DIY Follies

DIY Follies and The Danger Of Web Experts!

First let me start by saying I am a big supporter of DIY investing, both professionally and personally. I believe investing is too important for people to completely trust their money to a third party advisor, regardless of how qualified the advisor might appear to be. I also think that fees in Canada are so egregious that many investors can make a better return on any DIY portfolio than they will on a “fat fee” fund strategy.

So what frustrates me about DIY? It is the smug self assured certainty of many DIY investors I hear from or read comments from. The web has been a great source of information on DIY investing, and much of it is good stuff. Unfortunately a lot of it is also total crap. It seems that reading a single book and wasting a few hours an evening on web blogs is actually deemed sufficient training to become an unlicensed expert advisor to the masses. To make matters even worse, the advice is most often anonymously shared by somebody hiding behind an ego driven pseudonym. Who would not want to follow the advice of “dividendman” or “investpert”! (my made-up examples in case these pretentious pseudonyms are really being used by somebody out there)

So let’s take a look at some of the idiotic recommendations that appear regularly on investment blogs from DIY advisor wannabee’s:

1- Only Idiots invest in Fixed Income: This one is an idiotic comment that even some mediocre professional advisors spout! With the professional advisor it is understandable because they make more money selling stocks than bonds. With the DIY guys it is because they are navel gazers! They often have no concept of risk or downside protection, little understanding of investment horizons, and believe anybody who disagrees with them is a moron. Not surprising many also claim to be young and thus have little money and plenty of time! By the same theory you should invest in lottery tickets since you have years to invest which greatly increase your odds of success.....right?

• 1a- Contra the DIY: Equity investing is high risk. The returns on equities are typically higher over the long term but with no certainty that the returns will be superior on any given day, month or year. The larger market corrections can take over three years to recover and equity markets can move sideways for decades at a time. In fact some money managers believe we are in a seventeen year sideways market as I write. In looking at a top investment firm’s numbers for the past 5 years, I see a fixed income fund with average 5 year returns of 6% and with no negative returns in the 5 year period. The same firm’s equity portfolio was a top performer over the past 5 years and has a return of 6.3%. Net of fees (2% on equity and 0.9% on fixed income) and the fixed income portfolio has higher returns, lower volatility and lower fees. So what if the person was indexing their DIY portfolio? The benchmark returns were 3.7% for the equity fund and 4.9% for the fixed income fund.

2- Dividend Funds are the perfect strategy for everybody: The blog world is filled with folks who push the concept of 100% dividend stocks. They suggest that only the bright geniuses like themselves are aware that “dividends pay you to hold the stock in good markets or bad” and that historically, the “consistent dividend growth is the secret to better investment returns”. In fact dividends can pay more than GICs so sell your low interest GICs and buy dividend stocks and you will grow rich!

2a – Contra the DIY: Dividends are indeed a good thing! They are not however the primary investment goal of all clients. Most dividend companies are in older mature and thus lower growth industries. If you are in equities for growth then you may find non-dividend paying energy or tech stocks more appropriate than the dividend approach. The blue chip dividend stocks are often very highly priced with similarly high price earnings ratios. When dividends outstrip GICs it should come as no surprise that the additional return is compensation for increased risk. The other nasty part of a dividend strategy is when a firm suddenly decreases the dividend and the stock drops like a rock. It can take a lot of years of 3.2% dividends to make up for a 35% price drop! (think Manulife for a recent real life lesson)

3- Don’t Invest in Foreign Markets Because of a- currency risk, b- currency conversion fees, c- Canadian markets will outperform! : The Canadian market is a top performing market. European markets are weak sisters that never make a good return and Japan is a wasteland! The smart money invests in Canada because we have natural resources that can only become more valuable over time. We also have gold that will save us when the world ends as we know it. The stock markets all move together so it does not pay to diversify by geography. The loonie is king and foreign holdings increase currency risk too much.

3a –Contra the DIY: In fact diversification has very little to do with long term currency risk and long term investors do not suffer a lot of losses on currency fees (which are still annoying and to be minimized). The diversification into foreign countries is done for two reasons. Foreign countries often have less than perfect market correlation which means if we drop 30% and Europe drops 25% in a bad market, we would benefit by holding some Europe equities on average. Historically the major markets do not hold the top spot for more than a few years before a nation drops back and is replaced by a new market that is heating up. You cannot reasonably predict the world wide shifts so benefit from holding a little of many markets. You do not expect peak performance from every market every year.
The second reason to diversify geographically is to diversify across sectors. Canada is a small market with little health or high tech companies to be had. Foreign firms often provide better exposure to business sectors the Canadian market cannot offer.



4- Follow My Lead Because I Made 30% Returns For Every Year in The Last 7 Years!

I buy only a- dividend, b- small cap, c-gold and diamonds, d- options, e- outer Mongolia futures, and I have beaten the pros for years. Everybody else is stupid and I am a genius and am willing to share my brilliant approach with you! Honest! Check my blog! Honest! Ask my brother-in-law! Honest!

4a Contra the DIY: Unfortunately, I am only exaggerating a little bit! There are several thousand very bright and well educated investment experts with almost unlimited support from top analysts. They did not miss your magic formula for success! You are not a genius unless you do it, have it audited by professionals, and can repeat it over and over. You may be lucky, you may have incorrectly measured results or you may be full of crap! It’s hard to tell from this side of the screen, but I am very confident you are not a genius! Honest! Really! Seriously!

The DIY world is a great place with a lot of bright folks who are interested in investing! But be aware, not every comment is created equal and a little assumed knowledge can indeed be very dangerous. The key to success in the DIY world is very simple: Do Your Own Research! Blogs can be fun and informative but they are not tested or validated. The top forums or blogs will most often make it very clear they are expressing “opinions”, not expert opinions, and just somebody’s opinions. They also make it clear they are not licensed security advisors and you should not buy or sell on their opinions, but rather may want to research what they are commenting on.

Your sceptical of advice friend.....SOIS Mike!

POS DEBATE RAGES ON

Jonathan Chevreau fires a broadside at the Point of Sale proponents. You to need to do more and do it quicker!


Directions to the article. http://www.financialpost.com/opinion/columnists/case+little+late+mutual+fund+warnings/3244193/story.html

INVESTOR RISK: SKIM NOT SCAM!

SKIM: Skimmed milk refers to milk which has had the rich cream taken off the top, leaving a less rich milk product. For our purposes skimming refers to removing a hidden fee from a mutual fund portfolio prior to valuing the portfolio for an investor. It also leaves a less rich portfolio for investors.

The media and casual investors intently follow the stories of investment scams and how they devastate the lives of investors and their families. It is understandable of course: a good human interest angle will definitely get the attention of readers!

In fact, the damage done by investment scams and frauds is very minor compared to the damage done within the standard “rules of engagement” between investors and investment firms. F.A.I.R. Canada has reported that as little as 2% of the dollars lost in major frauds over the past decade in Canada involved a regulated investment firm. In short the odds of being “scammed” in a recognized mutual fund are near zero. The odds on having your investments “skimmed” however are close to 100%!

THE SKIM: As an investor you put money into a fund to gain diversification and professional management. Those are worthy goals and the fund industry is fully capable of delivering on both fronts. The issue that leads to the skim is putting a value on the services you want. In effect the industry has clouded the process on two key fronts by:

- Adding mandatory “advice charges” to many mutual funds, most often through hidden and excessive sales fees being mislabelled as an advice fee.

- Portraying licensed fund sales persons as “Financial Planners”, “Advisors” or some form of Vice President/Director. These titles imply an advice or planning offering often not available.

The net effect, for most investors, is a steady skimming of your investment portfolio in return for little or no advice or planning services. In fact, there is no requirement for a fund salesperson (your planner or advisor based upon their job title) to even talk with an investor in order to justify the skimmed fees for “advice”.

You can, in effect, be charged fees for an unlimited number of years without even knowing who your current advisor/salesperson is! Your salesperson could sell their clients to other salespeople and the advice fee continues to be skimmed annually and forwarded to the new “advisor” you have often never even met.

WHAT IS MISSING: At its most basic level, what is missing is the quality professional advice and planning most clients need but cannot identify or articulate without having experienced it. Basics such as a detailed financial plan, an annual review of the Investment Policy Statement, disclosure of material information on changes made in fund management, an assessment of client need versus risk etc.

All of these would require a salesperson to spend time before a client meeting doing preparation, time in a meeting reviewing client requirements and current finances, and post meeting time to implement any required changes. If a salesperson spent 3 hours per client per year doing a proper review then the fee likely could be earned.

