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.



Beware the passive-ists – they bear false gifts

Passive investing proponents hold on to the belief that advice is irrelevant. One merely needs to invest in an index. I refer to this class of believers as “passive-ists”.

Lately, I am seeing with increased frequency many articles, newspaper articles, even forum comments all concluding that passive investing clearly outperforms active investing because it is cheaper. And that mathematically and empirically, cheaper investments always do better.

Such reports are accompanied by charts of comparing various investments to, usually, a stock index of some sort. The chart, of course, always shows the index in the lead. The accompanying article would also include a calculation indicating if you dump your financial adviser and save 1% a year, you will save thousands of dollars over your lifetime and your portfolio will be guaranteed to outperform everyone else.

Sheer rubbish of the worst kind, I say.

It looks like another outbreak of cognitive dissonance[1] has broken out once again. It is similar to the belief that American real estate could never, ever go down in value and that banks really have no need for collateral on a mortgage because a house, any house at all, could be sold or foreclosed for that matter, at an enormous profit because a house’s rise in value was infinite.

Unfortunately, the sub-prime collapse and subsequent housing collapse of 2008 destroyed the widespread cognitive dissonance of the time along with a trillion dollars or so of real estate values. The existing “beliefs” and “truths” were completely and utterly destroyed. Millions presumed that residential real estate could never fail. The U.S. Financial Crisis proved them wrong. What was oblivious to millions of homeowners became immediately obvious to all.

Investing fads come and go. Nobody wanted to be in the S & P 500 index when it dropped -57% five and a half years ago but right now, everyone wants to be in that same S & P 500 stock index today merely because it is cheaply traded, can be traded on a smart phone and according to the press, we can manage our life savings entirely by ourselves without any help.

The truth is the do-it-yourself investors will abandon the index investments in a panic liquidation during the next financial, political, economic crisis as easily, quickly and cheaply as they had acquired them in the first place. These “no-help” investments will cut the deepest as cheapness, in the end, has a price. That price may be your retirement, the family’s life savings or a relative’s portfolio you were managing. And the very last thing you will be thinking about is how much money you saved.

Currently, investors are pouring billions of dollars into index-like investments. Buy and hold strategies used to refer to long term investments like mutual funds that were held for many years. Today, long term means 20 minutes. The collapse of trading commissions – practically almost zero these days – means that we can buy and sell investments using our smart phones, cheaply, instantly and with scarcely a thought.

That’s the scary part, buying and selling investments without thought.

Active investing refers to investing with an adviser. Passive investing usually refers to investing in some sort an index-related investment.

It is true that when a stock market index is soaring (like right now), active investing with an adviser is sure to lag. All advisers know this but the press or other “experts” somehow have acquired beliefs that advisers should match or beat the index at all times.

This is where the affliction called cognitive dissonance comes into play. This affliction or disorder affects many people - even really smart people that should know better. Most unfortunately, but most obviously, some “experts” base their charts and tabular numbers, spreadsheets and assume (without giving much thought) that 100% of all investors will receive 100% of the return of the index 100% of the time. They conclude that a fee (any fee) by an adviser will commensurately and absolutely reduce the rate of the return by the identical amount.

What sheer lunacy!

The “experts”, writers and journalists overlook the obvious; do-it-yourself investors have and always will actively mismanage their passive investments and therefore, investors will not achieve index returns as they trade in and out of the investments. In the long term (the last 20 years), the average rate of return is almost at the bottom of the scale. It is scarcely that of cash. And no, the difference in numbers is so vast that we can not blame mutual fund fees or MERs! See this astonishing chart below:


Invesco, a well known and respected Canadian mutual company, says it is having difficulty finding value in the lofty stock markets and are expecting to build cash reserves. Invesco could be right or wrong but they are quite happy to keep some cash in reserve for better bargains (perhaps after a significant stock market correction?) Will they underperform the index while investors pile in at the tippy-top of the market? Yes they will.

At the time of writing (September 2014), the index is soaring to all-time record highs. Millions of investors are pouring hot money not into actively managed mutual funds, but into index-like products that emulate the benchmark indices.

