Ten Tips on Working With A Portfolio Manager

HEALTHY LIVING MAGAZINE

Over the years, I have had many discussions with people about what is important to them.  Health is nearly always at the top of the list.  Connected to this is having time to enjoy an active and social lifestyle.

Life has become busy, and it is tough to squeeze in everything that you have to do, let alone have time left over for all the things you want to do. Sometimes it is simply a matter of making a choice. One of my favourite concepts I learned years ago in economics is ‘opportunity cost’. It can relate to time, money or experiences. We can’t get it back, borrow or save it. Time is sacred – especially family time and doing your own investing can take time and attention away from your family. So ask yourself – is doing your own investing worth the time you are spending on it?

One way to focus on the things you want to do is to delegate the day-to-day management of your finances to a portfolio manager who can help you manage your investments by creating what is called a ‘managed’ or ‘discretionary’ account. They are able to execute trades on your behalf without obtaining verbal permission, so when the market changes, they are able to act quickly and prudently.

Here are some tips for working with portfolio manager to improve your financial health:

Have a Plan

You are more likely to achieve the things you want if you set goals to paper. With fitness goals it would be things like running your first 10k race or lowering your blood pressure. Financial plans are the same – sit down with your portfolio manager and outline what you want to achieve with your estate, your investments and your retirement. Once a plan is in place, a periodic check-up takes a fraction of the time to ensure everything is on track.

Stay in Control

If you are worried about being out of touch with your investments, there are measures in place to keep you in the driver’s seat. One of the required documents for managed accounts is an Investment Policy Statement (IPS). This sets the parameters with your portfolio manager and provides some constraints/limits around their discretion. For example, you could outline in the IPS that you wish to always maintain a minimum of 40 per cent in fixed income. This lets you delegate on your terms, and ensures a disciplined approach to managing your portfolio. Technology has made it easier and faster for you and your portfolio manager to track your progress, review changes or update the program. Developing a written agenda that gets shared in advance of a meeting, whether in person or virtual, can create efficiencies and ensures nothing is missed. Whether it is email, Skype, or even text messaging – there are many ways for you to stay connected to your finances.

Think About Taxes and Legal Issues

Your finances often involve other professionals such as lawyers or accountants, so it is beneficial to get everyone connected early on. Work with your portfolio manager to complete a professional checklist that includes important names and a list of key documents. If your team can communicate directly with one another, it’s easier to map out planning recommendations and tax-efficient investment strategies. Your portfolio manager can also act as your authorized representative with the Canada Revenue Agency and can even make CRA installment payments on your behalf. Every summer, I am reviewing assessment notices, carry-forwards, contribution limits (i.e. TFSA and RRSP) and income levels to allow my clients to enjoy the outdoors and improve their quality of life

Put Family First

Having a complete picture helps a portfolio manager map out strategies to preserve your capital and to protect your family. If a life event occurs or your circumstances change – from new babies, to inheritances, to critical illness –  your portfolio manager can provide options and solutions. When the family member who manages the finances passes away suddenly, it can be very stressful for the surviving spouse or children during a time that is already emotionally draining. To help in this situation, many families create well thought-out plans that can involve working with their portfolio manager to make discretionary financial decisions in a time of transition. A Portfolio Manager can take care of your finances regardless of the curves that life throws them.

As a portfolio manager, I feel it is critical to be accessible and to keep clients well-informed with effective communication. What I am finding is that conversations are shifting to areas outside of investments, including the financial implications of health issues and changes within the family.

If you are looking for a way to simplify, reduce stress in your life, and proactively manage your finances, a portfolio manager might be a good way to improve your financial health.

 

Let’s make things perfectly clear

CAPITAL MAGAZINE

When hiring an accountant or lawyer, you’re billed after services are rendered. In the investment world, it’s not so transparent. With embedded costs, market-value changes, withdrawals and deposits, it hasn’t always been clear exactly what you’ve been charged.

The introduction of fee-based accounts and recent regulatory changes are making significant strides in providing better transparency to investors.

In the past, most types of accounts were transactional, wherein commissions are charged for each transaction. With fee-based accounts, however, advisers don’t receive commissions. Instead, they agree to a set fee schedule, usually charged on a quarterly basis. This fee is normally based on a portfolio’s market value and composition. Buy and sell recommendations are based on the client’s needs and goals. If an investor’s account increases in value, so do the fees paid; conversely, if an account declines in value, fees go down.

The recent increase in fee-based accounts correlates to the implementation of the second phase of the “Client Relationship Model” (CRM), a regulatory initiative passed by the Canadian Securities Administrators in March 2012. The CRM affects both the Mutual Fund Dealers Association and the Investment Industry Regulatory Organization of Canada.

While the key objective of CRM1 was relationship disclosure and enhanced suitability, CRM2 is designed to increase transparency and disclosure on fees paid, services received, potential conflicts of interest and account performance. All of these mandatory disclosures are being phased in from 2014 to 2016.

Last July, CRM2 mandated pre-trade disclosure of all fees prior to an investor agreeing to buy or sell an investment. With transactional accounts, an adviser must disclose all of the fees a client is required to pay, such as commissions when buying or selling positions. Many investors have complained about hidden fees, especially in mutual funds. With CRM2, all of these fees now have to be disclosed prior to the transaction.

Certain types of transactions had no disclosure requirements in the past. For example, an adviser used to be able to purchase a bond and embed their commission in the cost of the bond on the trade confirmation slip. Now, fixed-income trades also require full disclosure. In other cases, even if there was disclosure in the legal sense of the word, understanding this disclosure required clients to read the fine print in lengthy prospectus documents.

With fee-based accounts, the client has a discussion about fees with their adviser up front, and an agreement with full disclosure is signed by investor and adviser.