Does it happen? No it does not. How do I know? I worked for a major bank with a large financial planning team. The bank would never allow sufficient time to do even a basic annual review. We always had literally thousands of uncompleted reviews and no prospect of ever getting caught up.

Why? Take even 250 clients times three hours and you have 750 hours of review work. That is roughly 100 days of work per year. So, the salesperson gets the fee if they do not do the work and they get the same fee if they do complete the work. How many salespeople do you think will opt to do the work? What if you have 300 or 400 clients? The system clearly cannot work as it is structured.

WHY JOIN ORGANIZED CRIME WHEN YOU CAN GET RICH USING LEGAL SKIMMING TECHNIQUES?

As an ex-banker I was always amazed that bank robbers would risk up to ten years in jail to rob a bank for $300 (average take from a bank robbery these days is quite low) when instead passing bad cheques/cheque fraud could earn you thousands with virtually no risk of jail time. Only a dummy robs a bank using a mask and a gun these days.

Similarly, I cannot understand why fraudsters would go through the hard work and stress of scamming investors (false documents, false statements, a risky paper trail, high risk of being exposed and charged with a crime), when you can legally “skim” investment accounts with fees that add no apparent value and are not required to be disclosed to investors.

What Does Add Up:
Investors pay a number of innocuous sounding fees either directly or indirectly from their investment accounts. Most investors work on a basis of trust and have no clue what dollar amount they are paying nor what they should be receiving for those fees. This is the environment that makes the skim possible and lucrative.

The average planner/salesperson may have a portfolio under administration of $20 million dollars. At a mere 0.5% skim the portfolio is diminished by $100,000.00 per year. Many trailer fees are as high as 1% which translates to $200,000.00 being taken every year from client accounts. There is no accountability that would require any work to be done by the salesperson. The money is skimmed by the fund firms and forwarded directly to the salesperson's firm.

Many salespeople lock clients into the fund via a deferred sales penalty program for up to seven years. In the simple example given, with a 0.5% trailer fee, the total money skimmed by the average salesperson over that sales cycle will be $700,000.00. Now picture a firm with 1,000 salespeople on staff. I think it becomes clear why fund sales are such a lucrative business and why your salesperson can drive a nicer car than you can.

For those who say, well the salespeople have to eat too I will remind you of two things:

1- Front end loaded fees: Salespeople often receive 5% of the invested funds up front from the fund firm. On a $20,000,000 portfolio that is $1 million dollars. The commission is split amongst the 600 or so client accounts of the salesperson and is again a hidden charge. (Investor Economics data suggests the average portfolio for a salesperson in the advice business is just over $20 million)

2- With the skimmed fees we are talking about a forced, concealed payment for a service that is often neither articulated nor delivered to the client.

BEATING THE SKIM: We do not have to be skimmed as fund investors. You have several options to help fix the problem.

1- Set clear expectations with your salesperson for what you expect for the fees you pay.

a. Communication should include monthly updates, and semi-annual conversations as well as at least one face to face meeting every year.

b. Investment information should include an estimate and explanation of all fees paid from your account , performance results versus a set benchmark, and current versus targeted asset allocations.

c. Planning information should include a review of your financial situation, income, expenses, and liquidity needs going forward.

2- Ensure that your salesperson has the capacity to handle your account effectively. A salesperson with 100 clients is more likely to have the capacity for a review than a salesperson with 600 accounts. Ask about support staff but remember support staff is to aid with internal paperwork not to handle client reviews.

3- Purchase low cost mutual funds and you will not have as many worries about skimming. You can purchase funds without embedded advice fees from a number of fund firms and can purchase ETF funds without embedded advice fees as well. Ditching your advisor/salesperson does not ensure you avoid the skim as discount brokers often take the skimmed fees that normally went to the salesperson. That is of course the height of skimming as discount firms are not even licensed to provide any advice to investors.

It is not easy to be a wise investor when the market is such a deceptive place. It truly is a “buyer beware” experience and not a safe place for those who tend to trust without verifying.

sois mike

WHO GIVES A FIDU?

FIDUCIARY 101..... OR WHO GIVES A FIDU?

In keeping with industry tradition of backward processes and thinking, I will start with part 2 and then move on to part 1. This is important to reinforce the understanding that the sales discussion is most important and is always front and center. The information component required to make an informed choice will be provided at the end ....for those few who get all the way to the end! Think of it being just like a mutual fund sales conversation where key information is delivered well after the sale is closed.

PART 2:
So let’s get to my main topic: Fiduciary 101:

An advisor is a salesperson. A trusted advisor should be a "fiduciary". What is the difference and why should an investor care?

Fiduciary Duty would require an advisor to be legally and morally bound to put a client’s interest before their own interest.

Maybe I am just too simple a person but I cannot help but ask “why is this such a big deal for an advisor”? Why would any investor not want to be assured their advisor was acting in their best interests? We all understand that salespeople work to maximize commission, so it is always a case of "buyer beware"! But what if you did not know your salesperson was a salesperson? What if they created a false and misleading title to fool you? In that case a salesperson might deceptively call themselves an "advisor", "financial planner", or "investment manager", "retirement specialist", "estate planner" or any number of misleading titles! But underneath the sheepskin lies the cunning wolf we call a salesperson! A word of caution to all investors, whether experienced or a novice: If approached by a salesperson using one of the above deceptive titles, immediately put your left hand over your wallet and back away slowly! Place your right hand in your pocket and make a fist so that a pen cannot mysteriously appear in your hand to sign any seemingly harmless document!They are cunning so try to avoid direct conversation or answering any leading questions

But common sense and integrity aside...... let’s just look at real life for an example.
Starting Premise: For a fiduciary obligation to exist we would need to have a situation where one party has far more expertise, knowledge, access to information, and skill than the second party to a transaction. Now let’s look at the advisor/salesperson relationship with a new prospective investor.

STEP ONE IN SALESPERSON RELATIONSHIP:
The salesperson will:
- proclaim their accreditation and designation from an educational institute (typically Canadian Security Institute ) signifying both knowledge and skill
- explain their experience in the industry and with their current employer to show expertise as an advisor and money manager
- sell their access to current privileged information from company analysts and direct access to mutual fund managers and portfolio experts

The client will:
- Complain they do not understand what happened to their money with the last guy they trusted
- Profess a greater knowledge than they have for fear of looking like a pigeon to be plucked
- Sign whatever they are told to get the process started, regardless of any true understanding of the jargon
- Write a cheque or sign a transfer document
- Abdicate most or all decisions to the new saviour/advisor/salesperson

STEP TWO:
The salesperson will:
- Prepare a Know Your Client questionnaire to say whatever the salesperson pleases, exactly as they are trained to by their compliance department (department of obfuscation)
- Explain vague terms like “risk” in such a manner as to suggest only morons would claim to be low risk and only vegetables look for conservative returns
- Have the client sign forms to purchase securities being careful to:
o Avoid showing any alternatives that are lower cost
o Maximize the commissions to the salesperson without disclosing amounts or options
o Keep the salespersons employer happy by pushing proprietary securities
o Do everything they can for the client up to the point where an action might infringe on the advisor commissions or the parent company’s profitability

The client will:
- Nod when requested
- Sign where told
- Ignore the poor performance for years before getting frustrated and returning to step one.

WHAT WOULD THE FIDUCIARY DIFFERENCE BE?
Step 1:
- THE ADVISORS FIRM WOULD ENSURE THE ADVISOR HAD PROPER SKILLS AND ACCREDITATION SO THEY WERE NOT EXPOSED TO A LAW SUIT FOR VIOLATING THE FIDUCIARY OBLIGATION TO THE INVESTOR
- THE ADVISOR WOULD REVIEW THE PLANNING NEEDS AND INVESTMENT REQUIREMENTS OF THE CLIENTS SO INVESTMENT DECISIONS WERE BASED SOLELY ON ESTABLISHED CLIENT NEEDS
- THE ADVISOR WOULD STAY UP TO DATE ON PRODUCTS, FEES, COMMISSION STRUCTURES, PERFORMANCE OF SECURITIES AND REGULATORY REQUIREMENTS
- LESS TIME WOULD BE SPENT ON THE ADVISOR STORY AND MORE ON THE INVESTOR STORY

Step 2:
- THE ADVISOR WILL COMPLETE A THOROUGH ASSESSMENT OF THE CLIENT NEEDS, RISK TOLERANCE, AND KNOWLEDGE
- THE ADVISOR WILL EXPLAIN THE K.Y.C. FORMS AND ENSURE EVERY BOX TICKED IS APPROPRIATE
- THE ADVISOR WILL REVIEW THE UNIVERSE OF SECURITY OPTIONS AVAILABLE, DISCLOSE WHETHER THEY ARE RESTRICTED FROM SELLING CERTAIN TYPES OF SECURITIES, AND SELECT SUITABLE SECURITIES FOR THE CLIENTS NEEDS
- THE ADVISOR WILL EXPLAIN THE SECURITIES CONSIDERED, EXPLAIN WHY SOME WERE SELECTED OVER OTHERS, EXPLAIN THE COSTS OF ALL OPTIONS CONSIDERED AND EXPLAIN HOW MUCH THEY PERSONALLY WILL MAKE FROM THE PURCHASE OF THE SECURITIES IMMEDIATELY AND OVER TIME

Conclusion: Oh yeah, I get it now! Being a fiduciary would be a real pain in the butt for a sales person trying to maximize revenue with a quick deal! And yeah, if a client had the full range of product options, profits from hidden fees would be tough to maintain. And of course it costs money to actually train advisors on all the options they need to consider and the licensing they require to sell those other options. In fact, many of the sales persons disguised as advisors would have to spend months and thousands of dollars being trained to meet the new standards.

