Europe – ignored and unloved (again)

Alarms have gone off. My triggers have been triggered.

America’s severe journalistic bias against the European Union continues unabated and they have not learned the lessons about missing 2011’s fabulous European recovery and soaring stock market.

Unfortunately, financial amnesia is running rampant much like this year’s flu bug. In the dim recesses of our memories we might recall the European Crisis ( just a few years ago) where the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain) were to go bankrupt (any second now) and Bloomberg gleefully reporting their plummeting government bond values – daily. Canadian business reporting? Don’t Canadians have that genetically inherited, innate global viewpoint not shared by their American colleagues? Alas, financial amnesia does not respect borders and journalists Canadian or American, weren’t/aren’t touching Europe with a whole bunch of 10 foot poles all taped together.

While journalists were obsessing about the costs of McDonald’s value meals in Davos, Switzerland, I decided to check in with the European stock markets and see just how grim things really are over there.

Their stock market is up [1] over 20% [mid-October 2014 to January 23, 2015].

I think the market technicians would call this a bull market. Yes, grim news indeed!

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[1] Stoxx 600 chart: http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=XX%3ASXXP&insttype=Index

 

 


 

Anatomy of a Financial Adviser – the real truth about fees and commissions

I was disappointed to read an article penned by a Canadian business journalist with impeccable credentials where the author in this article presented clearly biased information. In order to address bias or a temporary lack of journalism standards, I thought I would open the “books” wide open, and continue with my series of articles that divulges exactly what a financial adviser makes, how he makes it and let our readers decide if securities regulators should eliminate cheaper commissions, replace them with higher fees and force advisers to bill their clients.

I am “dual-occupied” adviser meaning that I am allowed to sell mutual funds as a financial adviser and also registered to sell GICs as a deposit broker. For mutual funds, I fall in the category as a “Dealing Representative” under the self-regulatory organization called the Mutual Fund Dealers Association (MFDA). As I work in the province of Ontario, the provincial securities regulator is the Ontario Securities Commission (OSC).

For GICs, I am also registered with the Registered Deposit Brokers Association (RDBA). The deposit brokerage role I have is considered to be an outside business activity (OBA) with respect to the dealer’s mutual fund business. Under MFDA guidelines, the two businesses must remain separate and distinct although there are guidelines under the MFDA that require the Dealer to monitor any approved “outside business activities” (OBA).

For some historical context about the “how and why” of front-loads, deferred sales charges and low-loads please refer to my fees and commissions guide.

I can describe myself as a zero commission adviser where for the last 15 years or so, I would waive my commissions so that I would charge a front-end load of 0% commission for the purchase of a new mutual fund. This does not mean however, that I am not earning any compensation!

I would earn anywhere from 0% to a maximum of 1.25% annual compensation depending on the type of mutual fund. For instance a stock based mutual fund would pay me 1.00% to 1.25% annually. The 1.25% ones are relatively rare and these are mostly mutual funds offered by the Canadian banks. A more typical remuneration for a regular stock based mutual fund is 1.00%. In general, a money market fund pays me nothing, a bond fund pays me 0.25%, and a balanced mutual fund pays about 0.50%.

An analysis of my book of clients indicates average remuneration of approximately 0.80% annually for mutual funds as I tend to lean to more equities (stocks) and use GICs as my bond (fixed income) replacement. I haven’t quite figured out my overall total asset-under-management commissions (under the current commission system) but it could be as low as 0.30% per year.

Where does this compensation come from and who pays it?

The remuneration is paid by the fund company to the adviser’s mutual fund dealer (the adviser’s head office) and then to the adviser’s branch. The adviser only keeps a portion of this remuneration. This percentage is called a “payout”. The Dealer deducts my expenses from my remuneration: licensing, postage, insurance software, etc. and the branch pays me a percentage of what is left. For GIC’s, I get paid by the bank.

How does the investor pay the adviser’s compensation (for mutual funds)?

The adviser’s compensation is built into the price of the mutual fund. The built-in compensation is disclosed and new changes in regulation means there will be even more disclosure in the future.