Another reason for the popularity of the fee-based platform is that many advisers can offer both investment and planning-related services. Many advisers can offer detailed financial plans and access to experts in related areas, such as insurance, and will and estate planning.

In a traditional transactional account, where commissions are charged for every buy or sell, it has always been challenging for advisers to be compensated for additional services such as financial planning. Consequently, many transactional-based advisers would not offer these services to their clients.

Fee-based accounts also offer families one more opportunity for income splitting by setting up account-designated billing for their fees. The higher-income spouse can pay the fees for the lower-income spouse.

Another benefit of a fee-based structure for non-registered accounts is the ability to deduct investment counsel fees as carrying charges and interest expense. Anyone who has non-registered accounts would be well advised to read Canada Revenue Agency’s interpretation bulletin 238R2. Investment counsel fees cannot be deducted for registered accounts, but there is the benefit of paying the fees for registered accounts from a non-registered account.

Adviser-managed accounts have been the fastest-growing segment of the broad fee-based group. In this type of account, the adviser is licensed as a portfolio manager and able to use discretion to execute trades. In setting up the adviser-managed account, one of the criteria is that the account must be fee-based. Regulators have made it clear a portfolio manager is not permitted to use discretion when it comes to commissions or transaction charges. One of the starting points to setting up a managed account is to get a defined investment policy statement that sets out the relevant guidelines that will govern the management of the account.

Regulatory Change Helps Drive Popularity of Fee-Based Investment Accounts

CPABC IN FOCUS MAGAZINE

The investment services industry is changing at a dramatic pace, with investors demanding more choice, more transparency, and more personalized advice. One of the fastest growing trends within the financial services sector is the use of fee-based accounts. While there are many reasons for the increasing popularity of these accounts among advisers and clients alike, recent regulatory changes have been a major catalyst.

Traditional vs fee-based account structures

In the past, the most common type of account structure has been a transactional one, wherein commissions are charged for each buy or sell transaction. With fee-based accounts, however, advisers do not receive commissions—instead, they agree to a set fee schedule, usually charged on a quarterly basis. This fee is normally based on the portfolio’s market value and composition. Buy and sell recommendations are based solely on the client’s strategic needs and goals. If an investor’s account increases in value, so do the fees paid to the adviser; conversely, if an investor’s account declines in value, so do the fees paid. With a fee-based structure, the adviser has a direct (and overt) incentive to ensure that the investor’s account increases in value.

Client relationship model initiative enters second phase

The recent increase in the use of fee-based accounts correlates to a large extent to the implementation of the second phase of the “Client Relationship Model” (CRM), a regulatory initiative passed by the Canadian Securities Administrators in March 2012 The CRM affects both the Mutual Fund Dealers Association and the Investment Industry Regulatory Organization of Canada.

While the key objective of CRM1 was relationship disclosure and enhanced suitability, the key objective of CRM2 is to increase transparency/disclosure for investors with regard to fees paid, services received, potential conflicts of interest, and account performance. All of these mandatory disclosures are being phased in from 2014 to 2016.

In July 2014, CRM2 mandated pre-trade disclosure of all fees prior to an investor agreeing to buy or sell an investment. With a traditional transactional account, an adviser must disclose all of the fees a client is required to pay, such as any commissions for transactional accounts when buying or selling positions. However, many investors have complained about “hidden” and unexpected fees, especially with respect to mutual funds. With CRM2, all of these fees now have to be fully disclosed prior to the transaction.

This move to greater transparency is a major shift from certain types of transactions that had no disclosure requirements in the past. For example, an adviser used to be able to purchase a bond and embed their commission in the cost of the bond on the trade confirmation slip. Now, fixed income trades also require full disclosure. In other cases, even if there was disclosure in the legal sense of the word, understanding this disclosure required clients to read the fine print in lengthy prospectus documents. Similar CRM2-type regulations for full disclosure were implemented in Australia and the UK in 2013, requiring transparency regarding all fees. Not surprisingly, this resulted in a significant reduction in the number of financial advisers working in the industry in both countries. It’s possible that we could also see a reduction in the number of advisers here, once the new rules are fully implemented in Canada.

Fee-based accounts are already onside of the new rules, as transparency is embedded in their structure: The client has a discussion about fees with their adviser up front, and a fee-account agreement with full disclosure is then signed by both the investor and the adviser. 

Comprehensiveness

Another reason for the growth in popularity of the fee-based platform is the fact that many advisers now offer a comprehensive wealth offering, which includes both investment and planning-related services. This differs from the role of the stock broker of the past.

Clients have a variety of financial planning needs, primarily with regard to retirement and estate planning. Many advisers can offer detailed financial plans and provide access to experts in related areas, such as insurance, and will and estate planning. An adviser will often communicate with the client’s accountant and lawyer to ensure everyone is on the same page.

In a traditional transactional account where commissions are charged for every buy or sell, it has always been challenging for advisers to be compensated for additional services such as financial planning. Consequently, many transactional-based advisers simply would not offer these services to their clients.

Some unique benefits

Certain benefits are unique to fee-based accounts.

Rebalancing without additional cost

For example, this structure enables wealth advisers to rebalance portfolios as needed to reduce risk at no additional cost. Multiple types of rebalancing are important when managing risk. At the macro level, let’s assume a client’s optimal asset mix is 60% in equities and 40% in bonds. After a period of strong equity markets, the client’s equity percentage rises to 68%. Reducing equities by 8% and allocating this to fixed income is rebalancing at the macro level. At the micro level, there is an optimal position size for one holding. In this example, let’s assume the optimal position size is $24,000 for each company held in the portfolio. If one stock rises significantly above or below the optimal position size, then consideration for a rebalancing trade should occur.

