Author: Transcend

Trends: Riding investment waves

Trends come and go in every aspect of life, including the markets. Trends spike media attention and huge amounts of public interest– everyone looking for a get rich quick solution. Now in vogue is marijuana and cryptocurrencies. Wanting to be part of this, or other trends, is fine but here are some pointers to keep in mind while trying to ride the wave.

The greater fool principal

Essentially, this means buying into something risky and uncertain with the hope that down the road, it will sell it at a higher cost than it was purchased for to a greater fool. This is the case for cryptocurrencies, like Bitcoin. No one is intending to hold onto it, rather to buy it up and then sell it off when its market valuation shows greater worth. It is more of a game of timing than it is an investment strategy.

Sky high valuations

Trendy investments tend to carry huge valuations that do not always make sense. Take marijuana stocks, in Canada the value of shares are huge, especially for companies who have yet to turn a profit. The attention, rather than the value, is what is driving up stock price in what can easily be an artificial market.

Pushing the boundaries affordability

 When a share is hot, the price is high and the media is talking about it, it creates a perfect storm of temptation for an investor to buy quickly. The issue with this is that many investors end up pushing their traditional boundaries of what they consider affordable because they want to get in the game at any cost. The result, dangerously, is often extremely overpriced eggs in one flimsy basket.

There is success in boring

There is a reason patience and diversification seem to always win in the investment field. There is no instant solution to getting rich and if there is, it probably lacks longevity. There is value in getting rich slowly and steadily, that may just win the financial race.

Want to learn more? Check out or perspectives section (link) where we dig deeper into the markets on a monthly basis.

The Times Are Changing

As the old ways melt away it is time to establish your place and thrive in the new world. Pretty much everything affecting the process of providing financial advice is changing: regulations, products, technologies and business models. Advisors should not ask themselves “how will I operate going forward?”, but “how can I position myself to excel in the future?” There is no way to have absolute clarity about how things will evolve, but there are several big picture items that advisors can begin to prepare to deal with.

Just Learn to Love Technology

Obviously technology is changing our world, but the tech revolution should not paralyze advisors. With new fintech firms popping up daily or the latest “shattering” announcement that yet more robo advisors are being unleashed on the country, the proper response is likely to let out another yawn. The hype seldom lives up to the promise.

Seldom does a new technology or app rock the world on day one, but over time and with gradual improvements and adoption, the future starts creeping into the now. So take a deep breath and accept that this part of your job going forward will be changing. This means the sooner advisors adapt, the sooner they will be able to differentiate themselves from their competition. If an advisor does not have the necessary skills to leap the divide, outsource to someone who does. With the fast pace of change in the industry, what were once core competencies may soon be reduced to run of-the-mill functions. Get in front of the curve, while the getting is still possible.

Invent a New Value Proposition

Truth be told there are a lot of advisors who can do what you do. In the past, it was all about selling products, now it is about portfolios and financial plans. Technology creep will continually intrude upon the service advisors offer, so much so that it will be the unique elements of human interaction that will allow advisors to shine.

Rudimentary onboarding processes are in need of a major upgrade. The softer side of the client interaction will have to dominate going forward by creating customized solutions for each client that extends well belong asset mix and fund selection. Client behavior is greatly influenced by the daily bombardment of news, opinions and whimsy, allowing fear and doubt to adversely affect their portfolios results. Given that most clients have limited understanding of the investment world, advisors are presented with a great opportunity to teach clients how to behave as good, long-term investors for years to come.

Refine the Client Experience

Many advisors are their own business and it is their technical strengths that allow them to prosper. When they add great customer service, clients feel pampered. But will this be enough going forward? Increased disclosure is upending the status quo, particularly with fees where compression and cannibalization are gouging profits.

So maybe it is time to evolve and incorporate alternative fee structures that respond to client preferences and rationalize the way advisors and wealth managers get paid for their services, such as “success” based fees i.e. fees directly tied to client results . Whether it be performance, tax savings or simply a shoulder to cry on (after all a lot of psychiatrists get paid quite a lot for doing little more), aligning fees to a specific service or outcome will set you apart. Clients want options and to feel connected. Advisors need to tailor their services to create a human connection that the “robots” and giant players cannot reproduce.

Not every client wants the same thing so having a suite of solutions that are different or tailored to deliver the most robust results is paramount. In many ways it will come down to evolve or perish. So take time from your busy day; turn off the computer and stare into the future. Change is coming for you!