Despite all the increased disclosure, Canadian securities regulators are mulling over proposals to eliminate commissions entirely and imitate the U.K and Australia experience. If this happens, then all investors who wish to deal with an adviser would be forced to pay a discrete fee. The regulators feel that having separate fees and bills would ensure that investors would be fully aware of the cost of investing and the cost of their adviser. Although the regulators are aware that this will drive up the costs of investing they feel that the additional disclosure is worth the human costs and monetary costs (hundreds of millions?) to convert to a fee-based system.

Right now there are two different types of separate adviser compensation models:

  1. Commissions
  2. Fees

The Canadian Securities Administration (Canada’s possible, soon-to-be, national securities regulator) is proposing to ban all commissions completely but has not proposed a replacement. The industry is presuming that the only model remaining (fees) would be the favoured model.

[Editor’s note: With the choice of only the one option, the choice becomes self-evident.]

I have used both types of remuneration models –essentially the difference between the two is whether the adviser compensation is built-in (embedded and disclosed) into the price of the mutual fund or is charged separately to the investor as a bill/fee.

On paper, whether the fee is built in or not should not make any difference to the total cost to the investor. It would be the same as buying a wrench at Canadian Tire and having the tax built into the price of the wrench or the tax being charged separately at the check-out. The total price of the wrench – remains the same.

In reality, life is not so simple. Both models (commission vs. fees) will not be the same at the check-out. The problem with a regulator imposed fee structure is that you will be charged a fee on the whole account so that the low 0.25% and 0.50% commissions you may be paying now will be replaced by 1.00% (or higher) fees. In effect, you are replacing low commissions with much higher fees.

Additionally, many readers would be surprised to find out that if investors are forced to pay fees (if the proposed changes are approved) instead of paying commissions, your account must be of a minimum size. It depends on the firm but account minimums typically start at $100,000, $250,000 or higher just to have the privilege of paying for your adviser’s advice separately. If you don’t meet the minimum account size requirement then you won’t have access to an adviser and you will be left by yourself to figure out your own investments. Certainly these could be recipes for disaster especially for the young novice investor and especially for a senior investor who would need the guidance and wisdom of a financial adviser.

Business journalists and some investor advocates seem surprised that some advisers (myself included) do not want a substantial pay raise for doing the same amount of work and that dramatically increasing fees is plainly not fair to all investors. The brunt of the pain will be felt by smaller investors[1] who will be faced with the highest fee increases of all. And unfortunately, we advisers have very little say in the matter.

The sense I get from some investor advocates, the no-help mutual fund companies (Steady Hand, for example) and even the U.K securities regulator is that the demise of the small investor is merely acceptable collateral damage –a casualty of war whose losses are entirely acceptable. The thought often expressed is high net worth investors will be relieved of the burden of subsidizing the small investor and that the small investor will be cut adrift and left to their own devices to find financial advice.

In my personal view, I am completely aghast by such callous attitudes. Who speaks for today’s small investor? No one it seems.

As we already have openness and transparency in a commission based account, why would you say that higher fees are somehow more open and more transparent than lower commissions?

What is transparent to me is that the small investor gets kicked in the teeth.

To show how incongruent the press is on this topic, on the GIC side of my business I get paid by the embedded compensation built into the interest rate on the GIC. The built-in (embedded) compensation is paid directly to the adviser. Investors pay no fees to buy a GIC but the adviser is paid a commission paid directly from the bank. Exactly the same system used for mutual funds.

In a theatre of the absurd, to the press embedded and non-disclosed GIC commissions are perfectly OK, but open and disclosed commissions for mutual funds are not.

[Editor’s note: in the interest of full disclosure, I earn one time commissions for each GIC purchase of 0.20% to 0.25% per year of maturity on GIC business. Under the current commission structures, there are no ongoing management fees for GIC holdings; however there are no promises that under the new proposed fee model, those same GICs or other investments will remain fee exempt permanently.]

Bottom line, what is considered to be fair and equitable compensation to someone for managing one’s life savings?

In today’s marketplace, investors should expect to pay about 1% annually for advice. Higher net worth clients might pay less and under the newly proposed fee-based system, smaller investors (if they are allowed to even have an adviser) might expect to pay more – unfortunately – much more.

The solution to this adviser’s dilemma is surprisingly simple. We know that all commissions are completely disclosed and so are fees. Regulator concerns seem to be centered on some obscure fund companies paying much higher remuneration than average, perhaps as much as 0.75% higher. The existence of these very few marginal players appears to be the primary motivation to ban commissions for the entire industry. No one has apparently thought of an amazingly simple solution to address this issue:

Regulate adviser compensation or regulate the fund companies.

