Evaluating Your Financial Advisor

Ultimately everyone is responsible for their own financial well-being.  If you are one of the many individuals who choose not to take an active role in their finances for lack of time or interest, it’s important to acquire enough knowledge to determine whether the advisor you have entrusted is doing – at a very minimum – an acceptable job.

Many investors work with one or more of the following:  investment advisor, stockbroker, financial planner, mutual fund agent, or insurance agent.  Other individuals may have investment accounts with a chartered bank, credit union, or trust company.  Regardless of the advisors that are handling your investments, it is important to periodically evaluate the service you’re receiving and the performance of your investments.  Many people are unaware of the services that some investment advisors provide outside of investment selection.


How do you monitor the performance of your investments?  Unfortunately the tide of the market often affects investors’ opinions of their advisor.  One of the most widely used equity indices in Canada is the S&P/TSX Composite Index.  The Dow Jones, Nasdaq, and S&P 500 are also popular U.S. indices.

The single biggest factor that determines investment returns is asset allocation (percentage of cash, fixed income and equities).  The most common type of equity is common stock.  Stocks are exposed to the fluctuations in the indices noted above.  Fixed income investments such as guaranteed investment certificates, or bonds often provide investors with more assurance regarding the return of their capital and the income that they will be receiving.  Each investor should decide how much risk they are willing to take.

Risk Assessment

Do you have an idea of how your portfolio is structured from a risk standpoint?  What is your percentage of cash, fixed income and equities?  What is the quality of your equities?  Let’s look at an illustration of a typical investor with $200,000 and an asset mix of 30 per cent cash/fixed income and 70 per cent Canadian equities.  If we know that the fixed income investments earned four per cent last year then we can easily calculate that portion to be $2,400 ($200,000 x .30 x .04).  For 2005 the S&P / TSX Composite Index returned 24.13 per cent.  Provided the investor had investments that were similar to those in the index, the equity return would be $33,782 ($200,000 x .70 x .2413).  As a reasonability test, the combined portfolio should have earned approximately of $36,182 (18.09 per cent) less commissions and/or fees.

Using the same information from above, an investor with 100% guaranteed investment certificates earning four percent should not expect to earn more than four percent.  Investors that have taken the risk and have 100 per cent equities should have seen some reward last year for the risk they have taken.  Certainly some foreign markets did not fair as well as Canadian markets in 2005 and should be factored in if a portion of your equities were outside of Canada.  Individuals will also need to look at their individual equities to see the risk profile of their portfolio.

Other Services

A characteristic that should be admired in financial advisors today is the ability to communicate effectively and provide services beyond basic trade execution.  An advisor should have the expertise to deal with an increasingly complex financial and regulatory system.  The value added component is when your advisor is able to identify issues that should be proactively addressed.  Unless you speak with your advisor about issues that arise it may be difficult for your advisor to be proactive in providing you the best advice.  In many cases your financial advisor may not have the expertise to assist in all questions; however, they should have the knowledge to guide you in the right direction.

Over the 2005 fiscal year, did your financial advisor:

  • Review your plan at least once to ensure that the overall strategy is on track?
  • Discuss your asset mix to see if you were still comfortable with the amount of risk you were taking?
  • Incorporate any new personal information into your financial plan?
  • Provide you with regular updates on how your investment portfolio is performing?
  • Make themselves available to answer all of your questions or address your concerns?
  • Provide you with information to complete your taxes?

Over the 2005 fiscal year, did you:

  • Review the investment recommendations provided by your financial advisor?
  • Keep your financial advisor up-to-date on any changes to your personal situation?
  • Notify them when you could not be contacted (i.e. holidays)?
  • Review the performance of your investments?
  • Review your asset mix and discuss any concerns with your advisor?

Investors should periodically look at their asset allocation and returns over a period of time.  If you compare this information to the appropriate benchmark indices then you will be able to monitor the relative performance of your financial advisor.   We encourage those investors that have not spoken with their advisor recently to book a meeting to review their accounts.  Taking an active part in your finances may be one of the smartest investment decisions you will make.

Diversification a key component

The words diversification and investments go hand-in-hand.  The term diversification generally refers to owning a number of different investments.  Investors should generally diversify by asset class, sector, geography and capitalization.   Some investors may feel they are diversifying their holdings by having investment accounts at several financial institutions.

In our opinion, diversifying between financial institutions is not necessary.  The following are a few benefits of consolidating your investments with one advisor:

Asset Mix

The most important component of investment performance is asset mix.  Consolidation can help you manage your asset mix and ensure that you have not duplicated your holdings and are therefore, not overexposed in one sector.   Unless your financial advisors have been given a copy of all of your investment portfolios, it will be difficult for them to get a clear picture of your total holdings.  Even if you were able to periodically provide a summary of each account to each advisor, as transactions occur you would still need to update every advisor with those changes.