The compliance people would need to learn why a KYC questionnaire is filled out instead of how it should be filled out to protect an employee!

Of course all you salespeople hiding behind advisor titles can relax. We will not see fiduciary duty extend to the advisor industry in the near future! Whew, that was scary for a moment.... it was like a weird dream where investors have rights and advisors work for clients not security and fund companies!

PART 1: THE CONFERENCE

I recently attended a conference on FIDUCIARY requirements in the investment industry. Most advisors did not attend as they are not fiduciaries; and I suspect they also do not know what the big multi syllabic word means. In fairness, almost all investors also ignore discussions on “fiduciary duties” since they only tend to learn about advisor/salesperson obligations after they have been fleeced.

Based upon the conference discussions, it was clear to me that the usual entrenched positions are still in place. As always, the fiduciary question excites the lawyers who make a living from investor disputes and it excites the investment manufacturers (fund and insurance companies mostly) who make a killing by avoiding fiduciary obligations. The third excited group are the investor advocates and regulators who know fiduciary obligations should be in place but cannot seem to get attention or focus on the issue.

And again based upon the conference dialog, the third group will remain easily distracted by sidebar issues that prevent them from really working towards the end goal of investor protection.

A last comment on the conference would be to lament that the Ombudsman for Banking & Investment is very much an under-funded, under-focused, and under-performing group. The first two “unders” contributing to the third “under”! If an investor was willing to slog through the investment broker/mutual fund advisor complaint process, stick handle through the idiotic Bank employed Ombudsman, and then finally reach the end game Ombudsman for B & I: they would find themselves tired and frustrated from what has been a 3-6 month battle just to get to the starting line.

At this point they would be assured that a small over-worked group will look at their situation sometime in the next six months or so. They would also find a group that does not consider the battle to be one of giant company versus little investor, but rather a battle of equals. Taking a cautious non controversial approach they will likely try to saw off some workable agreement and get everybody to go away with a small piece of the loaf. Based upon the example situation presented to the conference, the small guy will get no break when confronting the big company lawyers and liars with paperwork to back them. The O for B&I has no big stick to make change, cannot order restitution and may well, at some point, be looking for work again from one of the big bank/insurance/law firms that oppose the little investor.

On the legal front, it was almost embarrassing to listen to the lawyers who work for the big firms. No duty or obligation is so small that it cannot seem far too onerous to enforce on the poor hard working advisor!

Hell, the Canadian contingent at the conference was still debating what name to call a salesperson as if that minor detail was an insurmountable hill to be climbed! While Europe and Australia lead the charge on big issues, Canada has no momentum and no process for change!

It seems the Canadian establishment is going to obstruct the regulatory changes on every front for fear a small win for investors will turn the tide of the battle. We should expect no concrete ideas or solutions from the industry or any willingness to listen. They will jam every panel, write a sea of position papers, demand second, third and fourth reviews and basically ensure no progress occurs!It is as close as we can get in Canada to having a Republican Party mentality of "obstruct at all costs!" Think I am exaggerating, then consider the recent Point of Sale document debates! It's been years of haggling and infighting to get a watered down thin gruel of a document.

Of the distinguished panellists present, Allan Hutchinson of Osgoode Hall was one of the few who seemed to get it! Peter Smith from the U.K. FSA also clearly got it and actually was able to do something about it for U.K. investors. I thank FAIR and the Hennick Centre for making the conference possible. Maybe next time they will find a way to have an independent investor voice on a panel as well as all the official institutions, but overall, a job well done in laying out the size of the opposition faced by investors in Canada!

Your "I give a fidu!" advocate.....soismike

p.s. The firm I work with has just passed an international fiduciary certification audit so fiduciary duty is real and we "walk the walk" while most firms just "talk the talk"! Check out Weigh House Investor Services at CEFEX for details on the certification process available for all firms who act as fiduciaries for clients.....including the one you deal with!

Follow Up on F.A.I.R.

A while back I expressed some concern about having F.A.I.R. act as the primary spokesperson for investor rights.( Why I Fear FAIR) I will confess that I still have a number of concerns about how FAIR set their priorities and the lack of a transparent approach to gathering feedback from the small investor. Having said that, I did want to give credit where credit is due!

FAIR had some good ideas backed by some sound research on issues involving investor scams. In short, why do so many frauds seem to involve registered salespeople who work for companies who DO NOT belong to an SRO (Self Regulatory Organization). They also had some insights into the difficulty for a wronged investor to actually get their money back after being victimized. Both of these issues are worthy of advocacy and, however they got on FAIR's radar, they are garnering some attention and discussion.

A recent article in Investment Executive highlights key issues that FAIR is championing. As discussed in last years review on investor advocacy groups , I felt that one of the tools required to make FAIR successful was the ability to engage the media. While Investment Executive is far from mainstream media, it is a significant voice in the industry.

So while I remain cautiously skeptical I did want to acknowledge good work by FAIR. I may not share similar ideas of how the research should be interpreted (mainly the concept that SRO's are effective at protecting investors versus better at avoiding the most obvious scams), but I could not even have expressed my opinion if FAIR had not completed the research and shared the outcomes. Kudos on this one go to FAIR!

MUTUAL FUNDS: GETTING IN THE WEEDS ON INVESTOR ISSUES

WHY MUTUAL FUNDS ARE ABUSED AND MISUSED

A lot is being written about Mutual Funds being the investment of choice by Canadians. The fund industry has done a great job of sales and marketing, and since the bankers joined the fund party there are really very few competing products to turn to. In fact many Canadians would have no idea what alternatives they should consider if they did chose not to invest in Mutual Funds. So that begs the question; why are so many bloggers and DIY investors so upset about funds and how they are sold? Can funds be all bad if almost every Canadian adult seems to own at least one fund?

Let’s start by acknowledging that few things in life are all bad. Mutual funds began life as a low cost, highly diversified product that allowed average investors to participate in the equity and bond markets. In the 70’s and mid 80’s you could well have made an argument that freeing investors from falling GIC rates allowed investors to break free from the bank GIC’s and share in the rising stock markets. So let’s concede that mutual Funds began their life as a very good concept to bring investment options to the masses. Having conceded that point, what is so different today?

Lets review some of the old strengths of funds and why they might no longer be strengths in todays world!

Old : When funds first gained popularity investors generally could not invest in equity markets unless they utilized a brokerage house that charged what we now call “full service” brokerage fees. In short you might pay $300.00/trade and constructing a diversified portfolio could cost $8,000-10-000 in broker fees. That generally meant most investors were shut out of the equity markets unless you were wealthy.

New : Today investors can utilize a discount broker (DB) to access the equity markets at fees ranging from $10-29/trade. The DB web sites offer research that is less likely to have a bias and that allows investors to utilize security screens and other investment tools to assist them in choosing securities.

Old: Fund fees in the booming 80’s were often in the range of 3% MER on funds that were earning 12-15% in annual returns. Investors looked at the net return (often over 10%) and felt the returns in excess of GIC rates warranted the fund fees... and they were probably right.

New: New products such as ETF index funds have been created. The new ETF index funds offer low cost diversified portfolios at MERs that are often less than a tenth the cost of current mutual funds. Now you can build a whole diversified portfolio for less than a half of one percent in fees. On top of that, the past decade has seen extremely low returns on equity markets. With MERs refusing to decline as economy of scales grow, investors are now finding themselves paying over 2% in MERs for funds that have lost them money for years. While a 3% MER once allowed for a 10% net return on funds, investors are now paying 2.5% to earn less than they would make by buying a GIC.

