit not happily, and moving on to firms that charge lower fees. Consumers have become more informed, thanks in no small part to journalists such as Jonathan Chevreau (ex-National Post, Money Sense) and Rob Carrick (Globe & Mail), and fee only advice firms such as Weigh House. As well blogs, a new breed of low cost fund firms (Steadyhand, Mawer, ING, TD eFunds), and a more cynical attitude towards big financial firms has helped spread the story on fund fees in Canada.

How has this impacted Investors Group? For a long time now the IG fund family has struggled to provide quality returns. Since returns are shown net of the MER, the fund managers at IG need to overcome the impact of the large fees when comparing returns with funds who charge lower fees. This problem becomes even more challenging when fund performance is measured against low cost exchange traded funds (ETFs are the fastest growing segment of the fund market worldwide and in Canada). The result is that IG has amongst the lowest percentage of funds of all the major fund families ranked in the top categories by independent rating firm, Morningstar. Although very large, IG has only 18% of funds ranked 4 or 5 stars out of 5 on the Morningstar scale. On average fund families have 28% of funds ranked in the 4 or 5 category.

This has resulted in retail investors shunning the mediocre performers. IG has had net outflows of funds for the last three quarters. In Q1 2012, year over year inflows dropped by 65%. When these types of numbers are appearing it likely follows that the sales team at IG is starting to defect. With sales driven by relationships, a salesperson often takes a large number of clients with them when they defect. In the fund industry competitors will often make it attractive for sales teams to switch firms. Being able to show existing clients that a new firm has better ratings and lower fees is a big sales assist for disgruntled sales people.

So, in the end IG is making the changes necessary to ensure they can continue to retain sales teams. They are not making changes in order to benefit investors nor are they reducing the fees on all their funds. What is happening is that IG is being forced to acknowledge that the days of fat profit margins and poor performance are threatened. IG is a smart company and they will spin their decision to seem more consumer focused than it is. The way to force changes is to threaten profits and thousands of small investors have done just that! It is the first small step in a long journey but it is a welcome site for all investor advocates.

In the end IG will act in an economically sensible way, as they always have. The company still has a large profitable business and a large well trained sales team. They will make revenue adjustments when forced to and not a moment before. That is no different than a bank lowering a credit card rate or a car company dropping prices. The main difference is that MERs are hidden from monthly statements and thus consumer awareness is slower to develop. While many advocates hold IG in contempt for gouging consumers for decades, the truth is always somewhere in the middle. IG exploited a business opportunity which is now being slowly eroded. As retail investors continue to become more enlightened IG will find new areas to exploit. This is more evolution than revolution but it is a great start on the road to a fair and level investment market for Canadians.

In the meantime, congratulations to the thousands of investors who voted with their wallets and forced a major change in the behaviour of the fund industry! Keep up the great work!


Thursday, May 10, 2012

Leafs, Mutual Funds, and Other Addictions

As I watched in awestruck horror, my Maple Leaf hockey team slowly disintegrated before my eyes this winter. It is a very difficult time to be a Leaf fan and it is getting harder to say ‘we will get’em next year”.  Of course my friends all claim to be long time fans of Boston or Chicago or anybody else that has had recent success. Many who claim to be friends seem to take great joy in pointing to the folly of being a fan of such an incredibly bumbling organization. The senior leaders in the Leaf hierarchy continue to insist they care more about winning than making enormous profits; yet year after year they manage to seem cheerful when they tell shareholders about the huge profits they have ‘earned’ (?) for the owners. As I watch this unfold I struggled to find an analogy for being a loyal Leafs fan.

Then, I had an epiphany!  I opened my investment statement and it all became clear. Cheering for the Leafs is the very same as investing in Mutual Funds! How could I not see it before? Think about the following points and see if you agree:

1.       They both seemed like a good idea years ago when I invested in them. In the early years (I am mid-fifties in age) the Leafs were winners and life was good for Leaf fans. In the early years Mutual Funds paid double digit returns and investors all made money!

2.       Being a fan of the Leafs is an emotional journey. They raise you up just to knock you down again and then they repeat the pattern endlessly. My Mutual Funds have also had great days, weeks, months and even years but they are now worth no more (and often less) than they were worth when I originally invested in them. The crashes are sudden, without warning, and devastating. Sound familiar?

3.       The Maple Leafs cannot seem to recognize quality assets. They trade draft picks and young ‘stars- to- be’ for old tired and worn out players. When they do get a good spot in the draft they still manage to find a dud. Not surprising all the top free agents stay away. Funny, when I look back at my fund holdings I see the same story. Stocks bought when they were past their prime and stocks sold just before they went on a tear. Top fund managers leaving for better firms and no quality replacements in sight.

4.       Leaf tickets are priced as if the Leafs of old were still here winning championships. Why am I forced to pay huge ticket prices to see a team that stinks! Similarly, Mutual Fund fees are the highest in the world here in Canada and performance also stinks. Paying a couple or 3 per cent on returns of 12-15% was not bad in the eighties. But paying over 2% now for funds that return nothing over a decade seems a bit much. I am being ripped off every way I turn!

5.       Sports analysts (talking heads) continually pump up the volume on how great the Leafs will be soon..... not now, but soon! Come the trade deadlines or draft day you would think the Leafs had phenomenal assets to trade or the next great star about to be drafted. Soon we realize it was all B.S. designed to get us to buy more tickets and Leaf jerseys with a new saviors name on the back. As for Mutual Funds, every terrible statement comes with an explanation of why now is the time to invest. Markets are just about to go on a bull run and the newest stock picker hired by the fund company is a real genius! Remember this RRSP season you need to double up on your deposits because this coming year is the big one for investors.....right?

6.       Perhaps the biggest similarity is my inability to wean myself off of these addictions. Why would I continue to work with an advisor that I have come to realize is just a salesperson sucking me dry? Why as a Leafs fan do I still turn on the game and start every season thinking this year will be different? Alas to this simple question there is no simple answer!

Having carried the analogy far enough I now see there is one huge difference. I do not really love my advisor/salesperson. I can picture life without them. I can manage my own investments or I can find a low cost fund firm like SteadyHand or Mawer or Leith Wheeler or I can buy low cost ETFs. In short, I have control over whether I use an advisor/salesperson.

As for the Leafs, well matters of the heart are more difficult. I will continue to try to grow apart from the Leafs but I can never, ever, ever, ever cheer for Montreal or Ottawa! That would just be too much to ask of a recovering Leafs addict!