Mutual funds over-regulated?

In a candid video interview, former OSC regulator Rebecca Cowdery, now partner at Borden Ladner Gervais and a specialist in the regulation of investment funds, discusses industry concerns that CRM 2 (in effect July 15, 2013) will put unequal regulations on different sectors and products. She responds to suggestions that mutual funds may be over-regulated causing possible harm to the small investor and driving investors away to other investment products. In the interview she comments on the “fractured” Canadian regulatory system and the Canadian Securities Administration (CSA) recent CRM2 regulations that place additional compliance “burdens” on advisers and the firms they work for.

[Editor’s note: when a lawyer hints there might be too many laws, I generally stop and check to see if hell has frozen over, etc.]

The video interview can be seen here:




I was experimenting with a cardboard template and an S&P 500 Index chart.


I had cut a square out of a piece of cardboard (creating a window) and would slide it left to right on the following S&P 500 Index chart:




Chart courtesy of


The "window" that I cut out in the card represented about a 5-year time frame. Actually it was about 4.x years - I needed a bigger piece of cardboard!


However, while I was contemplating whether or not my idea was blog-worthy, a recent Wall Street Journal Market Watch article (see hyperlink below) showed how my simple “rate of return illustrator” using a piece of cardboard could work.


"Why five-year funds are about to more than double" by Chuck Jaffe – Marketwatch


Here's my take on the eye-popping mutual fund returns that MarketWatch says are coming soon.


To calculate a rate of return, you need a starting point in time and an end point in time. 


Let's use the actual performance of the S&P 500 Index (an index of the 500 largest U.S. companies) as the benchmark for this illustration.


If we measure the S&P 500 Index from October 2007 (its peak before the Great Panic of 2008 -2009), to October 2012 the rate of return is negative in that five- year time period. Scarcely eye-popping to anyone.


Why is that?


Easy. You are measuring peak-to-peak on the chart.


Shift the starting point just 15 months later to the trough in March 2009 and the return for the index leaps to about 150%. Therefore, a 5 year rate of return from March 9, 2009 to March 9, 2014 is going to look fantastic because you are now measuring trough-to-peak.


Got that? Peak to peak, the index did 0% or less. Trough to peak, it did 150%. The rate of return all depends on what the starting point was.


No sleight of hand here - that's just the math.


Any lessons learned from this history? A couple things come to mind:


1. If you had money to invest but did not invest anything during the stock market decline, you are scarcely breaking even. Blame the newspapers.


2. If you invested during the decline close to the trough, you can brag to friends, relatives and colleagues ad nauseum about your great investment returns. Take your adviser out to lunch.


So unless markets go into a precipitous decline between now and March 9, 2014, five-year returns on equity mutual funds{1} are going to improve dramatically and will peak March 9, 2014. 


Therefore, Chuck's observation is quite accurate: five-year returns on our year-end 2013 statements could start to look much, much better.


{1} We are assuming of course, that the equity funds mentioned are more or less, tracking the direction of the S&P 500 Index.

You’ve got to have discipline

LUCY:  "You've got to take direction. You've got to have discipline! 

[Editor's note: Does the above line sound vaguely familiar? If you are thinking Charlie Brown, you are correct! There seems to be a complete transcript of the famous Charlie Brown Christmas TV special here.]

Sometimes, financial advisers feel a lot like LUCY:

You got to save for retirement! You've got to have discipline! ...

But alas, our well healed boomer has just bought a top-of-the-line SUV, moved to a nicer neighbourhood across town, bought a cottage in the Muskokas and are putting their later-in-life extended family children through university.

Who has time for saving?!!!

Trust me on this one. You have to make time. If boomers want to keep their spendy lifestyles in retirement, you need to save money in order to spend money!

There’s more bad news for boomers too. We are going to live longer. A lot longer - and our retirement savings will have to last 30 or more years.

But back to stocks, bonds, retirement and discipline…

I found a fantastic illustration that tracks what a $1 million dollars invested in 1970 would have done over the years based on the type of investments* that were purchased. He uses five distinct portfolios and tracks their market value right through to the end of last year (2012). Important point; you are withdrawing 5% of your investments per year, every year. Don't have a million dollars yet? Replace the last comma of each figure with a decimal point and you will track what $1,000 did during all those time frames.