Old: When funds first arrived on the scene they were often small and nimble. A high quality manager could make a difference and truly add value through smart trading decisions. As well, a well connected manager could gain advantage by having better knowledge of a specific firm or market sector. Indeed, if you check some of the largest and most successful long lasting funds you will see many examples of funds having a great first few years in the market.

New: We now have over 2,000 mutual funds in Canada holding over $600 billion in assets. Fund managers also manage pension plans in many cases. Every one of the 2,000 funds has a team of highly trained analysts and portfolio managers with MBA’s and CFA’s. It is now virtually impossible for a fund manager to outperform the markets because everybody has similar skills. As well, the fund industry is so large that they “are” the market! Trading between fund managers nets out over the year but the fees continue to increase with every trade. New laws on disclosure of financial data mean that the well connected broker/trader can no longer get information before the market. Despite what you see on TV, every fund manager knows where Russia is located and that they buy winter tires!

THE FEE FACTOR: I was reading a popular finance blog by a Canadian journalist and I am sure one of the comments must have come from a fund salesperson (unattributed of course). He expressed the view “fees do not matter, its the net return on investment that counts”. Only a fund salesperson could believe the two issues are not connected to one another. I agree wholeheartedly that fees are irrelevant if a fund can consistently earn better than the benchmark return after fees! The problem of course is that fund returns very rarely manage that feat. In fact the frequency of mutual funds beating the benchmark seems to be about what you would randomly expect with 2,000 managers trading securities with each other. Typically, less than 1 in 5 can match the standard benchmark indexes for any length of time. For those looking for empirical evidence, you can review the Standard & Poor’s SPIVA scorecards.

I would suggest the question is not “can a mutual fund with a 2.4% MER beat the index”, but rather can anybody tell me which one will manage the feat in any given year? If not, why would I not just buy the index for one fifth the cost?

SOLD NOT BOUGHT: THE ADVISOR FACTOR: The evidence clearly shows that Canadians have a greater willingness to pay fund fees (MER) than international investors. With MERs averaging near 2.4%, and with Canadians having $600 Billion in funds, the industry stands to pull in billions of dollars a year in fees. In the U.S. market fund fees are considerably lower than in Canada (even allowing for different rules on what is contained in the MER) and American investors are making ETFs the fastest growing securities product in the marketplace. So why are Canadians different?
Funds are sold not bought! Investors place their trust in salespeople who are licensed as a “salesperson” but who prefer to give themselves the title of “ADVISOR” on their business cards.

There is no licensing available in Canada for a mutual fund “ADVISOR” or “FINANCIAL PLANNER”, but there are licenses for mutual fund sales person and registered dealing representatives. Canadians place their faith in their banks and their advisors and choose to believe they will be rewarded by unbiased advice from those they trust their hard earned money to. What Canadian investors seem to be unaware of is that the trusted advice is coming from people trapped in a commission system. It truly is a case of “don’t hate the players, hate the game”.

WHY YOUR SALESPERSON HAS NO CHOICE: A salesperson is either self employed (rarely) or works for a larger firm. The large firm will both manufacture and sell funds (think Investors Group) or will just sell funds. Fund sales people tend to wrap themselves in the “financial planner” title, although they rarely provide comprehensive planning. Planning is a labour intensive task for which salespeople do not receive a fee or commission. It is similar to the free toaster when you open a bank account. Salespeople receive fees ONLY when they convince you to invest your money into a fund. At that point the industry forces the behaviour of the salesperson to mirror the fund’s objective. The funds objective is to maximize commissions. Only behaviour that maximizes commissions will generate payments to the salesperson.

SKIMMING YOUR MONEY: Mutual Funds take their revenue from YOUR account. Most investors understand the fact that fund companies and salespeople get paid, but few realize how or more importantly how much they get paid.

The primary reason investors are unaware is that the industry intentionally hides the fees and commissions from the investor. Imagine if fund companies ran a credit card business the same way they manage your funds. You would never get a statement of interest charges, would rarely be aware what the current interest rates are, would never know how much they took from your bank as a payment and your sign up documents would be written as a 50 page legal contract. Your statement would show a balance but no way for you to confirm how they arrived at the balance. In short, you would not allowthis type of reporting to happen with a $500.00 credit card. So why is it acceptable for your life savings?

MANY WAYS TO SKIN A CAT: The fees are hidden as discussed above; however a further issue is that the commission splitting between the fund and the salesperson is also hidden. Salespeople often argue that "how" or "how much" they get paid is not relevant to investors. Nothing should be or could be further from the truth

Hidden Gems: One reason why it matters is that different fund companies can pay your salesperson different commissions to sell Fund A instead of Fund B. Now consider the last recommendation from your salesperson to buy ABC Canadian Equity. Did you know that XYZ had a lower cost to you and a similar performance history but paid lower salesperson commissions? Did your salesperson recommend ABC because their firm wants more high commissioned funds sold and they pressured your salesperson? Was it because your salesperson was having a rough spell financially and needed the commission? The key point is I do not know, and neither do you.

A second hidden gem is the fact the very same fund can be sold to you in a variety of ways, all with different costs to the investor. So if you believe ABC fund was the best choice, was that based upon a seven year lock-in requirement known as “deferred sales charge” that pays a hefty up-front fee to salespeople; or was it based upon a “front end load” that paid a smaller up-front fee to the salesperson? Did you know your salesperson could sell the fund with a 0% front end load and still receive the annual trailer fees from the fund company as compensation? Did you know the salesperson could sell you an “F Class” or advisor class fund with very low expenses and no commissions? In this case the salesperson negotiates a fee with the investor for their services in an open agreement that sheds light on your costs.

The third broken leg of the commission process is hidden trailer fees. Trailer fees are a hidden commission paid to your salesperson every year by the fund company. The fee is only paid if you stay with the fund company. Now ask yourself why your salesperson insisted you “stay the course” in the recent market meltdown? Was it because going to cash would end their trailer fee revenue and cost them income? Did you know that the salesperson benefited by keeping you exposed to a falling market? To compound things further, the annual trailer fee varies by how you were sold the fund. This means your salesperson has a very direct conflict of interest. The higher your fees the more commission your salesperson likly makes from behind your back trailer fees. Do you still feel confident your salesperson is a trusted “advisor”?

As I stated earlier, the salespeople are caught in the system. The fund companies outline the commission rules and the salespeople have a difficult time avoiding the conflicts inherent in the system. A few truly good ones manage to balance investor needs with their own income requirements, but most slowly give in to the system and begin to feel they are “entitled” to the fees. When asked about the practice of accepting hidden commissions the most common refrain is a combination of “investors do not care” or “I work hard for my money”. The first is hard to assess since the investor is unaware of what is happening for the most part. The second is an irrelevant comment, since we all work hard for our money but few of us feel we need hidden commissions to make our business model work.

MONEY MAKES THE WORLD GO AROUND!
If we put aside the issues of excessive cost, manipulative sales practices and poor performance; is there an argument for mutual funds as an investment vehicle?

The answer is “yes”. The cost or MERs make mutual funds expensive as a core holding in a portfolio versus a low cost index fund, however mutual funds offer diversification and professional management. If an investor wants to hold some small cap or emerging market assets, a good fund manager can likely add value. The cost is high but so are the risks in investing in small cap or emerging markets without knowledge of the markets. As an example, I hold an Asian focused mutual fund as a very small weighting in my portfolio. I could not do the research required to build a high quality diversified Asian portfolio and I did not want to own the whole Asian market via an ETF index fund. I felt the professional management was worth the cost, not to make greater gains but to reduce the risk of large losses in a higher risk market.

CONCLUSION: Mutual Funds are a niche product being used to build core portfolios by salespeople who generally know better. The rationale for this volume of fund sales, from my perspective, can only be based upon the desire by the industry for the billions of dollars in hidden revenue streams.

In the light of full disclosure of fees, commissions, performance numbers and knowledge of available options, I believe investors would make different choices. Where more of disclosure is provided (the U.S. for example) investors have selected ETFs for their core holdings in many cases. In Canada we may never know what an informed investor might do because our current system does not generate sufficient numbers of informed investors to determine how we might choose to invest.

What Can You Do: In a world of busy people trying to make a living, raise families, and manage day to day cash flows there is precious little time to ride shot gun on your salesperson.