Instead of banning all commissions, why not regulate them instead? Cap them if necessary. Certainly, regulators at one time had no trouble in regulating commissions for stock brokers. Why not do the same for the mutual fund industry? Certainly it is within the mandate of a securities regulator to regulate mutual fund commissions.

In my view, if commissions are eliminated we will be left with the Wild West of higher fee structures. Fees will not be regulated and anything goes. The playing field will no longer be level. For the average investor, the human and monetary costs will be high – far too high.

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[1] What is a small investor? It depends on who you are talking too. One describes a small investor as having less than several million dollars! Unfortunately, I don’t rub elbows with Warren Buffet or Bill Gates and yes for them, several millions of dollars is loose change that has fallen between the seat cushions! Since there is no definition per se, I will have to make one. If you have less than $100,000 in securities then you are a small investor.

Related articles:

http://wealthadviser.ca/newsletters-8/205-big-changes-mutual-fund.html

http://wealthadviser.ca/newsletters-8/230-fees-commissions-which-one-is-better.html

http://wealthadviser.ca/newsletters-8/221-fees-and-commissions-to-embed-or-not-to-embed-that-is-the-question.html

http://wealthadviser.ca/newsletters-8/218-a-short-history-of-mutual-fund-fees-and-commissions.html

http://wealthadviser.ca/newsletters-8/214-a-fee-is-a-fee.html

http://wealthadviser.ca/newsletters-8/209-more-discussion-about-fees-and-commissions.html

http://wealthadviser.ca/newsletters-8/203-adviser-fees-the-pain-of-paying.html

 


 

Small investor mutual funds – can they continue to exist?

Mutual fund investors that hire financial advisers to manage their life savings have two choices to pay their adviser. They can have the adviser’s remuneration built-in the cost of the fund (all inclusive) or they can buy the same fund and pay the adviser directly (a fee is deducted quarterly from your account).

Which one of the above two adviser remuneration models is cheaper?

Neither –at least on paper. Presuming your fees are tax deductible (they are not for RRSPs, RRIFs and TFSAs) the fee-based account turns out to be the exact same cost as in the built-in (embedded) cost model.

In reality, the fees in a fee-based account will likely be considerably higher due to the fact that you are replacing 0.25% and 0.50% commissions on income and balanced mutual funds with a higher flat fee of say 1% per year.

Therefore, if you currently own bond funds, balanced mutual funds or any sort of income fund, your total direct costs may double or in some extreme circumstances – quadruple!

Still, the regulators seem bound and determined to replace lower commissions with higher fees. Advisers have seen the writing on the wall and have come to the sinking realization that they have lost the battle to keep their low commission structures and will be forced to charge higher fees while doing the same amount of work. Advisers are not willing to wait much longer for proposed regulatory changes to come into effect or wait for yet another study that may or may not result in a ban commissions in the mutual fund industry.

Advisers, although reluctant at first, have decided to convert their clients to the only option that will be left to them – a fee-based model. The initial trickle has since turned into a flood.

As the tsunami to asset based fees continues, revenues from fund companies to dealers will continue to drop and be replaced by increased internal AUM (asset-based fees).

Many advisers are transitioning their larger clients to fee-based accounts first. As the business of advising goes “upscale” and likely to proprietary in-house managed product solutions, dealers are also looking at algorithm based solutions for “small” clients that do not qualify for fee-based accounts. However the proposed fee structure for “advice-lite” type of accounts is unknown.

The fate of the small investor (less than $100,000 in securities) is still largely unknown. In a previous article I felt that the fee-based model will have a very detrimental effect on small investors as it appears that the small investor will be abandoned and left to their own devices to find help with their investments.

Abandoned by the regulators and with advisers helpless to interfere, small investors appear to be handed the wrong end of the stick in what I had described as a “casualty of war” and ‘acceptable collateral damage”. However there might be a slim glimmer of hope left for small investors.

Mutual fund companies to the rescue?

Investors and even many industry insiders are not aware that there is an alternative for small investors to consider should the Canadian Securities Administration ban commission based accounts.

There may be a choice after all.