Are the markets euphoric or merely complacent? Will bonds plummet in value when interest rates are set to rise once again? Do clients have too much stock exposure? We have not had a normal 10% stock market correction since 2011. Volatility has been quiet for some time – maybe too quiet.

I think it would be prudent to do a portfolio review and start exploring some of these questions.

Call your adviser today!

[1] Cognitive dissonance: technically it is a psychological condition, but in modern usage it usually refers to “being oblivious to the obvious”.



Fees or commissions – which one is better?

It depends.

Sorry for the cop-out, but today’s raging controversy about whether we should ban commissions and move entirely to a fee-based system (like in the U.K and Australia) has become a tug of war pitting one system versus the other.

The anti-commission, pro-fee crowd firmly believes that commission of any sort skews investment recommendations and that mutual fund commissions should be banned permanently. I disagree with the conjecture by some that commissions skew investment recommendations.

The pro-fee crowd believes that handing a bill to a client for managing mutual funds on a quarterly or monthly basis is the one and only path to enlightenment.

The annual fee is usually a percentage of assets under administration (AUM). A typical fee for a $250,000 mutual fund account might be 1% annually. One percent of $250,000 is $2,500 which means you will be billed $625 every few months. The fee collected does not all go to your adviser. The adviser typically might be on a 50% “payout”. At this 50% payout level she earns $1,250 but has to pay head office expenses, licensing fees, client statement fees, regulatory fees, etc. She might only get a portion of those total proceeds as the remuneration is split out to the adviser’s firm and the branch she works for.

Unfortunately, the adviser’s costs and expenses are not disclosed and this is a shame as most investors should know where all this money really goes to.

From the client’s perspective, you still have to pay the amount even though in previous years this 1% or $2,500 was built into the price of the product. In other words, the 1% was all inclusive. The regulators are proposing that the 1% built-in fee should be replaced by a bill of the same amount to the client.

So which system is better? Build the 1% into the cost of the product or charge 1% less for the product and then send the client a bill for 1%? (Assume all costs for either model are fully disclosed.)

From a mathematical perspective, reducing the product’s price and then adding the same amount back is a wash.

To the client not much changes; you are still paying the 1% in either model whether it is separated out from the product price or not.

The regulators are favouring the 1% bill model as they feel it is better for all clients.

I say –not so fast!

As an adviser, I am currently earning annual remuneration anywhere between 0%, 0.25%, 0.50%, 1.00% and 1.25% depending on the type of fund in the portfolio. The breakdown is this:

I earn 0% annual remuneration for GICs and money market mutual funds, for bond funds I would earn 0.25%. For balanced funds, I would earn 0.50% and for equity mutual funds I would earn 1.00% to 1.25%. Depending on the adviser’s asset allocation, the average compensation (excluding GICs) might be 0.80% or it could be a great deal less, especially if you do not have much in the way of equity mutual funds or do a lot of GIC business.

Do you see what the problem is? If the regulators ban commissions, I get an instant pay raise of at least 25% or more! And the regulators will force clients to pay the increased fees.

There’s nothing wrong with getting a pay raise if you deserve it but here is my point; I will be doing the same amount of work but I will be getting a 25% pay increase. Ironically, the pay raise will come courtesy of the regulators!

Reducing choices and increasing costs at the same time should be raising some eyebrows and certainly should be raising some questions. Not everyone has $250,000 to qualify to have an adviser and be charged a fee. What about new investors just starting out in life – recent graduates or young families? Will that market segment have $250,000 just to have the privilege of paying a new fee?

Commissions have the advantage of being transaction based and are not dependent on account size. In most cases, today’s commissions will be lower than the proposed higher fees in the fee-based accounts that the regulators seem to be favouring.

My vote is to keep the current two-tier system and let the client choose the appropriate model. I am all for reform, but limiting choice, inflicting monetary pain and excluding many thousands of Canadians from financial advice is not my idea of reform.

Instead, I would simply propose that commissions be capped by the regulators. If the renumeration is the same for everyone, then “skewing” or even the faintest temptation to skew investment recommendations would be completely eliminated.



Should we ban fiduciaries?