The average person has two viable options:

a) manage your own investments with a low cost “couch potato” ETF based portfolio or

b) separate who gives you advice from who sells you your investments.

The second option can be attained by hiring a financial planner or investment consultant who gives advice but does not sell securities, and then take that advice to a salesperson for the execution of your security purchases and sales. In both situations mentioned the conflict of interest between advice and security sales has been reduced or eliminated. That is a vital first step in taking control of your investments.

Sois mike

Risk: What my salesperson forgot to mention!

It may seem to many investors that the word "risk" is used in many different contexts without the author identifying what they specifically mean by risk? That is because "risk" is a term used to quantify many different investment issues that can lead to potential losses. So lets look at risk, its uses in the investment industry, and how the term is twisted to leave investors at a loss to understand what risk they are being asked to measure.

Risk is defined in "Investopedia.com" as: The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. Risk is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

Perhaps the first thing an investor might note is that "risk" is a statistical measurement, not a "feeling in my gut". The second point is that "standard deviation" measures risk of both higher and lower returns than were expected. I think its fair to say most investors personally define risk as only that part of the unexpected results that are negative. Few investors seek to avoid returns that were higher than expected. In short investors need to focus on "downside risk", understanding that upside risk (positive risk if you will) is generally proportional to the downside risk.

Risk Questionnaires: So I am filling out a "risk assessment" and need to identify the risk I am willing to take in my investment portfolio. Not surprisingly the the form does not define risk as a mathematical concept. In fact many of the questions talk about "feelings" and more specifically "hypothetical feelings". So, hypothetically, how would I feel if my investments dropped in value by 10% in a given year? This question is generally a "loaded question" as I am betting most investors would be embarrassed to say a 10% decline would scare them away from investing (especially the alpha male investors who equate risk taking with bravery!). So I would state unequivocally that this low level of risk does not worry me. Now the questionnaire has me thinking in terms of how brave I can "hypothetically be. If 10% doesn't worry me then how about 20%? Well I think to myself..... 20% is something to think about, but hey "no guts no glory" and what are the odds of actually losing 20%? In the end I saw off at 25% as my hypothetical maximum. Having said that we are talking about 25% as being a bizarre one time event which is hardly ever going to happen, right?

CONCEPT #1: Market drops of 30% or more have occurred 13 times since 1900 or, on average a little more than once every 10 years. Drops of 40% or more have occurred 9 times or approximately every 12 years. Losing 20% is likely to happen every 5 years! If you invest for 20-30 years you can bet you will see losses over and above your target several times.

Concept #2: Your losses will not be hypothetical! Your advisor will forget to mention an interesting concept she learned when entering the business: losses cause twice as much suffering as an equal gain would cause joy ( Prospect Theory). In short if you are told there is an equal chance of 20% gains and losses, the gain will feel good but the loss will absolutely devastate you emotionally. Think in terms of dollars and losses. If you saved your hard earned cash over the years and could lose $20,000.00 from a $100,000.00 portfolio in the next few weeks would you still want to stay invested? If you invest $5000/yr into your RRSP would you be okay if the last 4 years of returns were lost by a falling market? How about the last 6 years of deposits?

Risk and Time in the Market: If you have an advisor you have been told "we can take more risk because you are a long term investor. I can be assured of that because advisors want to tick the "long term investor" box on your application. If is basically a "get out of jail free card" for your advisor if you take too much risk and lose your shirt. Your wise advisor, having watched your money evaporate will tell you, with a great sense of false bravado, just hold the course and stay with me because the market will bounce back.... it always does! Should you decide to sell and sue your advisor the advisor will point to the "long term investor" box and say you caused your own losses by not staying invested for the long term! "Sorry Mr Investor but you said you could take risk and said you would not bail out of the market so don't look at me! It's all your own fault!"

Concept: Time in the market increases the likelihood of having large market declines occur. Your risk of catastrophic losses is not spread over 10 or 20 years, but rather it exists each and every year for the 10 to 20 years you might be invested. Since advisors cannot avoid the huge market drops (I think 2008 confirmed that for everybody) then you are at risk of the big drop occurring in every year you have money invested in the market. In short, keeping your gains fully invested is very similar to letting your bet ride at the craps table in Vegas. Look at every year in the market as another separate bet and make sure every year that you are only betting the amount you can afford to lose. Rebalancing a portfolio reduces risk as over time you can take profits out of the equity market and lower the percentage of a portfolio you have at risk.

Types of Risk: There are many types of risk so I will discuss only the two risks I think are most important to me.

Salesperson Risk: While I have lapsed into using the term advisor, your advisor or financial planner is actually a licensed salesperson. They typically earn money through collecting commissions which are often not disclosed to you even though you will pay the commission either directly (broker commission, flat fee) or indirectly (fund trailer fees, hidden fixed income fees, new issue fees). Most salespeople are paid to gather clients and are rewarded for getting your money into a mutual fund or generating fees off that money. Very few (think basically none) are paid a fee to manage your investments effectively. Whether you make or lose money has very little impact on the income of your salesperson so long as you do not leave the company he works for. Trusting your salesperson to effectively manage your money is a huge risk. Why do you think your salesperson buys mutual funds? It is because they do not know how to properly manage investments themselves.

Individual Security Risk: This risk is commonly called "un-systemic risk" and it refers to the concept of having too much risk in any one security, sector or industry. If you buy individual stocks you take unsystemic risk which can typically be minimized by holding 30+ securities. The catch is the 30+ securities also need to be diversified by geography, sector, and industry. Holding 30 small cap companies is less risky than holding 1 small cap stock, but it is much riskier than holding a mix of small cap , mid cap, and large cap stocks. Similarly you should diversify by asset class (holding bonds as well as stock and cash is a good start). If you have an individual holding that is more than 5% of your portfolio you should look at the security risk and decide whether cutting back on the security might be prudent. (I make an exception if it is a government bond).

Measuring Risk: The simple measure is a personal measure you should make annually....how much of my hard saved investment portfolio will I put into the equity or high risk security markets this year knowing I can lose most of it if the market tanks.

Once that measure is clear, you might get a little more technical since we started this blog by discussing the fact that investment risk is a mathematical concept.

RISK MEASURES:

SHARPE RATIO: A common method of measuring investment risk is to measure the investment returns on a specific security or fund, relative to the risk of owning the security/fund.( risk here is defined as the standard deviation of returns). In short; how much did I gain relative to the risk I have taken? This is generally expressed as a ratio known as the "Sharpe Ratio". Many securities firms show a "sharpe ratio" when you check the portfolio performance of a fund or portfolio.

Concept: You should not compare returns of Fund A versus Fund B unless you know the risk each fund carries. Comparing the Sharpe Ratio allows you to determine if the actual returns on a fund or portfolio are likely due to better portfolio management or just bigger risk taking that happen to paid off in the period you are looking at. In short, when it comes to the Sharpe Ratio, bigger is better as you are measuring returns for a common measure of risk.

Sortino Ratio: The Sortino ratio is a modification on the Sharpe ratio. It correctly presumes investors are worried about downside risk not upside risk. As such it measures the return of a security against the standard of deviation of negative price moves only. If a security tends to have sharp upward price moves and fewer large negative moves, then investors are likely to benefit from the positive volatility. Similar to Sharpe, bigger is better.

The purpose of this blog is to have investors take ownership of their personal "risk" tolerance. To do so you need to understand what your advisor/salesperson is talking about when they mention risk. Many supposedly qualified advisor/salespersons have talked about their clients reassessing the risk tolerance they have. The suggestion is that "clients overestimated their risk tolerance". Nothing could be further from the truth. Your risk tolerance does not change based upon portfolio performance because it is hard wired into your personality. If I had told you the amount of money you were going to lose before the market dropped you would likely have said "no way" because your salesperson/advisor would not leave you exposed to that size of a loss. You likely never understood the risk profile of your portfolio and your salesperson knew that. They understated the market risk you were exposed to and now they are pointing the finger of blame on you for not realizing you should never have trusted their rosy forecast to begin with. They knew that losses were emotionally devastating because they studied the Prospect Theory. Unfortunately they were motivated by the Modern Commission Theory and you were the ticket to their big commission.

Fool us once, shame on the salesperson.....fool us twice.......

soismike

2009 A YEAR WELL WASTED.....

A YEAR WELL WASTED FOR INVESTOR RIGHTS!