Several trades could be required on an annual basis to rebalance a portfolio. With transactional accounts, the commissions for doing multiple small adjustments would likely be prohibitive. However, not doing the trades because of the commission payable in a transactional account means that you’re not managing risk as effectively.

The adviser’s ability to make tactical shifts in an account is another benefit of fee-based accounts. For example, there are times when investors benefit from moving in or out of USD-denominated holdings. Being able to make these changes when the currency is right should be done without concern for the trade’s commission cost. Being able to move between sectors based on current outlook can also be strategic, especially when transaction charges are not a factor (if a transaction charge is 2% to sell and 2% to buy, then the cost of any switch trade has to increase by 4% to break even).

Income splitting and “householding”

Fee-based accounts also offer couples and families one more opportunity for income splitting by setting up account-designated billing for their fees. For example, the higher income spouse can pay the fees for the lower income spouse. Let’s assume the lower income spouse has an RRSP and a TFSA. The higher income spouse can put funds into the lower income spouse’s account as a contribution of fees without attribution. In another example, a client with multiple fee-based investment accounts (i.e. one non-registered and five registered) can arrange to have all of the fees paid out of the non-registered account.

“Householding” is a term used in fee-based accounts to link accounts together for fee-billing purposes. As the total of the householded assets increases, the percentage fee for the adviser’s services decreases. Let’s say we have a middle-aged couple with $400,000 in investments. The couple has parents with $680,000 in investments, over which the couple has power of attorney. The couple also has a corporate account totalling $120,000 in investments. By householding, or combining all accounts under one agreement, the household value becomes $1,200,000, which results in lower overall fees for everyone.

Deducting investment council fees

Another benefit of a fee-based structure for non-registered accounts is the ability to deduct investment council fees as “carrying charges and interest expense.” Many investors are still not aware of these tax benefits. Anyone who has non-registered accounts would be well advised to read the Canada Revenue Agency’s (CRA) interpretation bulletin on this topic (IT-238R2). The investment council fees cannot be deducted for registered accounts, but there is the benefit of paying the fees for registered accounts from a non-registered account, especially for younger clients where registered accounts are deferred for many years.

Adviser-managed accounts

Over the last several years, adviser-managed accounts have been the fastest growing segment of the broad fee-based group. In this type of account, the adviser is licensed as a portfolio manager and able to use his or her discretion to execute trades.

In setting up the adviser-managed account, one of the criteria is that the account must be fee-based. The regulators have made it clear that a portfolio manager is not permitted to use discretion when it comes to commissions or transaction charges. One of the starting points to setting up a managed account is to get a clearly defined investment policy statement that sets out the relevant guidelines that will govern the management of the account. At this same time, a fee-based agreement is signed that clearly outlines the negotiated fee structure.

Shifting to a new model

As the financial services industry continues to change and evolve, so do the solutions being offered. There is now more flexibility and choice in how a wealth adviser and an investor can work together.

High-net-worth clients are looking for advisers who have the credentials and licensing to offer discretionary portfolio management. Within that context, there is also an expectation that financial planning and other related services will be part of the overall fee-based structure. The traditional model of solely doing stock trades for trading commissions is becoming an increasingly difficult business model to sustain.

Kevin Greenard is a portfolio manager and associate director of wealth management with ScotiaMcLeod, a division of Scotia Capital Inc. and ScotiaMcLeod Financial Services Inc.

Behind the scenes with trade execution

If we define every transaction in an account as a trade then we can start a conversation about the basics of trade execution.

Some people may believe that trading is executed through a primary stock market. If we keep this article specific about Canada, the primary exchanges are Toronto Stock Exchange and the TSX Venture Exchange (for small and medium sized companies). Both of these exchanges have trading hours between 9:30 am and 4:00 pm eastern time, Monday to Friday, with the exception of certain holidays. In British Columbia, this means the primary exchanges close at 1:00 pm.

Over the last decade new marketplaces have emerged in Canada, these have been referred to as Alternative Trading Systems (or ATS). These systems at first grew in popularity because brokers were able to avoid paying the exchange trading fee. Also, an ATS may have different hours of operations than the primary exchanges. The Investment Industry Regulatory Organization of Canada (IIROC) regulates the above noted primary exchanges and the following ATSs: Canadian Securities Exchange, Alpha Exchange, Bloomberg Tradebook, Chi-X Canada, CX2 Canada ATS, Instinet Canada Cross Limited, Liquidnet Canada Inc., Lynx ATS, MATCH Now, Omega ATS, and TMX Select.

When an advisor enters an order it may be executed on the primary exchanges, an ATS, or a combination of both. The main factors effecting where the trade is ultimately filled is best available price, historical liquidity, and likelihood of execution. If a Canadian trade is executed on just one exchange then your confirmation slip would have a message something like “AS AGENTS, WE TODAY CONFIRM THE FOLLOWING BUY/SALE FOR YOUR ACCOUNT ON THE TORONTO STOCK EXCHANGE/CANADIAN VENTURE EXCHANGE/ALPHA/OMEGA/ etc.” If the Canadian security transaction was executed by a combination of exchanges/ATS then the message on the confirmation slip would reflect this by stating something like “AS AGENTS, WE TODAY CONFIRM THE FOLLOWING BUY/SALE FOR YOUR ACCOUNT ON ONE OR MORE MARKETPLACES OR MARKETS. AVERAGE PRICE SHOWN. DETAILS AVAILABLE UPON REQUEST“.

For example, a client wants to sell 2,500 of ABC Company at market after watching BNN and seeing the the price per share at $15.59. If all the shares were sold and executed at this price, the proceeds would be $38,975. The actual value once we enter the order is almost always different. The reason for this is both depth of quote and dark liquidity.