Bernie Madoff was responsible for the most massive fraud and Ponzi scheme in history.

The actual fraud number in dollars is still somewhat murky but may be somewhere between $12 billion and $20 billion dollars.

Curiously, in the U.S. they refer to Madoff’s firm, Bernard L. Madoff Securities LLC, as an “investment adviser”. In Canada it is very different. An investment adviser or financial adviser refers to a person not a company.

Amongst the many charges levied against Madoff and his firm is breach of fiduciary duty. Although, Madoff is no longer in the daily headlines, I find it incongruent the media made Madoff out as just another financial adviser that has gone bad.

I do not think this is correct. Since Madoff was charged with breach of fiduciary duty, then he must have been a fiduciary.

Therefore, I have problems with the media’s assumptions that Madoff was a rogue investment adviser that stole billions of dollars. I think it would be more accurate to say that Madoff was a rogue fiduciary who stole billions of dollars.

Considering the scope of Madoff’s crimes, do you really want your money managed by a fiduciary?

Author’s note: I thought I would write a counterpoint to what passes for journalism today. Specifically - journalistic bias. Some journalists point to Bernie Madoff as the worst crook that ever lived. Just this one fiduciary managed to steal and defraud more money than in the entire history of fraud in Canada of 100,000+ advisers. This person was a fiduciary. So I wrote the above absurd article from strictly a biased journalist point of view. Oddly, the same biases that journalism holds for advisers do not seem to apply to fiduciaries. See article below. The following journalist refers specifically to Madoff as a fiduciary yet in the same breath says everyone should need one! Therefore, when someone says all advisers should become fiduciaries, think about Bernard L. Madoff, fiduciary.





Regulating the regulators

When the Supreme Court ruled that the Canadian Securities Administration had no jurisdictional powers to be Canada’s national securities regulator, most everyone thought that the Canadian Securities Administrator (CSA) was effectively dead and that Canada would never have its own national regulator.

Not so.

It seems the rumours of their death were indeed, greatly exaggerated.

In a brilliant move, the CSA essentially ignored the ruling entirely and continued to hold itself out as Canada’s national securities regulator.

[Editor’s note: jargon alert!]

I spoke with a former Chief Compliance Officer (CCO) of a mutual fund dealer at length and they were completely amazed/appalled that the Self-Regulatory Organizations or SROs (IIROC and MFDA) are “dancing to the tune” of a national regulator with no regulatory authority. I assured the former CCO that although the CSA has no jurisdictional powers, they will eventually likely become Canada’s national securities regulator as each of the provinces “bend the knee” and pledge fealty. Not all provinces or territories are in favour of a national regulator and until they all agree, having a consistent and uniform regulatory environment from shining sea to shining sea is going to be difficult.

[Editor’s note: Legislators in September 2014 are creating yet another national security regulator called the Capital Markets Regulatory Authority (CMRA) which is to be in place by the fall of 2015.]

Therefore, it is with some amazement that the fund companies have come under the baleful watch of the phoenix-like Canadian Securities Administration who suddenly has foreseen problems and issues with the mutual fund industry with respect to fees and commissions.

My personal view is that the CSA can certainly regulate commissions but it is difficult to regulate something that is about to disappear or has already disappeared! Many mutual fund advisers, myself included, have dropped their commissions to zero many years ago and are selling mutual funds at 0% commission.

I can’t speculate why the CSA is investigating my commissions (or lack thereof). Maybe the CSA is worried that some advisers have dropped their overall compensation excessively?

The only remaining “commissions” for the 0% commission advisers (if we can indeed call them commissions), are referred to as “trailers”.

“Trailers” are ongoing asset-under-management fees for the management of existing investment portfolios which is exactly the same as what banks and private money managers have been using for decades, if not for centuries. Some refer to “trailers” as “commissions” but I do not agree with that view. Commissions are usually a one-time charge. For example: you buy 100 shares of Bell, you pay a commission. You sell the shares of Bell, you pay a commission.

However, annual asset-based percentage fees like “trailers” do not fit the traditional definition of a transaction-based commission. In other words, if it is not a transaction, it is not a commission – it is a fee. If it is a fee and it is based on asset values, we should call it what it really is: AUM (asset under management) fees.