As 2009 arrived it seemed like the only silver lining to the economic and investment mess was the fact that true change would come to the investment industry on the investor rights front. It seemed inconceivable that the media, politicians and regulators could ignore the disastrous consequences of the unfettered sales approach of the securities and mutual fund salespeople. Similarly it seemed a certainty that investors would not allow the status quo to continue; either voting with their feet or demanding redress from the security sales forces that had miserably failed in their duty of due diligence.

The financial crisis exposed irresponsible sales activity by all levels in the security industry. Indeed the only common denominator seemed to be the absolute lack of due diligence by all participants. The bond rating agencies were on the defensive arguing that their triple-A ratings did not mean the securities were safe; just that they existed, in some form, somewhere, and contained some stuff that smarter security firms seemed to somewhat understand. Clearly they had no intention of supporting the investors who counted upon their ratings nor acknowledging the fact that ratings were deficient if not fraudulent. Integrity is a very rare commodity in the securities field....only found in amateurs such as retail investors.

So against that tumultuous backdrop, how did investor rights do in 2009? Well, the answer is clearly a split decision! International investors, supported by strong regulatory bodies and engaged politicians, have made strong progress. Australia and Britain have taken aim at hidden trailer fees that distort the honesty of the sales forces selling mutual funds. I suspect that within 5 years trailer fees will be limited to only Canadian sold mutual funds. In the U.S. the government has taken dead aim at the sales person conflict of interest and is looking to enforce a fiduciary obligation on all financial sales people. The surprise for most people is discovering that sales people, hidden behind advisor titles, actually have no duty to protect their investor clients.

So, in the glass is half full view, the international rights of investors have prompted action worldwide. Investor rights have been supported by numerous regulatory driven legal actions, including large fines and settlements levied against Canadian banks in the United States. Worldwide there is a consequence for the firms who lead the retail investors down a greed filled path.
Now, let’s talk about Canada. At the start of the year we hoped that Canadian complacency would finally be overcome by the need to act to protect our financial futures. As with Britain, Australia and the U.S., our democratic, free market approach would allow the will of the people to manifest itself in corrective action. The time was now and the need was great! So let’s reflect on what has occurred in Canada.

Federal Politics & Media: Alas, the political class continued to play politics in Ottawa and self preservation and power games (think our coalition farce of a year ago) were the focus of our political parties as well as our myopic media. Between the Toronto Star, The Globe & Mail, and CBC, the media heavy weights did what they do best: they focused on their own agenda and had little time for the plight of Canadians. In a midyear blog I espoused the belief that action required an engaged media and politicians who could use the media focus to drive legislation through parliament. Again, I note that by media I do not point at the financial media, but rather the editorial pages that are the key to broad awareness of complex issues. Clearly I was far too optimistic that issues driving worldwide change might be noticed in Canada.

Provincial Governments: With securities regulation being well within the provincial mandates, and with Ontario in particular having a nanny state approach; it seemed to be a natural fit for the Provincial Government of Ontario to take up the plight of the Ontario investor. The ability to influence regulatory bodies meant that Daddy McGuinty had a great opportunity to improve on his primary focuses (banning pit bulls, banning cell phone use, mandating helmets for all activities involving movement). Again, the plight of investors fell to the wayside as the provincial focus was on helping auto workers maintain massive incomes, benefits, and pensions not available to investors. Indeed, if investors had the pension plans of either McGuinty or an auto worker this focus on investor rights might well not be a major issues for investors.

Regulators: With regulators worldwide lighting the path it would seem that investors in Canada might benefit by even some simple "copy cat" legislation. In short, we did not need to create the better way, just follow the better regulators. Alas, in a bizarre way, Canadian regulators have used the mess of 2008 as an excuse to assist dealers at the expense of investors. How so you ask?
Dealer Representatives: One of the few points of clarity for investors in this bizarre regulatory mess was the fact that security salespeople were licensed as salespeople. The primary focus of regulators should be to add clarity to the security industry. Instead our regulatory folks thought this would be a good time to blur titles so that investors have no idea whether they are dealing with a sales person striving for a fee or commission, or a fiduciary advisor focused on investor needs. Now you will deal with a “dealer representative”, which is Latin for “huh?” Apparently the solution to the concern about selling securities nobody can understand is to create titles that nobody can understand! Clear only to IIROC ,we can presume.

Point of Sales Disclosure Documents: The regulators had a great idea when they surmised that investors would benefit from a clear Point of Sale (POS) document explaining the features, benefits and risks of the security you are about to buy. They also correctly determined no normal investor could read or understand the legal prospectus. This great idea, however, was quickly attacked by the investment industry. My father often said that “a camel is a horse designed by a committee”. By the time the self serving SRO’s had flooded the process with objections, the document was missing a few rather vital components. Small questions like “how much does my sales person get for selling me this”, “what other purchase options exist for this security and what would those options pay my sales person”. As well the document was not sullied by "performance against relevant benchmarks" or information on the risk ratios that might assist an investor. Clearly investors were not sharp enough to understand a Sharpe Ratio!

Similarly, the regulators are either not sharp enough to know when the industry is playing them or are more focused on dealer relationships than investor protection!

Product Complexity: Well, the P.O.S. is at least a partial victory. It speaks to the need to make disclosure more transparent and thus protect investors from complex products with risk profiles they cannot easily quantify. On the heels of this success (?) the regulators then opened the markets to higher risk and higher complexity products. Counter-intuitive to me, but clearly a quid quo pro for security dealers. Rather than be chastised for the abuses occurring with leveraged ETFs that were sold by sales people with little understanding of the risks, now sales people could sell complex derivative products with even higher risk potential. After all, what could possibly go wrong?...... Welcome to CFD’s and the joys of combining gambling with investing. Throw in “blind pool” investing and mix well until your portfolio melts! My forecast is that abuse of these products will result in significant losses for many unwhitting investors over the next 5 years.

Pet Peeves:
Well, as you can see, 2009 was not what investor advocates in Canada hoped for! Will it get better? I am afraid the answer is not likely. I wanted to end this dismal year with a message to two groups who can potentialy make a difference.

FAIR: The advocate community has been further splintered with the addition of FAIR, a foundation who appear well positioned to bring advocates together . As the only advocate group with a source of funding (tainted as it may be), FAIR needs to rally investor advocates. Arrogance toward those who have long fought the advocacy battles is both unwarranted and unhelpful. Focus more of your efforts toward changing the industry and a little less towards chastising the approach of other advocates.

Ombudsman Offices in the Banks: An ombudsman is supposed to investigate impartially on investor concerns in dealing with the banks. The office of the ombudsman was not intended to be a “tactic” used to shield the bank. The offices however appear to be fulfilling little more than the role of a speed bump. They slow, frustrate, and deflect investors with little apparent desire to resolve conflicts. Again I offer a little unsolicited advice; if you have completed the report on an investor complaint without ever speaking to the investor, you are probably not an ombudsman and should change your title.

Investor advocates and investors should mourn a year lost…….and then get back at it! I just received a notice today from TD Waterhouse raising the fees on a registered account so I can help them attain a new profit record in 2010! Obviously the timing is meant to show the empathy they have for the many investors who they exploited in their "advisor" services guidance in 2008 and who have yet to get back to where their retirement accounts need to be.

Soismike

The Birth of a new Fund

Birth of a New Fund

Even the cynics in the mutual fund industry had to scratch their collective heads when the latest fund “solution” was unveiled by Invesco Trimark. It might be useful to stop a minute and walk through how the newest mutual fund came to be. New funds do not just appear without a thought to what the market either needs or will bear. It costs money to launch a fund and it costs money and time to wind down an unsuccessful fund. The industry is quite efficient at burying the dead within the living by merging the failed funds with other more successful funds to make them disappear. However, every new fund is somebody’s best idea and the fund industry needs to breed many more successes than failures if they are to continue to thrive.

The Winning Conditions: To be successful and receive support within a fund factory, a new idea has to hit two primary thresholds:
1- Can we market it successfully? Funds are “sold” not bought. As such, the fund must have sex appeal within the investing marketplace. A great example is creating a fund focused on Gold when the market is hysterical about either a crash or hyper inflation. The gold market has its moments, as all markets do, but buying a fund after the hysteria has occurred means getting in high and likely selling off shortly thereafter at a market low. Having said that, it is as easy as falling off a log to market a fund during the hysteria.

2- Can we incent Advisors/Salespeople to push our new fund off the shelf and into portfolios? Because funds are a “sold” product, you need to excite the sellers to be successful. If funds were “bought” and not sold products then you would need to excite the investor. Fortunately, while investors can be fickle, salespeople are not. The way to an advisor/salespersons heart is through their wallet. Salespeople sell to make commission.