The financial planning industry is coming under increasing scrutiny these days. On the regulatory front, the Ontario government has announced plans to develop legislation that would regulate financial planners in Ontario. Under the proposed framework financial planners would be required to meet specified proficiency requirements. Additionally, the government indicated that it will take steps to reduce consumer confusion created by the wide variety of titles used in the financial services industry by restricting the use of titles related to financial planning.

While a start, there are calls from some consumer groups to more clearly separate product sales from advice. What people really need to get from a planner is an answer to the question, am I on track? Planners should focus on getting to know their clients and helping them to simplify, declutter and remove their financial anxiety. Investment managers are qualified to keep clients up to date on portfolio returns but returns are only part of the picture. How many people, irrespective of income or net worth, genuinely know if they are on track to achieving their goals? This is where financial planning specialists can really help. Advising on products and investments is not financial planning. Investment advice should follow a properly developed financial plan. Financial planners should help clients to understand that financial products and investments are tools that only need to be used if required. Proper financial planners should only use products to help implement certain strategies. With that approach consumers will finally come to understand what proper financial planning really is and how they can benefit.

The investment industry’s main focus has traditionally been to gather assets and build assets under management (AUM). Historically financial advisers have been money managers. This model has been in place for decades although there has been a shift from transactional fees to fee based accounts. When advisers meet and swap notes, one of the first questions asked is, “how much do you have in AUM?”. There certainly is a client need for some basic services at low, and perhaps subsidized, prices but at the higher end, professionals should adhere to certain standards such as providing disclosures concerning their relationship with clients. If the consumer wants to be transactional in their relationship this should also be clear to them. The legal profession receives fees for service and they have nothing to sell other than advice. Could the financial planning industry survive without product? Until the value is seen as being for advice and strategy, advisers will continue to sell products.

Regardless of the business model, financial professionals of all types need to be clear on who their optimal client is, what their client experience will be, how they are structured to support this experience and how they manage to do it profitability. They need to answer the key strategic questions around why they exist in financial services, regardless of which regulatory structure they operate under. As the financial industry continues to evolve, more advisers are likely to view themselves as financial planning professionals and not product distribution outlets.

What clients should look for in a Financial Planner :

  • They have studied financial planning to a high level,
  • They are keeping current with the latest trends in the industry,
  • They will tell you what you need to hear, not what you want to hear,
  • They will not receive financial remuneration for any products they recommend and, most important of all,
  • They will act in your best interests at all times.

 

Enshrining the term ‘financial planner’ is a step in the right direction. In most jurisdictions these days anyone can call themselves a financial planner, whether they are licenced or not. In conjunction with the proposed Ontario legislation the media and public will need to be educated to understand that there are qualified and ethical financial planners, many of whom are CFPs, in the financial industry. There are many compelling reasons to seek financial planning advice, not only as a oneoff, but ongoing, however few people do. If the planning industry doesn’t change, then the interest of ordinary people utilizing the industry’s services won’t change either. People will handle life’s financial challenges the way they have always done it for the most part, without financial planners. There are many very good financial planners and there is great advice provided to clients but it needs to be complimented by a product sale or by building up assets to enable the adviser to be remunerated. Going forward, consumers need to be better educated about the need to stay on track with a plan and be willing to pay for it. There needs to be a clear separation of advice from product if the financial planning industry is to become a true profession. While it may be a long way off it seems likely that this overdue separation is coming.

The fiduciary standard is getting a lot of attention in the United States once again as the Department of Labour’s rule requiring advisors to act in the best interests of their clients was denied by an appeals court. The most interesting aspect of the debate on these standards is not whether a fiduciary standard will ever be applied, but the increase in public awareness for this issue. As more retail investors become aware of the different standards, it is important for you to be prepared to answer the inevitable question: Are you a fiduciary?

Many investors assume financial advisers have a duty to act in their best interests yet that is not necessarily true. The requirement in Ontario, for example, is to act “fairly, honestly and in good faith” which is known as the duty-of-care model.

The fiduciary standard is much stricter than the “suitability standard” that applies to brokers, insurance agents, and other financial professionals. The suitability standard only requires that as long as an investment objective meets a client’s needs and objectives, it is appropriate to recommend to clients. A Fiduciary duty is a commitment put the clients’ best interest first.

Canadian regulators have been reluctant to move to an industry-wide fiduciary standard partly because some of the new standards being proposed in other countries have been in place in Canada for some time. The existing duties and obligations imposed on investment professionals, together with the rules developed through the CRM project, provide investors with significant safeguards in their financial dealings with registered investment professionals. As it stands, the only Canadian financial professionals who are under fiduciary obligations to act in the best interests of clients are those registered as portfolio managers with discretionary authority over their clients’ accounts.