Most firms provide access to view your investments online.  If you have accounts at different institutions, then you will need to get online access from each. It is unlikely that you will be able to transfer funds between these institutions online.

Tax Receipts

If you hold non-registered investment accounts at several institutions, you will receive multiple tax receipts.  By consolidating your accounts, you will receive a limited number of reporting slips for income tax each year.  Reducing the number of tax receipts may also reduce the amount of time your accountant will spend completing your tax return.

Managing Cash Flow

Projected income reports from different institutions will be presented in various formats and at different points in time.  For you to obtain a complete picture of your financial situation, you will have to manually calculate the total income from your investments.  In situations where you have instructed your financial institution to pay income directly from an investment account to your banking account, it becomes more complicated to manage when there are multiple investment accounts.

Estate Planning

A couple of weeks ago we highlighted the benefits of registering your physical share certificates in a nominee account.  Another helpful estate planning measure is to reduce the number of investment accounts and bank accounts.  Having your investments in one location will certainly simplify estate planning and the administration of your estate.

Monitoring Performance

Some investors may be comparing the performance of one firm/advisor to another.  Investors should be careful when doing this to ensure they are really comparing apples to apples.  One investment account may have GICs while another may have 100% equities, in which case we would expect the returns to be different.  It is easier to understand how all of your investments are performing when you receive a consolidated report.

Conversion of Accounts

If you have multiple RRSP accounts and are turning 69 next year you may want to consider consolidating now and discussing your income needs with an advisor that you trust.

Account Types

Fee-based accounts are usually suitable for a household that has total investment assets of $100,000 or more at one institution.  Consolidating allows these types of accounts to be an additional option.  As your account value grows, the fees as a percentage may decline in a fee based or managed account.

Other Benefits

When individuals have all of their registered and non-registered investments in one location an advisor may be able to fund RRSP contributions through in-kind contributions.  Your advisor may also be able to swap investments between accounts to improve the overall structure from a cash flow and tax efficiency standpoint.

Building Relationships

Building trust between advisors and their clients goes both ways.  Clients want their advisor to have the expertise and ethics to do what is in their best interest.  Advisors want to be able to trust their clients and ensure that the effort they are dedicating is appreciated.

As you’re looking through all your individual account statements you may want to give some thought to the level of service you’re currently receiving.  If you are happy with one of your advisors, the best compliment you can give is to consolidate your investment accounts with them and this will provide you with all the benefits described above.

Due Diligence of Mutual Funds

Publicly offered mutual funds are required to file a prospectus that provides full, true and plain disclosure.  Most of the time, investors are sent the prospectus by regular mail after purchasing units/shares of a fund.  How many people actually read it?  Most rely on their advisor to summarize the main points of the fund.  It is always possible to get a copy of the prospectus prior to investing.

We understand that most investors do not have the time or interest to read through a lengthy prospectus.  After all, the reason they have hired an advisor is to do that homework for them.  Whether or not you read the prospectus yourself, or rely on your advisor, we recommend that you are comfortable answering the following questions: 1) What are the investment objectives? 2) What is the investment strategy? 3) What are the investment restrictions? 4) Who is the manager? and 5) What are the fees and expenses?

Investment Objectives:  A mutual fund’s investment objectives provide investors with information regarding the funds goals and how it intends to achieve them.  Typical types of objectives are growth (primarily stocks), income (primarily bonds and more recently income trusts) and balanced (combination of stocks and bonds).  The investment objectives may also provide information on the types of investments the fund is allowed or prohibited from holding.  Within these objectives an investor should be able to obtain a feel for the risk/reward nature of the investment.  Most importantly, investors should ensure that the fund being purchased is suitable for their overall portfolio.

Investment Strategy:  The investment strategy or style is important because different management styles tend to perform better in certain markets.  Typical types of styles are value, growth, sector rotation, blend, top-down, bottom-up and combination.  A planned approach may consider a blend of management styles as a component to overall portfolio structure.

Investment Restrictions:  Certain mutual funds provide restrictions on the types of investments.  As an example, Socially Responsible/Ethical Funds may restrict the purchase of certain companies.  Another example of an investment restriction may deal with the minimum investment grade of bonds in an Income Fund.  Many mutual funds may also have clauses such as no one position will exceed 10 per cent weighting within the portfolio.  When purchasing a mutual fund it is also useful to know if there is a mandatory holding period.

The Manager:  One of the most important components to selecting a mutual fund is the portfolio management team.  Most managers provide information to investors regarding their management style and philosophy.  When a member of the management team changes, it is important to assess the experience, style and investment philosophy of the new manager.  A change in management warrants careful consideration and may result in a decision to sell the fund.