Depth of quote is when we can see the quantity of shares available and the current bid and ask at each price level. Prior to the above trade execution I outlined the depth of quote with my client (see table below). Advisors assisting retail clients typically have what is called Level II quotes where they can see both bid and ask at different price levels – I refer to this transparent part of the market as the “lit” system. Using the above example of a client wanting to sell 2,500 shares of ABC Company at market, the beginning few lines of the bid side of a depth of quote/level II would provide the following information:

Depth of Quote/Level II

Orders          Size           Bid

14                       700            $15.57

22                     1,600           $15.54

  9                     4,200           $15.50

  3                      9,000           $15.40

15                    10,000           $15.37

Orders represent the number of limit orders entered on the lit system. It is possible for the same client to enter multiple limit orders. Size is the number of shares available at the bid price on the lit system.

Using the above Level II table, 700 shares would be sold (also referred to as filled) at $15.57, 1,600 filled at $15.54, and 200 filled at $15.50. An Advisor could communicate to the client what is visible on the lit system and that the total estimated proceeds would equal $38,863. It is possible that once the sell button is pressed that the actual trade is executed at a higher price as a result of dark liquidity (also referred to as dark pools).

Dark liquidity is a term that relates to traders being able to enter orders without providing the above transparency to other market participants. Effectively, the trades are not transparent or lit; thus the term dark pool came about because the orders can not be seen. Retail clients and advisors typically do not have direct access to entering trades with dark liquidity. Most financial firms have traders that assist Portfolio Managers, Wealth Advisors and institutional clients with larger trades.

Traders can use dark pools on both the primary exchanges and ATS. Dark pool trades in Canada are nearly all limit orders, and are typically done for institutions executing large trades. Using the above table, if an advisor entered an order to sell 100,000 shares at market, the price would immediately get driven down to as low as $15.00 (assuming no dark pool orders to buy). The benefit of dark liquidity for institutions is that they do not have to “show their cards” before they are played. In other words, an institution may want to sell 100,000 shares of ABC Company with a limit price of $15.57. A trader could work the order with acquiring smaller fills without creating big swings in the price of the security. The trader could enter a limit order putting 20,000 shares on the lit system so it shows on level II, enter 50,000 in a dark pool at the same price so it is not displayed, and hold off entering the remaining 30,000 in order to continue to work the order.

Wealth Advisors must verbally confirm each trade with clients and then execute the trade right after they obtain confirmation. With frequent small trades at different points in time, dark pool trades are not generally used in Canada at the retail level. In the US, dark pools are much more common, even for smaller sized trades. Some individual clients may have large holdings in a particular security and the traders are available to assist. Portfolio Managers on the other hand often execute large block trades (combining all the shares for all clients) on a discretionary basis. Once a quantity of shares to buy or sell is determined the Portfolio Manager is often in direct communication with the traders.  Together they can choose to use dark pools, or not.

Dark liquidity is still relatively small in Canada when compared to the United States. Earlier this year, the US Securities and Exchange Commission noted that around 40 per cent of all U.S. stock trades avoid the exchanges. The increase in dark pool transactions make it more challenging to determine the true liquidity and price transparency of a security. Market makers assist in the lit market but are non-existent in the dark pool. The Canadian Securities Administrator and IIROC have already implemented a few rules with respect to dark liquidity and I would suspect that further rules will be unveiled in the future.

 

Kevin Greenard CA FMA CFP CIM is a Portfolio Manager with The Greenard Group at ScotiaMcLeod in Victoria. His column appears every second week in the TC. Call 250-389-2138.

 

Research ETFs before you buy

Exchange Traded Funds (ETFs) have become one of the fastest-growing areas of the financial market.   “Index Shares” is another similar term and many advisors use these terms inter-changeably.  Investors can participate in a broad variety of investment opportunities using ETFs. 

The original ETFs differed from traditional actively managed mutual funds as these are passive products.  For example, an investor could purchase an ETF of a well-known index such as the S&P 500 which holds the largest 500 U.S. public issuers. 

As their popularity has grown, so has the number of ETFs being created.  Some companies are creating a hybrid product with relatively low fees and some active management.  The water is getting a little murkier as new features are being added to these new products, so I caution investors to understand before they buy.

One reason for the growth in ETFs is the relatively low cost and transparency of the fees.  Investors do not want to be burdened with the cost of high fees, especially if these are hidden or embedded.   The management fee for the S&P 500 is 0.14 per cent through iShares by BlackRock (TSX symbol: XUS), and 0.15 per cent through Vanguard (TSX symbol: VFV).  These are just two symbols that track this common Index.  Other ETF examples trade directly on US exchanges and some that are currency hedged.  You should have full understanding of the tax component, risks and features before purchasing.

The annual cost of an actively managed mutual fund is significantly more than an ETF.  Mutual funds have a Management Expense Ratio (MER) that is embedded.  New regulations and rules are coming soon that will require full disclosure of all fees.  Trading costs are in addition to the normally published MER.  A passive ETF would have very little trading.  Like all services, fees are really only an issue in the absence of value. If an actively managed mutual fund is consistently performing better than an ETF, then the MER and trading costs may be fully warranted.

Some advisors may not recommend ETFs for a few different reasons.  It could be that an advisor only has a mutual fund licence and they are not permitted to discuss or provide ETFs as an option.  Mutual funds can be sold on a no-load, front-end (initial service charge) or a back-end (deferred service charge) basis. We recommend that investors ask their advisor what the initial commissions are, the ongoing trailing commissions, and the cost to sell the mutual fund investment.  Understanding the total cost of choosing an investment option should be done prior to purchase.