Some mutual fund companies have had fee-based accounts for a number of years but they were rarely used. The advantage of these accounts is that:

  1. The fee is completely negotiable between the investor and the adviser.
  2. There are no account minimums!
  3. They retain a client-name structure which means that unlike nominee plans where the securities are held directly at the investment or mutual fund Dealer, there are no annual fees, no unscheduled withdrawal fees, no transfer-out fees and no multi-plan fees.
  4. Full access to a financial adviser.

There are some what I would describe as accidental benefits to client-name fee-based accounts:

  1. Regulators are determined to stamp out all commissions at all costs. This structure will effectively “get rid commissions” and replace them with equivalent fees. Regulators, journalists and other groups can claim a moral victory in that they can claim they have eliminated evil commissions and trailers and replaced them with something else (fees).
  2. Zero commission advisers can effectively keep things as they are. An adviser earning an annual trailer of 1% can replace it with an exact 1% fee.

Discerning readers might ask the question: Why replace commissions with fees if it comes out to the exact same thing? That’s a great question and is one that an investor might ask at the next public townhall meeting.


 

Terrorists don’t drive

Why Canada’s privacy laws need more bite

 

It is very easy to become cynical regarding Canada’s privacy laws; many Canadians would simply say: “Don’t bother, there isn’t any privacy anymore...”

 

In dealing with 30+ different financial institutions on a day-to-day basis, I am finding a wide disparity in the policies and procedures regarding data collection and privacy issues.

 

Canadian deposit taking institutions (banks, trust companies and credit unions) have been over collecting and using our personal and confidential information inappropriately and perhaps illegally[1] for years and it did not merit much of a reaction from the Office of the Privacy Commissioner other than a moderate “Tsk, tsk” amidst concerns of data over-collection. 

 

Although we might criticize the financial institutions for being overzealous with Canadian's personal and confidential information, the Office of the Privacy Commissioner appears resigned to playing a minor role in government by merely finger wagging at possible violators.

The Office of the Privacy Commissioner has no real teeth and their rulings are non-binding. In speaking with many financial institutions about these issues, some seem to be privately snickering behind their sleeves – Canada’s privacy laws are only disclosed at the bottom of their corporate web sites. Or perversely, deposit taking institutions cite privacy regulations when it is not appropriate to do so.[2]

Privacy rules at financial institutions are centered primarily on the safeguarding of collected information. Privacy Officers appear to be doing very little in the way of not collecting information that is not needed for the operation of their businesses – one of the very basic and important tenets of privacy law that every Privacy Officer should be following.

Identity theft is becoming an increasing threat. Computer hacks of Home Depot, Target, America’s largest bank – JPMorgan Chase and even the CRA (formerly known as Revenue Canada), means that data can be and is being stolen. These and other incidents involve over a billion customer data breaches.

Despite the epidemic of data and identification theft, corporations (including financial institutions) still aren’t getting the message; information can’t be stolen if it is not collected in the first place.

Will Canada’s newest Privacy Commissioner address the issue of data over collection or the possible misuse of Canadian’s personal and confidential information? In my view this is highly doubtful as the Office of the Privacy Commissioner with their limited powers has their hands shackled. Not much of a bark and also, it appears - no bite.

[1] Legal? Illegal? Under federal law, RRSPs and other registered plans are supposed to be completely exempt from record keeping and client identification requirements (except on suspicion of terrorist or money laundering activity) but almost all deposit taking financial institutions disregard the law and will insist on collecting this exempted information despite the laws passed by Parliament (see Department of Justice link below). If an investor refuses to divulge such identification; are financial institutions violating the laws of the land and/or the privacy rights of the individual? Good question. In my view, institutions are testing (if not skirting) the boundaries of strict anti-money laundering and privacy laws by over collecting personal and confidential information that is exempted and is not required.

[2] Please refer to a previous story where a bank delayed a registered plan transfer to another financial institution citing “privacy concerns”.