Fees and Expenses:  Most prospectuses have a section that is titled “Fees and Expenses” that outlines the initial fees and expenses to set up the fund.  This section will also list the annual fees that are paid to the manager and the ongoing expenses of the fund.  The last part of this section normally outlines the service fees that are paid to the investment firm that has custody of the investment, a portion of which is generally paid to the advisor that works for that firm.  The annual fees and the service fees are commonly referred to as the Management Expense Ratio (MER).

In our next column we will highlight the newest development in the mutual fund industry – F Class Funds.

Building plan keeps investors on track

Imagine building a house without a set of plans.  How would that house look if you randomly selected flooring, furniture and window coverings without regard to how they would look together?  It certainly can be done, but we all know that when building or decorating a home, it is best to follow a plan.  Once a plan is put in place, the results can be spectacular!

Too often investors select investments without consideration given to the other investments within their portfolio.  Does purchasing that one additional investment increase or reduce the risk to the investment portfolio?  Does it increase the return potential or reduce it?  Does it compliment the other investments?

The financial equivalent to a blueprint for building a home is an Investment Policy Statement (IPS).  Ideally an IPS should be laid out in advance of the portfolio’s construction, however, an IPS can be done at any time – call it a renovation if done after the fact.  Developing an IPS normally begins with the investment advisor asking their client to answer a series of questions.  The investment advisor should review the answers to these questions with the investor and clarify any inconsistencies.  The responses to these questions, along with notes made during preliminary discussions, are the foundation to an IPS.

An IPS is part of a disciplined approach that attempts to remove some of the “emotional component” of investing.  Uncertainty about the markets, fear of losing your money, and confusion as to what is the best course of action during volatile market times can cause investors to abandon the plan.  Sticking to the IPS during difficult times is a critical part.  As we all know, we cannot individually control the market, however, we can control how we react to it. An IPS can help manage those bumpy times.

An important component of those discussions should focus on risk tolerance.  The easiest way to look at risk tolerance is by the percentage of equities in the account.  An investor who is risk averse would have a lower percentage of equities.   Investors that do not want to incur risk should have a larger component of investments such as GICs, treasury bills, and investment grade bonds (often referred to as fixed income).   As fixed income investments are not as volatile as equities, they are a key component for those seeking low risk investments and have capital preservation as a primary investment objective.  Most investors desire total returns greater than those currently offered by fixed income.  As a result, risk tolerant investors are willing to hold some component of equities.

As every investor reacts differently to volatility, it is finding that balance (also known as Asset Mix) that the investor is comfortable with.  Investors that do not assume some risk may feel they are missing out on potential opportunities, and investors that feel they are taking on too much risk may be continually worrying about their investments.

So, what are the typical characteristics of the risk-tolerant and risk-averse investor?  Typical characteristics of risk-tolerant investors are:  longer time horizon, high annual income, high net-worth, and multiple sources of income.   The typical investor who is risk-averse, would have the following characteristics:  shorter time horizon, no longer in the work force/approaching retirement, fixed income, low to moderate net-worth, and limited sources of income.

The above general rules certainly do not apply to everyone, this is the reason a customized IPS is necessary for each investor.  The most risk-tolerant investor may intentionally overweight equities while the most risk-averse investor may deliberately select mainly fixed income.  However, most investors fall somewhere in between.

Determining the balance of cash, fixed income and equities is ultimately the decision of the investor.  An advisor has several tools in which to assist their client in making this decision.  An IPS is not set in stone – changes may occur with time, life changing events and investment experience.  Some advisors may recommend increasing or decreasing the fixed income component during certain economic cycles.

One rule of thumb that is used by some investment advisors is that the fixed income component should be reflective of your age.  A 20 year-old investor should have 20% fixed income where an 80 year-old investor should have 80% fixed income.   This method of determining the asset mix is overly simplistic but it does illustrate the trend of having a larger fixed income component as an investor gets older.

As it takes time to build a house, it takes time and patience to build an investment portfolio.  Once built it still requires maintenance.  The IPS is a plan, not an immediate reflection of how the portfolio will look on day one.

After reading this article, we hope investors will try to locate their written Investment Policy Statement.  If they have one, they should ensure they are using it and that it is up to date.  If they do not have one then statistics state they are among the majority of investors without a plan.  We also hope those investors without an IPS will meet with their investment advisor to discuss the benefits of an Investment Policy Statement.

Riding out of a perfect financial storm

October can be a scary time – especially when it comes to stock markets and money.  Historically, the month of changing leaves, carved pumpkins and Halloween has not always treated investors with sweet rewards.

In fact, this past October represented the third-worst point decline in the TSX Composite Index over the past 30 years.  Only the Octobers of 1987 and 2000 were worse.  Black Tuesday – October 29, 1929 – remains one of the scariest days in market history.  Black Monday, the worst one-day decline the world has ever known, is more recent, occurring on October 19, 1987.  Even more recent has been the decline in the Nasdaq Composite, largely comprised of dot-com and technology stocks.  During a painful, 19-month decline the Nasdaq fell 78 per cent off its high of 5,046.86 to 1,114.11 on October 9, 2002.