ETFs are very much an option that can complement a fee-based account.  Both cost structures are low and provide complete transparency.  ETFs are listed, and trade, on exchanges similar to stocks.  For transactional accounts, there is a cost to purchase an ETF, and a cost to sell them.  For fee-based accounts, there are no transaction costs to purchase or sell an ETF, however, the market value of the amount purchased would be factored into calculating your fees.

When a new client transfers in investments traded on an exchange, it is always easy to make changes.  Investors who have purchased proprietary mutual funds or mutual funds purchased on a low load or deferred sales charge may have fewer options.  In most cases, proprietary funds cannot be transferred in-kind and a redemption charge may apply to transfer in cash.  For example, say Jack Jones has $846,000 in a basket of mutual funds in his corporate investment account.  Jack is paying 2.37 per cent (or $20,050) annually in MERs to own his mutual funds.  I mapped out a lower-cost option for Jack that would decrease his cost of investing, to one per cent ($8,460).  The approach to investing involves a fee-based account with a combination of direct holdings and ETFs.  Annually, Jack would save $11,590 and have full transparency and liquidity.

ETFs can be used strategically to obtain exposure to various types of asset classes, sectors, and geographies.   Although the cost is lower, they are not immune to declines when markets get shaky.  An advisor can design a portfolio of positions that are lower risk then the market.  This is tougher to achieve with off-the-shelf  ETFs. 

Although the traditional ETF is a passive approach, we still feel that an advisor can provide advice with respect to the active selection of the ETF, tax differences, hedging options and more.   To illustrate using bond/fixed income ETFs, an investor could choose amongst many different types depending on the current environment (i.e. interest rate outlook, current economic conditions). 

An advisor can provide guidance on whether to underweight or overweight government bonds or corporate bonds and provide guidance on whether you have a short term, long term, or laddered bond strategy.  Based on your risk tolerance, should you stick to investment grade bonds or seek out greater returns with high yield bonds.  An advisor can explain some of the more complex fixed income ETFs including those holding real return bonds, floating bonds, or emerging market bonds.   An advisor can provide recommendations with respect to actively switching between these passive ETFs.

 

Portfolio manager can act for clients more quickly than traditional adviser

Over the years, I have had great discussions with people about financial decision-making. It is tough for most people to make decisions on something they don’t feel informed about. 

Even when you are informed, investment decisions can be challenging.

When you work with a financial advisor, you have another person to discuss your options with. In the traditional approach, an advisor will present you with some investment recommendations or options.  You still have to make a decision with respect to either confirming the recommendation and saying “yes” or “no,” or choosing among the options presented. As an example, an advisor may give you low-, medium-, and high-risk options for new purchases. An advisor should provide recommendations that are suitable to your investment objectives and risk tolerance.

Another option for clients have is to have a managed account, sometimes referred to as a discretionary account.  With this type of account, clients do not have to make decisions. The challenge is that very few financial advisors have the appropriate licence to even offer this option.   To offer it, advisors need to have have either the Associate Portfolio Manager or Portfolio Manager title.

When setting up the managed accounts, one of the required documents is an Investment Policy Statement (IPS). The IPS outlines the parameters in which the Portfolio Manager can use his or her discretion. As an example, you could have in the IPS that you wish to have a minimum of 40 per cent in fixed income, such as bonds and GICs.

Portfolio Managers are held to a higher duty of care, often referred to as a fiduciary responsibility. Portfolio Managers have to spend a significant time to obtain an understanding of your specific needs and risk tolerance. These discussions should be consistent with how the IPS is set up. Any time you have a material change in your circumstances then the IPS should be updated. At least every two years, if not more frequently, the IPS should be reviewed.

The nice part of having a managed account with an up to date IPS is that your advisor is able to make the decisions on your behalf. You can be free to work hard and earn income without having to commit time to researching investments. You can spend time travelling and doing the activities you enjoy. Many of my clients are intelligent people who are fully capable of doing the investments themselves but see the value in paying a small fee. The fee is tax deductible for non-registered accounts and all administrative matters for taxation, etc. are taken care of. A good advisor adds significantly more value than the fees they charge. This is especially true if you value your time.

Many aging couples have one additional factor to consider. In many cases one person has made all the financial decisions for the household. If that person passes away first, it is often a very stressful burden that you are passing onto the surviving spouse. I’ve had couples come in to meet me primarily as a contingency plan. The one spouse that is independently handling the finances should provide the surviving spouse some direction of who to go see in the event of incapacity or death. In my opinion, the contingency plan should involve a portfolio manager that can use his or her discretion to make financial decisions.

In years past it was easier to deal with aging clients. Clients could simply put funds entirely in bonds and GICs and obtain a sufficient income flow. With near historic low interest rates, this income flow has largely dried up for seniors. When investors talk about income today, higher income options exist with many blue chip equities. Of course, dividend income is more tax efficient than interest income as well. A portfolio manager can add significant value for clients that are aging and require investments outside of GICs.

Try picturing a traditional financial advisor with a few hundred clients. A traditional financial advisor has to phone and verbally confirm each trade before it can be entered. The markets in British Columbia open at 6:30 AM and close at 1:00 PM. An advisor books meetings with clients often weeks in advance. On Tuesday morning an advisor wakes up and some bad news comes out about a stock that all your clients own. That same advisor has 5 meetings in the morning and has only a few small openings to make calls that day. It can take days for an advisor to phone all clients assuming they are all home and answer the phone and have time to talk.

A Portfolio Manager who can use his or her discretion can make one block trade (the sum of all of his clients’ shares in a company) and exit the position in seconds.

Sometimes making quick decisions in the financial markets to take advantage of opportunities is necessary. Hands down, a Portfolio Manager can react quicker than a traditional advisor who has to confirm each trade verbally with each client.