Related articles:

GICs are a dangerous game: http://wealthadviser.ca/newsletters-8/222-gics-are-a-dangerous-game.html

References:

Proceeds of Crime (Money Laundering) Terrorist Financing Regulations (PCMLTFR) 

EXCEPTIONS TO RECORD-KEEPING AND ASCERTAINING IDENTITY 

Paragraph 62.2 (i):

http://laws-lois.justice.gc.ca/eng/regulations/SOR-2002-184/page-30.html#h-44

FINTRAC Guideline 6G (exemptions for registered plans):

http://www.fintrac-canafe.gc.ca/publications/guide/Guide6/6G-eng.asp#s3-1

http://www.fintrac-canafe.gc.ca/publications/guide/Guide6/6G-eng.asp#s4-2

 


 

2014 End of year summary

The “Great Rotation” – the great stampede to stocks finally started (some 5 years after the stock market lows of March 2009). Most of the hot money is going into index products. Is this a contrarian sign?

U.S. interest rates both surprised confounded most everyone by declining throughout the year. In the U.S., the benchmark index I use to track U.S. interest rates is the 10 year Treasury Bond. Despite all kinds of predictions of higher U.S. interest rates and “fed policy”, rates started the year at around 3% and will likely end the year in the low 2% range. Declining interest rates are good news for bond holders, as bond prices generally increase in value when interest rates decline.

Canadian interest rates seemed to move in opposite directions – mortgage rates moved lower but deposit rates (GICs) went higher. Longer term GICs are back in the high 2% range and is approaching the 3% range. A 5-year mortgage can be had for less than 3% even as Canada’s housing boom continues unabated.[1]

The GIC spread over two of Canada’s largest banks moved to historically high levels. Their 1 year GIC rate interest rate offering was a meagre 0.9% while deposit brokers could offer 2.36% credit union guaranteed investment certificates for the same term, some 2.5 times higher!!

One of the bigger investment stories in Canada was about our plummeting currency. Canada’s dollar decline accelerated in the summer of 2014 and is hovering around the $0.87 level. Canada’s currency as recently as 2012 was at or over par with the U.S. dollar. CIBC’s chief economist, Benjamin Tal believes the Bank of Canada has an unofficial “low dollar” policy in place in order to help drive growth in the economy. The Bank of Canada may get their wish with the strong tailwind of plummeting oil prices. Canada’s currency has an international reputation as being a “petro-currency”. Where oil goes – so goes our dollar.

It is not only the Canadian dollar that has taken it on the nose. Bloodied somewhat is Canada’s stock market that was doing really well until about early September. Energy is a major component in Canada’s market and the decline in energy stocks has caused a significant stock market correction. The stock market is still in positive territory for the year but not by much.

The Cold War is back! The tit for tat economic battles over the Ukraine has isolated Russia from the West once again. Russia’s economic isolation is putting the ruble under significant downward pressure.

Emerging markets are being hurt by the soaring U.S. dollar and at time of writing, was trading in negative territory from a year ago.

Europe is slightly better but barring any surprises over the next couple of weeks, may eek out a low single digit gain for the year.

From an advisor viewpoint, 2014 is a watershed year in our industry as many new regulations came into effect. New fund disclosure documents called “Fund Facts” made their debut. If you purchased a new mutual fund or added to an existing one, you have received the new Fund Facts disclosure document for the mutual fund you will be buying. Regulators are still mulling over the idea of eliminating commissions in the mutual fund industry and going to a fee-based system. I have written extensively about this topic for some time on www.wealthadviser.ca. I wanted to let everyone know in advance what these changes will be and how the changes will significantly change the way we buy mutual funds in Canada. These changes are important. Please see my blog at wealthadviser.ca for more details.

2014 was certainly not a dull year as stock markets had a very strong year initially –setting many all-time record highs – especially the U.S. stock market. Whether we have a weak finish or not depends on the month of December. The year 2014 could be very much like 2011 – a flat year.

Although the stock markets may take away some of our ebullient gains, on a positive note, the U.S. economy appears to be strongly recovering. This bodes well for their most important trading partner – Canada. With our cheaper dollar and much cheaper energy costs, our manufacturing heartland may spring back to life once again.

Stock markets have been on a roll for many years now and we should not be sitting on our laurels. It is possible you may have too much stock exposure. My greatest challenge is getting clients to review their accounts during today’s good times. It is very easy to become complacent in these types of markets.

Please call me to set up a portfolio review in order to see if you have had any material changes in your life, changes in your financial objectives, risk tolerance etc. Some important changes to your portfolio may be required.

Merry Christmas and a Happy New Year!

 

[1]at time of writing, Home Trust was offering a 2.95% 5 year mortgage.

 


 

 
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