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The fund biz: the good, the bad, and the ugly

Friday, October 01,, 2010

The mutual fund industry does a lot very well, but there are also a number of areas that need to be improved upon. But that goes for any business, industry, or sector. The Canadian mutual fund business is relatively small (compared with, say, the U.S.), and the negatives and sore spots stand out prominently. For many commentators, that makes a temptingly easy target. But I think far too many offer a simplistically negative viewpoint, unfairly demonizing the entire fund business along with the various business models advisors use to serve their clientele. So herewith my view of the industry, in what I hope is a more balanced critique. Full disclosure: I make no bones about the fact that I’m a financial advisor. And that, I think, gives me a unique insight into the industry, warts and all.

The good

• Most financial advisors (FAs) work hard on their clients’ behalf to ensure that the goals set out are attainable within the confines of fluctuating markets and an industry that is complex and constantly evolving with new investment solutions.
• Most FAs put their clients’ interest ahead of their own.
• Most FAs help clients achieve retirement goals and help them invest tax efficiently through mutual fund corporations and Tax-Free Savings Accounts (TFSAs).
• FAs do more than invest client assets. Most of us look at cash flow, credit cards, debt (and how to reduce it), mortgages, powers of attorney matters, help young adult children get into investing for their future, and insurance needs, to name a few. We keep clients on track and help them to buy/sell at the right time. Too many people wish to buy/sell at the worst possible time. We visit clients once a year (minimum) to keep abreast of their lives, so we can give proper advice. This is a very important aspect of what we do.
• Most fund companies are working to reduce management expense ratios (MERs). Fidelity, CI, and Invesco Trimark are three that come to mind that have reduced MERs in the past few years.
• We talk clients out of “investment deals” brought to them by friends/co-workers that offer unrealistic returns (10% to 15% annually) or “guaranteed” results.
• Most FAs continually upgrade education and experience by going to conferences and seminars.
• The best testament to FAs are the millions of Canadians we have helped to retire, leading productive and meaningful lives with the resources to do the things they want to do.

The bad

• Many fund companies still have MERs north of 2.6%, which to my mind is unreasonable. This is one of the major points that critics of the industry continually write about. And to be sure, MERs must keep coming down. MERs need to be more tied to the funds that investors buy. For example, one company has a $1 billion fund with an MER of about 2.5% and a $50 million fund with the same MER. There are many economies of scale that should bring the MER of the larger fund down.
• FAs who continually sell deferred sales charge (DSC) funds to clients. These funds essentially lock up client monies with a fund company for six to seven years, and require investors to pay management fees to access money or move to another fund company. I think it’s reasonable for newer advisors to use DSC as a tool to survive in the business while their clientele grows. After all, if you can’t help your clients, you’re out of the business. Some FAs who manage large amounts of money and who have been in the business over 10 years use the DSC as a tool to get more revenue out of clients. Having money locked up for six to seven years isn’t to a client’s advantage.
• FAs who work part time in the business. They are doing a disservice to their clients when they work part time, or as they wind down their career and coast. Experience is great, but you need to stay up to date with changes in the industry.
• Fund companies that create too many new funds (without downsizing their current line-up) or add “flavour of the month” funds, which they then often “consolidate” three to five years later when performance begins to lag. More fund companies need to examine their line-ups and eliminate most funds smaller than $100 million unless they are experiencing positive cash in-flows. If they add 10 new funds, they should eliminate a similar number.
• FAs who invest almost all their clients in the same investment vehicles regardless of the differences in their age, finances, risk tolerance, and goals. One couple who are both 50, but work in positions that receive a great defined pension (teachers, nurses, police, fire fighters, municipal, provincial, and federal employees among others) require something quite different from a couple of the same age who are both self-employed or don’t receive work pensions.
• Writers who harp single-mindedly, almost obsessively, on industry negatives. A corollary to this is a type of one-size-fits-all mentality that often sets in. And this often devolves to cheerleading for a single type of asset class or approach, such as exchange-traded funds (ETFs), stocks, or self-directed plans. But these simply don’t work for everybody. A client’s assets, age, financial IQ, and the need for simplicity are just some of a host of factors that determine which investments work best for what clients. Focusing on a particular agenda, however well-intentioned, without telling both sides of a story does investors a disservice.
• Clients who have an FA, but mostly don’t listen to his/her advice. Listen to the experts, whether it’s your doctor, mechanic, or plumber. That doesn’t mean you can’t question direction or strategy, but if you listen to only 10% to 15% of your FA’s recommendations, something is wrong in the relationship.

The ugly

• Notorious FAs who deceive clients, invest in inappropriate high-risk investments, and collectively give the industry a black eye. Fortunately, most of the bad ones end up in jail, but not before fleecing their unsuspecting “clients” – usually family and friends – of millions. They’re called “confidence men” for a reason.
• Fund companies that have MERs in excess of 3%.
• FAs who put clients in products that they don’t understand. Having elderly clients with low financial IQs buying and selling stocks repeatedly while the broker earns hefty commissions is another example. As clients age, they need to begin simplifying their affairs. I have seen clients who passed away leaving investments at 10 different banks and mutual fund companies. It’s a mess for the executors and heirs to sort out.
• FAs who have so many clients they don’t know them by name and couldn’t recognize them in the street. I’ve met FAs who have over 500 clients. Unless you’re very efficient, it’s difficult to properly serve a clientele that large. As financial advisors, we are obligated to know our clients (and any financial advisor worth his or her salt understands that that takes more than just filling out the mandatory “Know Your Client” form).
• FAs who convince clients to leverage (borrow money) to invest without giving full disclosure of the potential downside risks (a 30% market correction, for example, or loss of a job).They show great charts showing 6% to 7% portfolio growth. But markets never go up 6% to 7% per year. They go up 20%, up 15%, up 5%, down 18%, down 9%, and so on. If you borrow to invest and experience a big correction early on, it’ll take many years to get back to your initial investment, while you continue to pay interest on the original principal amount.

I have tried to give a balanced viewpoint of what I see happening in the financial services industry. Like any business, there are things to improve upon, but I believe that for the most part, financial advisors and mutual fund companies play an important role in helping Canadians reach their retirement and other important financial goals.



Generic Mutual Fund Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Personal Opinions & Recommendations Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.