Fee-based accounts benefit investors in the long run

A fee-based account is a tranparent way of paying your financial advisor.  The fee is charged based on the market value of the assets being managed, and it is distinctly different than a transactional account, where commissions are charged for every buy-and-sell transaction. 

When clients open up a fee-based account, they sign a fee-based agreement that establishes the agreed upon fee, how the fees are calculated, when the fees will be charged and the accounts involved.   

There are a number of benefits for clients in moving to a fee-based account. 

Working on a “fee for service” basis, rather than a commission or transactional fee basis, means the best interests of the client are more aligned with those of the advisor. If fees are based on the market value of the account, then the only way an advisor will be compensated further is if they can grow your account in value.  If your account declines in value, then so does the compensation paid to your advisor.  

Another benefit of a fee-based account is the additional services clients receive from their financial advisor.  Financial professionals today are rarely called stock brokers because the services offered extend well beyond buying and selling stocks. Financial planning meetings cover many topics such as tax and insurance as well as education, retirement and estate planning. 

Financial professionals today spend a significant amount of time understanding each client’s needs and integrating this into an increasingly complex tax and regulatory environment. 

As a result, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes.  The main benefit is the fees relating to non-registered accounts can be deducted on your income tax return as a carrying charge.  If your fee is one per cent before tax, and your marginal income tax bracket is 30 per cent, your fees have a net cost to you of only 0.70 per cent.   

Fees are typically charged quarterly. As an example, Jane Wilson opened a new fee-based account and invested $750,000 on Jan. 1 with an annual fee of one per cent.  She will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $1,875 ($750,000 x 0.25 per cent).  Wilson’s fees are one-quarter of one percent after each quarterly period. 

Other methods of compensating that are not fee-based often have commission charges upward as high as five percent on the first day of buying the investments. For an advisor to be successful with a fee-based business, he or she needs to establish good long term relationships. 

The periodic payment of fees better aligns the interests of clients and financial professionals.  When explained to clients, most would prefer to spread out the fees over time as services are provided versus paying a large amount on the first day.  

One question we are asked is how the quarterly fees are actually paid.  To illustrate we will use Don Spalding, who has three investment accounts totaling $750,000 – $500,000 in a non-registered account, $200,000 in his RRSP account, and the remaining $50,000 is in a Tax Free Savings Account. 

There are a few different options for how Spalding can cover the quarterly fees. 

The first option is to have the fees charged to each of the respective accounts.  Wilson had only one account and the fee of $1,875 was simply charged to that one account.  Mr. Spalding has three accounts and each account is charged the respective amount based on one-quarter of one percent of the market value of each account. 

The first quarterly amount for Spalding is $1,250 for the non-registered account, $500 for the RRSP, and $125 for the TFSA.  He has the option of keeping cash in each account to cover the fees, depositing cash quarterly or selling investments. 

With fee-based accounts, Spalding has the option to instruct us to designate the billing of the fees to come out of one account.  Don could instruct us to pay the fees for his RRSP and TFSA accounts from the non-registered account.  This enables him to maximize the amount he maintains in his registered accounts keeping it tax sheltered. 

The payment of fees from a designated account enables an advisor to fully invest the non-designated accounts and to utilize compounding growth strategies such as the dividend reinvestment plan.  Fee-based accounts can assist with income splitting as the higher income spouse can pay the account fees of the lower income spouse.

Liquidity is another benefit of fee-based accounts.  As there is no cost to buy investments, the same applies to changing or selling investments.  If you require money for any reason, there is no commissions payable for selling or rebalancing your investments.  Rebalancing can include reducing a position that has performed well, dollar cost averaging on a position that has underperformed, adjusting sector exposure, modifying asset mix, and changing the geography of your investments. 

Another benefit of fee-based is the ability to link additional family members to the platform.  Clients with children and grandchildren often would like introduce them to the benefits of full service brokerage, but do not individually have the capital to be able to open accounts on their own.  This could include parents wishing to assist adult children in opening and funding Tax Free Savings Accounts and grandparents who wish to open Registered Education Savings Plans for their grandchildren.  Fee-based accounts that are linked can make wealth transfer strategies within the family group of accounts significantly easier.

New disclosure rules on adviser’s fees could reduce ranks

Over the next few years, you are likely to hear more about what is referred to as the “client relationship model,” or CRM.  CRM is a regulatory requirement introduced by the Canadian Securities Administrators to enhance disclosure, which partially came into effect this year.  Further phases over the next three years are intended to enhance the standards financial firms and advisors must meet when dealing with clients.  These amended rules provide greater disclosure requirements for advisors and enhance the standards they must meet when assessing the suitability of investments for their clients.

The key objective is increased transparency for investors surrounding the fees they pay, services they receive, potential conflicts of interest and the performance of their accounts

All of these mandatory disclosures will be phased in from 2014 – 2016.   Similar CRM mandatory disclosure rules were implemented in Australia and England.  The implementation of the changes in those countries resulted in a significant reduction in the number of financial advisors working in the industry once rules required them to be transparent about all the fees charged.  I suspect that once the new rules are fully implemented, there will also be a reduction in advisors working in Canada.    

To help illustrate how these changes may affect you, let’s look at GICs and mutual funds.

Many people may be aware that when a financial institution receives investments from people, they then lend that money to other people at a higher rate, simply acting as an intermediary for profit. What most people likely do not know is that every time you invest in a GIC, the financial institution makes a spread, or simply put, a profit. 

Depending on the rates of the day and the length of the term that profit could be range from 10 to 25 basis points per year invested.  The range of the fees could be as low as 0.10 per cent for a one year GIC to 1.25 per cent for a five year GIC.   So on a $100,000 GIC for 5 years, your local financial institution might make between $500 (low end) and $1,250 (high end).  One percent equals 100 basis points in financial lingo.  Low-end is calculated 10 basis points x five years x $100,000.  High-end is calculated 25 basis points x five years x $100,000.  Starting this coming July, all financial institutions will have to disclose this to everyone. 