Did We Have Any Warning?

The crash in October 29, 1929 had some warning signs.  Increased volatility earlier in the year, economic indicators pointed towards a slowdown in May and June, and export earnings had declined – all giving an indication that the economy could be heading towards a recession.  It all led to the Great Depression.  The crash on 1987 caught investors more by surprise.  Most investors who stayed the course saw the value of their portfolio come back to pre-crash values in relatively short order.

Crash vs Healthy Correction

Nothing goes up forever.  After a strong performance over the beginning part of this year, it was reasonable to expect some sort of pullback at some stage.  These pullbacks are, for the most part, viewed as a healthy component to the stock market.  Crashes are few and far between.  Certainly extended bear markets can give the same end result of a crash, the difference being that they provide more time for decision making.

The Perfect Storm

October 2005 shouldn’t be a complete surprise.  As we approached this October we were in many ways entering the perfect storm – inflation concerns increasing, interest rates rising, Canadian dollar trading in high range against the U.S. dollar, an unusually strong summer, rising energy costs, decreased corporate earnings forecasts, and continued uncertainty regarding the taxation of trusts.  Not to mention the natural storms/disasters that have occurred in recent months and concerns over the avian flu.  It was reasonable to expect a healthy correction was coming.

The Skinny on Income Trusts

The markets had some pretty drastic declines this past October, which especially impacted income trusts.  The tax-efficient equity investments generally offer a higher yield (monthly distribution) to unitholders than the average common stock (dividends).  The main attraction of holding income trusts is to receive the regular cash distribution payment that in many cases is treated favourable for tax purposes.

The ability for the trust to pay out distributions on a sustainable basis is a function of the success of its underlying business.  Income trusts are more similar to common stocks than fixed income securities as there are no guarantees surrounding the distribution or the principal, nor are there set maturity dates.  There is a wide variety of underlying businesses that income trusts are based upon including power distribution facilities, real estate properties, pipelines, restaurants, advertising and resource-based operations.

The primary benefit of investing in income trusts is the ability to fulfill income objectives. The majority of investment returns tend to be generated by the distribution stream while total returns may be enhanced or hindered by capital appreciation or depreciation of unit prices.  Over the past few years in an environment of declining interest rates and equity market volatility, there has been strong investor demand for investment income, which has led to higher income trust prices.

Some of the risks associated with investing in income trusts:

  • The viability of the business to continue operations.  On September 26, 2005 the CFO of Heating Oil Partners Income Fund issued a press release announcing the Chapter 11 filing.  In this press release, they cautioned that it is unlikely that unitholders will receive any consideration after the restructuring.
  • Distribution levels are not guaranteed.  On October 18, 2005, a press release from Clearwater Seafoods Income Fund announced a reduction in annualized distributions for 2005, suspending monthly cash distributions for the remainder of the year.  Clearwater’s unit price was punished severely immediately following this release.
  • Unit price volatility primarily due do changes in supply and demand and the relative illiquidity of certain income trusts.
  • Income trusts are interest sensitive.  Changes in the level of interest rates can have a significant effect on trust units.  As interest rates increase the demand for income trusts should decline as investors can obtain yield elsewhere.
  • Currency risk for those income trusts operating south of the border.
  • Uncertainty regarding Government policy on trust taxation.

We believe that the relative weakness in business trusts can be attributed primarily to the uncertainty regarding possible changes in the Ottawa’s policy on trust taxation, as well as increased concern about higher interest rates. The lack of trading volume of some trusts may also result in greater price volatility.  Some of this uncertainty should be reduced after the Ottawa releases the results of the consultation process which is expected to be completed by December 30, 2005.  The government also announced at the end of September that it will immediately postpone providing advance income tax rulings on flow-through entities (income trusts and limited partnerships) until the consultation process is complete.

Where Is The Treat This October?

As with everything in life, it’s how you look at things.  A healthy correction can be a treat.  Unless you need the cash in the near term, these pullbacks or “healthy corrections” can be a positive thing, especially if you have cash on the sidelines.  If you have cash, this is likely what you were anticipating may happen.  Unfortunately, stocks seem to be the one thing that investors are reluctant to purchase when they go on sale.  For investors with a long-term time horizon, greater than 10 years, look at the pullback as a part of equity investing and a positive opportunity.  Signs of slowing economic growth, rising inflation, rising Bank of Canada overnight lending rates, rising long-term bond yields, as well as uncertainty regarding the taxation of income trusts suggests that the market trajectory remains downwards for the remainder of 2005 in our opinion.  This is a good time to look at asset allocation, clean up the weaker names, focus on quality and value.