The Birth: The latest fund to enter the investing world is PowerShares Fund which combines the efficiency of ETF investing with the (?) of Mutual Fund investing.

The Challenge: This is the point at which the marketing folks start to earn their dollars. We know that ETF Index funds are efficient, low cost, and highly diversified. We also know that investors are becoming keenly aware of the popularity of ETFs. Combine that with the knowledge that ETFs are the enemy of the high cost, inefficient salesperson sold funds and you understand the challenge. How do we meet the demand for “bought” ETFs with a “sold” mutual fund? An equal marketing hurdle is how do we get salespeople to even have a discussion about the feared and hated ETFs with a potential investor?

The Solution(s): The challenge requires two solutions. The first is to make the investor feel they are getting the latest hottest craze, these new fangled ETFs, without needing to actually investigate what makes then so efficient. For that we need a name that screams ETF and avoids any in-depth detail on what makes then work. The focus needs to be “look you can get ETFs without leaving your salesperson”! Knowing most investors are totally reliant on the salesperson to select the funds, this approach meets the criteria for a successful marketing campaign.

The second part of the solution is to position the new fund as lucrative and beneficial to the salesperson. First we commit to the old standby; a fat commission via lucrative trailer fees. When the trailer fee is sufficient the salesperson/advisor will be more than happy to ignore the investment paradox of a high fee, non-managed fund. The second part is to play on the advisor/salesperson fear of the growth in ETF investing worldwide. The salesperson/advisor is well aware the ETF trend is a threat. What better way to handle the challenge then by jumping on board with a fund product wrapped in the disguise of an ETF.

Advisor/Salesperson Pitch: The product sales pitch is a great one and easy to understand.....what, sorry? Oh, let me be clear, the sales pitch is to the salesperson not the investing client. Why would we pitch an investor who has no clue what the salesperson is about to sell them? It would be a counterproductive extra step, as well as a potential death blow to the fund launch. No, let’s stay focused on who really matters, the salesperson/advisor who butters the fund company’s bread!

Now, as I was saying, the sales pitch is easy. Say you have clients upset that the funds they own massively tanked during 2008/2009 and they are thinking of starting a couch potato low cost ETF approach. Rather than slandering the ETF approach you can now say “no problem, I can take care of that for you with no need for a messy discount broker account and all that reading and research you need for a couch potato portfolio”! A further side benefit for the salesperson/advisor is that the ETF, with a huge 500% or so increase in MER costs, may very well underperform some of the mutual funds the investor owns! You get to rake in the trailer and if the fund underperforms due to high fees, you just tell the client “that’s why I recommend the high fee active managed funds; you should have listened to me!”. Clearly a win-win for advisors.

Well, that brings us to the end of the process. For clear proof that funds are “sold” and not “bought”, keep a watchful eye on the volume of the new fund sold by advisors who, up to now, have railed against ETFs as an extremely poor investment choice for their clients.

If the advisor/salesperson truly believed the ETFs were a poor product, then the ETF fund should be a total flop! If the advisor/salesperson is motivated primarily by trailer fees, the fund should be a raving success. I know which way I am betting!

For a great article on this new fund launch visit Jonathon Chevreau’s blog, Wealthy Boomer . He raises all the relevant points and leaves no room for waffling! The follow up industry responses seem to be a hodge podge of whining and denial.

Your “still looking for the meat” blogger, SOISMIKE

HST & Fund Folks

HOW CAN YOU TELL WHEN A MUTUAL FUND SPOKESPERSON IS LYING.....?

It is of course the oldest joke in the book when it comes to politicians (their lips are moving), however you can make a case for the fact that the fund industry is a much bigger source of disinformation than the local politician!

As for how blatant the lie can be....well we only need to look to recent events to see how little the industry respects the intelligence of the average investor. Failure to disclose all relevant information allows the industry to “stand up for the average investor” publicly while continuing to shaft the public by carrying on just like the folks the industry attempts to vilify!

THE LIE:
How about this from a recent Globe & mail article....

” At the heart of the fund industry's lobbying effort is one of the simplest concepts in personal finance: the magic of compound interest. Take the example of a 45-year-old investor who puts $20,000 into a mutual fund in an RRSP. This hypothetical fund comes with very high fees (2.75 per cent) but nevertheless churns out some excellent gains; by the time the investor is 85, he has a nifty nest egg of about $835,500.
Here's the punch line: If not for the provincial government imposing its dastardly HST, that number would be $70,000 higher. “We would hope that the government would not want to take 350 per cent of your initial investment if they truly understood the consequence of this tax,” writes Patrick Farmer, chief executive officer of EdgePoint Wealth Management and the author of this example.”

So why is this less than complete disclosure….well part of dishonesty is telling only a sliver of the truth. You know the old saw about when I point my finger at you, 3 fingers point back at me! Well, the industry complaint is that the government can only get away with this because the fee is hidden from consumers. The point being if consumers saw this egregious fee they would surely storm parliament and have the Harmonized tax reversed.

In fact I absolutely agree with the Fund Folks on that point. And truth be known, the Fund Folks (FFs) know this because they have been charging the most ridiculous fund fees on the planet using exactly that same deceptive approach. All fund fees are hidden in the investment returns where an investor cannot see them….EVER! What the uninformed investor does NOT know WILL hurt the investor, but not the FF’s (nor the politicians of course).

So to summarize, when the government hides a fee of say 12% HST on the MER fee charged to a fund it is equivalent to theft from an unsuspecting investor…. but when a fund company hides a fee approximately 8.5 times larger from the same investor it is good business practice.

THE TRUTH: The truth is that the industry has used considerable pressure on the government to gain an exemption from disclosing its GST charges. Check other receipts and you will see the GST number and amount for virtually every purchase you make! Why not the MF MER’s that you currently pay GST on?

Well the FFs realize that the average investor may well discover that a $100.00 GST receipt means the fund fees were $2,000.00 last year. At this point the investor becomes “informed”, the advisor likely becomes “fired” and the FFs become “unemployed”! In fact, it only takes about $80,000.00 in MFs to generate those types of fees! A $100,000 fund portfolio at 2.5% MER generates $2,500.00 in MER, which taxed at the current 5% GST would be $125.00….etc,etc.

So back to another old parable….. The guy crapping on you (politician) is not always your worst enemy, and the guy helping to wash the manure off (the Fund Folks) is not always your friend. The only certainty is that it is always the investor who comes out smelling bad!
Raising a stink on HST…….sois mike!

Who Is Fighting Against Modern Commission Theory

It is encouraging to see the number of organizations and ex-industry veterans who continue to lead the charge against what we view as the greedy and unethical majority in the investment industry. More advocates seem to jumping on board every day. In fact the advocacy boat is getting so full it might well sink under its own weight. So who are these advocates and what should they do? Lets first frame the issue as viewed by SOIS Mike, and then look at the players in the world of advocacy.

THE ISSUE:
The Modern Commission Theory holds that the actions of sales persons are directly driven by the ability to derive maximum revenue. Any suggestion that salespeople work in the interests of clients to mitigate risk and ensure suitability to naive at best and most likely is deceitful.

THE PLAYERS:

In an effort to sort out the playing field I have categorized some of the key players on the advocacy front (my opinion only of course) below

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Infiltrators (Infil-traitors?): Groups that on the surface are there to help!

The Ombudsman Office of each of the major banks: The banks are not the nicest people to deal with at the best of times! But they are amongst the cleverest of the investment folks. Outwardly they have convinced many clients that they have an army of compliance folks just waiting to jump on any trade that is not a perfect match to the client’s needs and risk profile. In fact the compliance folks serve a much more important role in the banks. They are the canary in the coal mine. Complaints come in and are regularly assessed to see what damage they might do to the bank profits and bank reputation. If your claim is deemed to pose little risk you should not be surprised to get a quick note back to you saying your case has been reviewed and you signed and acknowledged the actions of your advisor/manager and thus have no claim. In fact, the compliance folks do a great job of training bank staff to ensure you signed the forms in such a fashion as to minimize bank risk. The problem is the forms are supposed to minimize your risk not the banks! Your complaint provides the bank with all the details they need to build a case against your claim. They have many experts and you are pretty much on your own.

Self Regulatory Bodies: The folks at the IDA and MFDA attempt to provide consumer education and basically a friendly face to anybody looking for information on investing. Enough said about self regulatory bodies in the past; suffice to say beware strangers offering candy. In the world of investments you need to ALWAYS follow the money trail. Who is paying for whom to do what to whom? SRO’s are member paid and industry funded to ensure the most egregious issues are dealt with before the industry gets a black eye. The day to day slashing and high sticking do not get any attention from these referees.