Let’s move to mutual funds. Take that same $100,000 and assume that you invest it into a balanced mutual fund. There are three potential ways the advisor could get compensated for their advice.  They could charge a fee initially, between one and five percent – referred to as Front End (FE). 

Front End is sometimes referred to as Initial Service Charge (ISC).  Some advisors have adapted a structure similar to banks and don’t charge a Front End fee.  Other advisors could do a Deferred Sales Charge Fee (DSC), where the client pays nothing initially but the advisor collects around five per cent immediately, so in this case, $5,000 from the mutual fund company because you are now committed to that fund family for six or seven years.

The fees to redeem the DSC mutual fund in the first couple of years may be approximately five per cent, and declining over a six or seven year period at which point the fund can be sold for no DSC costs.

There is also a variation called Low Load (LL) which is simply a form of DSC. If you see DSC on your statements, you know you are locked in.   Then inside, embedded in every mutual fund is an ongoing management fee.  As an example, a typical Canadian equity fund may have a 2.5 per cent embedded annual fee that is divided up amongst the advisor every year along with the mutual fund manager and their company.   These combined fees are often referred to as the Management Expense Ratio (MER).  I have found that the MER is rarely disclosed and, with the new rules, it will have to be.

It is very likely that many investors do not know how their advisor makes money or what fees they really are paying.  Knowledgeable and professional investment advisors, just like a good accountant, deserve to charge a reasonable fee for their service. But unlike accountants who send you a bill, investment advisors can currently sell you a product and not tell you what they just made.

More advisors are moving to a fee-based approach which is transparent and, in many cases, tax deductible. There is so much more to come that it may be a good idea to start asking questions now. The next time your banker or your advisor speaks to you about a new investment, consider asking for a complete breakdown of what fees you are paying going in to the investment, what the advisor is getting paid, if any fees apply to sell the investment, and what your fees will be each year thereafter for the advisor to manage your affairs. 

Advisors that have always provided complete transparency to their clients will not need to make any changes in the way they communicate with their clients. In fact, they may end up benefiting from the CRM changes. 

Liquidity in investments

Investments that can be bought and sold easily are considered to be liquid. Investments that are difficult to buy or sell are considered illiquid. Liquidity is one of many important objectives of investing. We can actually look at liquidity in several different ways, and for purposes of this article I’ve broken it down to four general discussion items, as follows: Basic Rules of Settlement, Liquid for a Cost, Exceptions to Liquidity, and Ratio of Liquid to Illiquid.

Basic Rules of Settlement

When buying and selling different investments, there are specific rules with respect to transaction dates and liquidity. Two dates are often used to describe transactions, trade date and settlement date. Trade date is fairly straight forward to understand. It is normally the day your purchase or sell is first executed. If you spoke to an advisor after cut off times (i.e. market hours) and your advisor entered the order for the next market day then trade date would be the next market day. Settlement is a little more difficult to understand and changes with different investments. The following is a chart with the most common investments and the respective settlement dates:

Common Investments

Settlement Date = Trade Date + (below)

Money Market Mutual Funds

1 business day

High Interest Savings Accounts

1 business day

Short Term Bonds (3 years or less)

2 business days

Long Term Bonds (3 years plus)

3 business days

Mutual Funds

3 business days

Canadian and US Equities

3 business days

European and Foreign Equities

Depends on market

To illustrate trade date and settlement date we will use a typical week with no public holidays. Michelle purchases a stock named ABC Company on Monday – this is the trade date. Settlement as per the above schedule for equities is the trade date plus three business days – settlement is on Thursday. What this means is that Michelle does not have to deposit money into her investment account until Thursday, even though the investment was purchased on Monday. If Michelle already had money in a high interest savings account then her advisor could sell a portion of this investment on Wednesday to cover the purchase. The opposite happens when an investment is sold. Let’s assume that a few months go by and Michelle needs some money and sells ABC Company on Monday – this is the trade date. Although we did the trade on Monday, the settlement date is Thursday. We would not be able to transfer funds to Michelle until the settlement on Thursday. We explain settlement to new clients to ensure they give us a few days notice if they require funds.

Liquid for a Cost

At any time you should have the right to make a change in your investments without it costing you a fortune. Having flexibility with investments ensures you never feel like you are backed into a corner with no options. We recommend asking the liquidity question prior to making any investment decisions – what will it cost me tomorrow if I need to sell. Everyone should know the total cost to liquidate an entire portfolio. When I have sat down with people wanting a second opinion the first thing I look at is the types of investments they have and what it would cost to make any necessary changes. I will use Wendy who came in for a second opinion as an example. Wendy was holding a basket of proprietary mutual funds that were originally sold to her more than two years ago on a deferred sales charge (DSC) basis. I explained that with proprietary mutual funds they can not be transferred in-kind (as is). Her only option was to sell the mutual funds, and transfer the net cash after redemption charges, if she wanted to make a change with her investments. In explaining DSC mutual funds to Wendy, she was shocked to know it would cost her four per cent (or $23,200) of her $580,000 investment account to make a change even though she has owned these investments for more than two years. Immediately Wendy felt she was backed into a corner. I explained to Wendy that if she had sold these mutual funds soon after she purchased them two years ago then the cost would have been $37,700. Although Wendy had liquidity, it was liquidity for a cost – she had no idea. In my opinion, every investor should avoid being backed into a corner with excessive liquidity costs.