Source: Paul Merriman is a columnist for MarketWatch (a publication of the Wall Street Journal). 

Mr. Merriman illustrates five different investment scenarios:

1. 40%/60% combination of stocks and bonds

2. 50%/50% stocks and bonds

3. 60%/40% stocks and bonds

4. 100% stocks

5. 100% S&P 500 stock market index

Note: all stocks are global stocks except for the S&P 500 Index which is comprised of U.S. stocks.

It appears the theory matches reality although there are some surprises. In this illustration, over a long period of time, the more stocks in your portfolio, the higher the ending balance. However note the exception. The S&P 500 Index did significantly worse than the 100% Global stock portfolio or even the 60/40 Global stock/bond combination portfolio. The S&P 500 Index is a stock related index consisting of U.S. stocks.

Of particular interest, are the year-end market values from 1970 to 2012.  Note the fluctuations up or down from year to year. Despite the swings in market value, over a long period of time, look at the bottom line.  The $1,000,000 invested in global stocks in 1970 was worth $12,891,227 in 2012. You might be tempted to comment: So what?  It has grown only 12 times or so in forty years. True, but you also withdrew a total of $14,058,637 during those same years. Put another way; you invested 1 million, withdrew 14 million and still had about 12.9 million left in the account to spend or pass down to your heirs!

Generally, direct investment in stocks do pay off in the long run but you need to ride out the various crises of the last forty years or so. Lose your nerve along the way and your retirement savings could evaporate if you panic and sell out at inopportune times.  Therefore, it is essential to have a good adviser in order to keep you on course with a good mutual fund portfolio that is suitable for you, despite the continuous din of media noise.

For more information about accelerating your retirement plan and putting savings into high gear, drop me a line at

*global stocks indices

More discussion about fees and commissions

Buying a mutual fund 25 or 30 years ago might have cost upwards of an 8% commission. Today, the commission for the same fund is likely to be 0%.

Despite the hysterical press declaring all commissions are inherently evil and must be banned, the truth of the matter is that you can't ban commissions if they've already disappeared on their own.

Advisers have largely eliminated front-end load commissions for purchases of mutual funds. If advisers have voluntarily eliminated the commissions they would normally have charged on fund purchases, how then are advisers to be compensated? And what is considered fair and equitable for both the client and their adviser?

As mentioned in my previous articles about fees, back-end load funds (deferred sales charge funds) are rapidly declining in popularity especially for new accounts as new money is mostly going into 0% commission front-end mutual funds.

An inquiry to one of Canada's largest mutual fund companies (Invesco) indicated that "north of 90% of front-end funds are at 0% commission."

The 1% solution

If the regulator decides to ban all commissions, then mutual fund accounts would have to go to a fee-based account system. The fee amount that I see most often quoted as a starting point is about 1% of assets under management (AUM).

Smaller accounts might pay a lot more than 1%, larger accounts would certainly pay less. In the fee-based system, commissions are eliminated but the client is handed a separate bill they must pay.

It is apparent to me that based on U.S. experience, moving the mutual fund business to strictly a U.S. type of fee-based one is a recipe for disaster. The power and influence of the press is very strong here. The press has the regulator's ear even if there are no current problems, conflict of interest issues or any other imagined headline news story.

Better disclosure is already a fait accompli with the new CRM (Client Relationship Model) that is just coming into affect now, and the phone book-sized mutual fund prospectus has been eliminated and will be replaced by Fund Facts. These improvements and reforms have already been done prior to the release of the CSA discussion paper about improved disclosure and banning commissions. Many industry participants are puzzled as to why the CSA appears to be so anxious to pull the trigger without studying other countries fee-based adviser remuneration systems.

Be careful what you wish for

There has been a lot of debate in the press about which remuneration model is "best". Some say the fee-based system is best and will solve all the perceived problems. Others say that fees should be charged hourly and we should emulate the legal profession and bill clients directly each time we touch a client's account. Yet others say that flat fees or asset-based fees could work too.