Nice Guys Finish Last: This group represents the folks with good ideas and a good heart, but they are entering a gun battle with only a dull knife to defend themselves.

F.A.I.R.: This group is relatively new and as stated in the past, I do not like their chances of making meaningful change without a regulatory cannon to threaten the powerbrokers in the industry. The approach of keeping a watchful eye on the industry can only drive change if FAIR can harness the media. The ability to harm reputations can get the attention of the industry; however, again we must follow the money. The media will support the ideals of FAIR but only up to the point it causes stress in the advertising budget when a big bank/investment dealer threatens to pull an advertising.

Media: Within the media, there are folks who know right from wrong (well, within the business section anyway). The journalists who challenge fund fees and hidden costs and lack of disclosure are brave souls indeed. They depend on the investment industry for the revenue that keeps the paper/TV going and keeps them employed. The net result has not been that they sell their souls for ad revenue (at least some of them do not), but their ability to criticize is limited to the generic issues. It is hard to point to a single firm like Investors Group and say “hey, your MERs are way too high”, but they can point to the industry as a whole and do in fact do so on occasion. Unfortunately many are cheerleaders for the industry and a consensus approach will never happen as long as the media battle for ad revenue.

The Ombudsman for Banking Services and Investments (OBSI): The bank is a powerful master in the Canadian investment scene. With their own Ombudsman offices being ineffective (even the politicians did not fall for that one), a Bank Ombudsman was set up to handle the investors not completely overwhelmed by the Bank’s in-house Ombudsman. Unfortunately you need to go through the bank sham to get a hearing with a truly impartial arbitrator for your complaint. How good are these guys......well RBC has stopped dealing with the Ombudsman for Banking because they found the Ombudsman was actually listening to complaints and making sound recommendations that cost the bank real money! Clearly that cannot be allowed to continue! So RBC took their ball and bat and set up their own cosy game. Good luck with those RBC complaints! The issue here is clear to see. The Ombudsman simply cannot force investment dealers to toe the line. As to why the bank would have an option to back out of this government driven approach is a question for another day. The OBSI clearly states they do not act as an advocate for investors....the scary thing is they might be as close as we get to a true impartial advocate. Of course, follow the money and they again are funded by participating firms.....does this conflict never end!

The Don Quixote’s: In this category I include all of us who knish our teeth at the investment shenanigans but who have neither media clout not enforcement powers. While we are too many to name, you only need go to a bank board meeting to see somebody stand up and challenge the status quo. Below is a short list of people who continue to tilt. I exclude myself from the list, not because I do not tilt at windmills, but compared to the folks below, I have accomplished nothing worthy of being included.

The folks below continue the battle with long odds against them. They rile the giants and annoy the heck out of the pretenders in the industry. They just do not give up no matter the odds, the lack of power, and the lack of clout!....and of course, lack of money!

Larry Elford: http://www.investoradvocate.blogspot.com/

Joe Killoran: http://www.investorism.com/

Stan Buell: http://www.sipa.ca/

Ken Kivenko: http://www.canadianfundwatch.com/

If you look at the sites noted, you will understand that the power of the collective efforts is leveraged by the exposure provided by the internet. The internet however is unfocused and hard to motivate for a single cause. (Unless United Broke Your Guitar of course). So what are advocates to do?

FIGHT MONEY WITH MONEY: The Political Solution is "Money=Power=Money"

The key, if not yet obvious, is to follow the money! Politicians get elected by fanning the flames of issues to motivate voters, who in term vote for the politician and thus give them access to the money! Most voters are totally disillusioned by the investment world and how it operates.GREAT! That makes it a top of mind issue for politicians!

Our only hope of making meaningful change is to have a political solution.....why? Because politicians trade power for money! And the only way to deal with the powerbrokers is to have more power.... and the only one with more power than the investment world is the political world. And they will only use the power in return for THE MONEY!

In short, the message to all advocates is focus on the politics (as disgusting as it may be to many) because the regulatory approach just does not work! Instead of bringing our dull knife to the gun fight, we need to borrow a tank from the government and resolve this issue for good!

You’re “not likely in my lifetime” author....SOIS MIKE

Investor Hopes: Canadian Security Institute or Investor Advocates

Grey Knights and Mixed Messages: The Canadian Securities Institute or Investor Advocates

As I look through the massive reams of media commentary on Investor Education and the flurry of activity from so-called SRO’s and other industry shills, two questions come to mind?

1- How did Canada, a well educated, conservative, rational nation of mostly honest people end up with such poor consumer protection and awareness in the area of investing?

2- Who is going to be the white knight that will expose the flaws in a multi-billion dollar industry that does not want to change?

The questions are quite simple; the answers a lot more vague than I would have thought. To set the scene lets first acknowledge that much of what is wrong is the result of entrenched financial interests. Things do not just happen....people have agendas and set out to make things the way they are.

Having said that; it also appears that some people with great intentions have added to the problems they were trying to fix. A primary reason seems to be that the white hats always focus on changing the consumer behaviour while remaining either helpless to deal with the industry or unable to find a strong regulatory body to act for the consumer against the industry.

So, on to question number one; How did we get here?

Since investor education is considered a current buzz word, let’s focus on the body that claims to educate both the advisors/brokers/salespeople as well as the public. The Canadian Securities Institute is a company that sells courses required for people to enter the financial securities industry. They also provide courses on securities and investing for the average investor as well as financial planning courses. There is a very good chance your investment advisor and insurance agent have taken a CSI course to get licensed. Thus we have the source of much of the training that has given us the advisors of today in one spot, managed by one firm with a pure education mandate! So that appears to be strength, right. But when you scratch the surface things are more grey than black and white.

The Canadian Securities Institute makes more money by attracting more people to the industry and thus providing more courses. They also make more money if the mutual fund firms are happy with the process and send all the new recruits to the courses. Thus the courses are “mutual fund friendly”.
Sample from a wealth management course: “An investor is looking to invest money for two years and is offered a 10% return by a mutual fund....” . Let’s stop right there! This is a course for wealth managers (Wealth Management Techniques) and it uses an example of a 10% mutual fund return over a 2 year investment horizon! That might seem like a moderate return to a hedge fund like the one that financed the privatization of the CSI, but a couple planning on using the money in 2 years should never be in a hedge fund. The assumptions are clear; mutual funds offer options such as guaranteed 10% returns and clients with a 2 year time horizon before a major purchase should look at mutual funds. The course does not clarify what type of fund offers such a deal of course! It is little wonder new advisors think funds are a bullet proof way to get rich when the advanced planning courses they take teach them just that!
As stated, nothing in the industry is ever all bad or all good. .The CSI does teach ethics and does a good job of teaching the benefits of diversification and of explaining the workings of many securities The main challenge is that the educational industry is intricately tied to the fund industry and is not in an independent position to expose the issues and challenges that come with funds. In many subtle ways (as in the above example) the institute has given in to the fund industry and abdicated the educational independence required to provide critical comparisons of competing strategies. That's why our education system has public funding and not corporate ownership; otherwise Coca Cola would be taught to be health food!

Question 2: Who will be the white knight!
Independent consumer advocates are our only current hope! Amazingly, it is refugees from the fund companies who are its biggest critics and who are opening the doors on the industry’s activities. Warren MacKenzie, an ex-insider, wrote the Unbiased Advisor which is an expose on how advisors exploit investors. (Disclaimer; I work with Warren)

As the likes of hardline investor advocates Joe Killoran and Ken Kivenko rattle the chains of politicians and the regulators; small parts of the industry are being exposed to light. The media plays a big, if somewhat conflicted, role as well. Consumer advocates like Ellen Roseman, Rob Carrick and Jonathon Chevreau tread the line of exposing the bad parts of the industry while realizing fund companies advertise a lot in their papers. William Hanley from the National Post has written very direct articles on the industry shortcomings as well.

Unfortunately, I suspect the above advocates will never be in the same room together due to some strong personalities and significant differences of opinion. Nonetheless, they will continue to push the envelope (Ken and Joe) and build on the small gains (the media folks) and collectively they will move investor advocacy forward. As for Warren, he is trying to change the industry from the inside with a radical new advice model that may or may not gain traction.

Where will F.A.I.R. land in this mix? Too early to say as they have not really shown their true colours yet, just the tangle of connections to the industry money that makes me so nervous.

Are we winning? No.

Will we win? I do not know.

Will the above folks quit the battle and surrender? I hope not!
Tilting at windmills.....sois mike