Exceptions to Liquidity

Not every investment will be easily converted to cash. Your principal residence is one investment that is not easily converted to cash. Many assets that people buy either have restrictions on when they can be sold or take significantly longer than the settlement dates for common investments noted above. Examples of investments that are not easily liquidated include: infrastructure assets, private real estate investments, antiques, art work, private companies, hedge funds, flow-through investments, venture capital funds, etc.. Some investments have in the fine print that they reserve the right to suspend redemptions under certain circumstances. It can be very frustrating for people who have invested in illiquid investments and would like their money back. Prior to purchasing any investment you should determine if it is liquid, illiquid, or has the possibility of becoming illiquid. If it is illiquid you should be prepared to hold it until key dates are reached or a liquidity event occurs.

Ratio of Liquid to Illiquid

A good exercise for all individuals is to list all of your investments and categorize them in the liquid or illiquid category. In my opinion, everyone should have some liquid investments, including cash as an emergency reserve, or investments to either obtain income, growth, or a combination of both. There is no set rule on what ratio of liquid to illiquid investments people should have. As a general guideline, younger individuals may have more illiquid investments, especially if they have real estate with debt or the higher risk tolerance to invest in illiquid investments. Another general guideline is that as people age, or if they have a lower risk tolerance, the ratio may favour liquid investments.

Control investment costs, increase your net return

Many people don’t pay too much attention to the costs associated with investing. If we look at both your returns and cost of investing, we can create what is called your net return.  Your net return can potentially increase by either improving your return, or lowering your cost of investing.

To illustrate we will use Mr. Lee, a 55 year old investor who has $500,000 in an RRSP account.  Mr. Lee has explored the following four options with various costs of investing (increasing at one per cent increments with each option) and service levels:

Option 1:  Self managing investments through Exchange Traded Funds (ETFs) – often referred to as couch potato investing.  With this approach, you receive no planning or investment advice.  This approach is passive as it holds the investments that are in the respective index and are not actively managed.  The annual cost of investing for this option can be around 0.5 per cent, or $2,500 in the first year.

Option 2:  Working with an advisor owning direct holdings in a fee based account.  The fees for this option can fluctuate depending on the advisor and the amount invested.  The fee often decreases as the account value increases.   The benefit of this option is that an advisor is able to assist you with both planning and your investments.  Option 2 is the most transparent with respect to fee disclosure of all options.  If Mr. Lee put the $500,000 into a balanced portfolio, it would typically be priced at 1.25 to 1.5 per cent.  For our example we will use 1.5 per cent, or $7,500 in the first year.  It is important to note that a good advisor is well worth the additional fee over the ETF approach.

Option 3:  Purchasing mutual funds is another commonly used investment approach.  Mutual funds are actively managed by a portfolio manager that has a specific skill set in the fund(s) that you’re buying.  Mutual funds have embedded annual fees called a Management Expense Ratio (MER).  In addition to the MER, funds may be sold on a front end basis with addition fees of up to 5 per cent initially, or sold on a back end basis where you are typically not charged a fee initially but would be charged a fee if you sell the fund within the applicable Deferred Sales Charge (DSC) period, often seven years.  The fee may be as high as 6 per cent initially if sold in the first year, and declining every year until the DSC schedules is complete. An advisor selling funds may look at Mr. Lee and think his time horizon is ten years and that he may be invested in the funds through the DSC schedule.  If Mr. Lee is sold funds on a back end basis where DSC may apply, he is somewhat squeezed into a corner if he is not happy with his performance, or would like to make a change within the DSC period.  For purposes of this illustration we will assume that the only fees Mr. Lee pays is the 2.5 per cent annual MER, or $12,500.

Option 4:  Mr. Lee has heard about some guaranteed insurance products called segregated funds.   The primary difference between mutual funds and segregated funds is that the later is an insurance product.  Being an insurance product, the investments can be set up with different maturity and death benefit guarantees.  Another feature is segregated funds have the ability to name beneficiaries to bypass probate and public record.  In the case of Mr. Lee the funds he has are registered.  With registered accounts it is not necessary to purchase an insurance product to get this benefit as he already has the ability to name a beneficiary, his spouse, which also will assist them in avoiding probate on the first passing.  There is a cost to have the insurance benefit noted above. For illustration purposes we will assume the annual MER for a basket of segregated funds is 3.5 per cent, or $17,500 annually.

The long term effect on accumulated savings can be quite shocking when different net returns are explored over a ten year period.  To help with the illustration, we will make the assumption that investment returns over the next ten years will be six per cent for all four options.

Option 1:  ETF approach – net return is 5.5 per cent (6.0 per cent less the 0.5 per cent fee). A net return of 5.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $854,072 at the beginning of retirement.  He would have been responsible for all of his choices of ETFs and have no planning advice.  Although costs are low with option 1, there is a high degree of involvement to determine timing of when to buy the ETF and which ones to buy.

Option 2:  Direct Holdings in Fee-Based Account – net return is 4.5 per cent (6.0 per cent less the 1.5 per cent fee). A net return of 4.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $776,485 at the beginning of retirement.  The additional cost of investing over option 1 would more than likely be offset by higher returns with a good advisor.  A knowledgeable advisor is also able to provide you financial planning tips, and service that enables you to do other things in retirement.

Option 3:  Holding a Basket of Mutual Funds – net return is 3.5 per cent (6.0 per cent less the 2.5 per cent fee). A net return of 3.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $705,299 at the beginning of retirement.

Option 4:  Holding a Basket of Segregated Funds – net return is 2.5 per cent (6.0 per cent less 3.5 per cent fee). A net return of 2.5 per cent compounded over ten years would have grown Mr. Lee’s $500,000 RRSP to $640,042 at the beginning of retirement.

The above illustrates a one per cent change in the cost of investing for each option – it clearly shows how these small changes can have a material impact on your long term financial success.  The same exercise can be done assuming different percentage returns (i.e. four, five, six, and seven).