In the context used today, fees are ongoing and systematic, and are charged to the client either separately or embedded into the product price. In all cases, all dollar amounts for both fees and commissions are fully disclosed and transparent. Whether or not fees are embedded, it is not important as long as everyone agrees that all fees should be fully disclosed and transparent – with the CRM2 rules, they are.

While the regulators battle it out at the federal and provincial levels, GIC deposit brokers are also dealing with a number of new regulatory regimes. A new SRO (Self-Regulatory Organization) called the RDBA (Registered Deposit Brokers Association) wants to regulate the sale of GICs in Canada, but it has been tough slogging for them. In the opinion of some, like the CSA, they also do not appear to have a mandate to regulate, and they do not seem to have the blessing and encouragement of any other regulatory body. If anything, the existing regulators appear to be reluctant to give up turf for ostensibly an investment product that may or may not be a security. The RDBA might say that they are merely filling in a vacuum as most regulators haven’t paid much (if any) attention to GICs in the past. If GICs are not regulated by a regulatory agency in some manner, the government will do their job for them!

[Editor’s note: The federal government has done exactly that and created a new law called the Deposit Type Instrument Regulation (DTIR) which neatly bypassed all of the existing regulators!]

Guaranteed Investment Certificates (GICs) are unusual investments in that for decades, they were considered non-securities and not part of the National Securities Act. They fell through the cracks from a regulatory viewpoint likely due to their guaranteed nature and low or no risk.

Even the Ontario Securities Commission were not sure when asked if GICs are bone fide securities. GICs fall under the Bank Act, which is separate from the rules governing securities like stocks and mutual funds. Today, some regulators refer to GICs as securities, others do not.

The above background is important to know as the deposit brokerage industry is a relatively new one. In the 1970s, deposit brokers started selling GICs through agency agreements directly with many banks and trust companies. The deposit broker was paid a finder’s fee for placing the proceeds with the bank. A deposit broker could shop at about 40 different financial institutions (banks and trust companies) and obtain the highest interest rates for their client without charging any fees. The “Agent” or deposit broker was paid directly by the bank who issued the GIC certificate.

Deposit brokers were not regulated by the conventional regulators, and no one saw the need to regulate them until about 2007 which was when they decided to form their own organization. Therefore, we now have a new Self-Regulatory Organization called the RDBA to create standards, rules, guidelines, governance, compliance and licensing with respect to the sale of GICs in Canada.

It is my view that all deposit brokers should have their own self-regulatory organization that is independent of the product manufacturer. And that deposit brokers must uniformly, on a national level, pass certain minimum requirements (as in all professions) before calling one’s self a deposit broker.

Also, there needs to be some sort of compliance regime and audit process (including on-site branch audits) to ensure that GIC business is conducted in the best interests of the client at all times. Hopefully, a self-regulatory organization can fulfill all of these considerable mandates, but there is still a long way to go.

Whew! I have barely scratched the topic of securities regulation in Canada. There is something that everyone can agree on: there is more compliance now than ever before in the securities industry and most of it will be of benefit to everyone. But to balance this view, Benjamin Tal, Chief Deputy Economist of CIBC said in a recent speech[1] that too much compliance will bog things down. Too much of a good thing, perhaps?

Related articles:

CRM2 - Big regulatory changes coming to Canada’s mutual fund industry: http://wealthadviser.ca/newsletters-8/205-big-changes-mutual-fund.html

Fund Facts - The risk and reward of fluctuation, volatility and standard deviation:



CSA (Canadian Securities Association)

CCO (Chief Compliance Officer)

IIROC (Investment Industry Regulatory Organization of Canada)

MFDA (Mutual Fund Dealers Association)

DTIR (Deposit Type Instrument Regulation)

GIC (Guaranteed Investment Certificate)

RDBA (Registered Deposit Brokers Association)

SRO (Self Regulatory Organization)

[1] Benjamin Tal – Chief Deputy Economist CIBC “The Waiting Game” speech, Sept. 16, 2014 (Waterloo Inn, Waterloo, Ontario)

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