If commissions are targeted and eliminated by the Canadian regulators and replaced by negotiable fees, we will be in the wild, wild, West of fee-toting gunslingers. Fees will be all over the map with no indication of what a client is getting for their money. What you end up paying will be entirely dependent on your negotiating skills. If you are someone who does not have the requisite flea market bargaining skills to hammer out a deal, you could very well pay more than you should. Is that fair? Is this a system we truly want? Unfortunately, advisers will have no choice in the matter as they will be forced to follow the new rules - whatever they might be.

For some sense of what might happen in Canada should advisers be forced to charge high fees instead of low commissions, we only have to look at the U.S. model where American advisers have already been using a fee-based model for many years. If you read this article about U.S. fees you should come to the same conclusion as I did - what a horrific mess!

Proposed solution

Although I could be accused of overusing the term, "a solution looking for a problem", I think it best describes the media's play on this story.

Banning commissions entirely would cause far more problems than it would solve. It would raise the barriers of entry to new investors, discourage investing in general and would only be of economic benefit possibly, to the high net worth investor.

[Editor's note: I contacted Dan Ariely, renowned behavioral economist and New York Times bestselling author of "Predictably Irrational". He describes a scenario where the consequences of replacing embedded commissions with fees could be "terrible". See my previous article, Adviser fees - the pain of paying]

My proposed solution is very simple. Keep the embedded fixed rate commission structure for mutual funds. Keep also, the existing fee-based account structures.

Shorten the disclosure document (although this has already been done). The regulators can keep the current system of embedded commissions but they can choose to cap them if they deem this as being necessary. For instance, embedded trailer fees could be capped at a maximum of 1%.

Perhaps existing DSC and low load funds can be transitioned to a new class of mutual funds that have no commissions to buy or sell but have an embedded remuneration (AUM fee) to the adviser of say, 0.5% to 1% per year to the adviser.

Whether you call the 0.5% or 1% a fee or a commission is a matter of semantics however, the regulator and the press seem to prefer fees over commissions.

Therefore, the current asset-based trailer commissions we use now could be relabeled as an embedded fixed AUM (asset under management) fee. Needless to say, relabeling commissions and calling them fees in order to boast that you have eliminated commissions seems pretty silly to me.

The psychology of money

Every time I ask my clients, who have previously purchased all-in-one mutual funds with all costs embedded (as long as they know what they are), they typically recoil in horror when I tell them that there is a possibility that I may be forced to send them a new bill for the same services I had provided in the past.

Clients want and prefer the all-in-one pricing but the regulator and press is telling investors –no, that is not what you want.

Somehow the message is not getting through.

I believe that the current system of commissions and fee-based accounts offers a plethora of choices to meet the needs of every investor. To eliminate all choice and increase overall costs/fees to the client may not be in their best interests.

"Dear Canada: Your mutual fund fees still stink"

[Opinion - Editorial by Glenn Szlagowski - Financial Adviser aka the "Wealth Adviser"]

Wow! That is some headline. This recent headline from Moneysense magazine is certainly eye-popping but is it accurate?

The Moneysense article is referring to Morningstar's latest research on Canadian mutual fund's internal costs.

Morningstar is a U.S.-based company that sells software, mutual fund database information and other products and services to financial advisers, money managers, pension funds, etc.

Based on my own investigation, Morningstar admitted that their original fee report was indeed, flawed with respect to the Canadian MER (Management Expense Ratio) numbers but chose to release the inaccurate and flawed report to the press without comment or explanation. The press predictably, jumped all over the story. As a result, you will see and will continue to see headlines similar to the above.

There is always a story behind the story. I thought it was highly inappropriate for a respected company to release a report that they knew to be inaccurate beforehand and yet, released it to the press anyway. The press did not do their due diligence or checked their sources and merely parroted what the report said. We'll have to give the financial press a great big "F" for failure for that one.

For every Morningstar report that claims Canadian MERs are uncompetitive, there are other reports and studies that say Canadian MERs are indeed, highly competitive. It is an unending argument that I first blogged about fifteen years ago. Based on Morningstar's less than stellar (pun intended) history of dicey press releases and admitted flawed research, in my view, their conclusions remain suspect.


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