This lack of uniformity can create a fundamental misunderstanding between the expectations of investors regarding the duty that is owed to them by their financial advisors. If nothing else, the fiduciary duty debate has increased public awareness. Now, more than ever, prospects are questioning not only the qualifications of advisors, but also how they are compensated as well as their philosophy on how they run their practice. A prospect wants to know if you are truly serving their needs or are you pushing products.

Fiduciaries are different from other financial advisors structurally, philosophically and legally. Due to the extensive requirements it takes to become a Portfolio Manager (including qualifications and experience) it is unrealistic for most advisors to get registered as such. So the reality is that most advisors cannot say they are bound by fiduciary standards. Yet there is a way to address this which would give your clients peace of mind. Advisors who outsource portfolio management and compliance responsibilities to a discretionary Portfolio Manager like Provisus can assure their clients that they are being cared for by money managers with a fiduciary responsibility to act in their best intrest.

 

Canadian securities regulations place different standards of care upon financial advisors depending on how they act on behalf of their clients. Currently there is no single standard that applies to all advisors. Advisors fall under these two registration categories on the Canadian Securities Administrator’s national registry search:

  • Dealing Representative – This category includes virtually all InvestmentéFinancial Advisors. Regulations only require them to ensure that investments they recommend are suitable for their clients.
  • Advising Representative – Held to a fiduciary standard.

 

Established in 1979, the Beutel Goodman Private Client Group extends the concept of value-oriented investing to individuals, estates, trusts, private holding companies and foundations. Through active portfolio management, and by drawing upon the collective strengths and resources of the overall firm, it is uniquely positioned to achieve personal investment objectives. It has customized the value principles of the firm to meet the needs of its private clients, recognizing that each client has individual financial needs, investment parameters and service expectations. Today, the Beutel Goodman Private Client Group manages assets of $1.0 billion and benefits from being affiliated with one of Canada’s largest and most successful pension fund managers with over $35 billion in assets under management.

In terms of International equities, Beutel has noted that global equity markets rallied strongly in 2017 and reached multi-year highs across many countries. Surprisingly synchronized global economic growth was the key reason behind the strong market movements. While no major economies are expected to grow at a particularly fast speed, all of them continue to show positive signs of improving growth momentum. In the U.S., the much anticipated tax reform seems within reach and may further strengthen business and investment confidence.

Throughout 2017, valuations have moved up as markets climbed to new records. Beutel’s valuation discipline and investment process prompted them to trim or exit positions as they achieved strong returns and reached their upside potential. In the meantime, they are finding great opportunities and have added a good number of high quality businesses into the portfolio. 2017 certainly saw market enthusiasm in some new technology areas such as artificial intelligence, self-driving/electric vehicles and cryptocurrencies, to name a few. The frenzy in those areas also led to a market rotation out of some strong, wellestablished (but “boring”) businesses and offered opportunities to invest into those highly cashgenerative operations at unusually low valuations.

Stock Sectors After Rate Hikes

Last year the Bank of Canada (BOC) implemented its first interest rate hike since 2010 and many investors reached for their crystal balls to try and forecast the future. While rising rates tend to signal stronger economic conditions and inflationary pressures, they can also have a meaningful impact on stock market sector returns. Changing the overnight interest rate, which is the cost that depository institutions pay to borrow money, is how the BOC attempts to control inflation. When the BOC increases the overnight rate, it does not directly affect the stock market but it does have a ripple effect that can rock the market. However some sectors benefit from interest rate hikes and others do not.

transcend-december

A review of equity performance following previous BOC tightening cycles over the past 20 years shows that in five of the past six periods of hiking overnight interest rates; October 1997, November 1999, May 2002, October 2004 and June 2010 (July 2017 excluded), there was some deviation from normal results which provided excellent opportunities but there are grounds for concern. The conventional way of thinking is that cyclical sectors like Industrials, Materials, Energy, Information Technology and Financials do well in a rising interest rate environment. A healthy economy has more investment activity, increased profit margins for financial entities, improved employment and a healthy housing market; all of which allow consumers to splurge. Meanwhile, defensive sectors like Utilities, Telecom, Consumer Staples and Healthcare (which tend to be proxies for bonds and do poorly as interest rates climb) generally show weaker results when the world’s central banks take away the cookie jar.

At times Canada dances to a different beat and over the past 20 years our stocks have for the most part have done the opposite of what economic theory would forecast. Perhaps it is a weak Canadian dollar, the near term glut in crude oil or weak commodity prices, but whatever the cause, the unexpected has occurred. The chart on the right shows the net difference between the average annual calendar returns for the 10 Canadian stock sectors since 1998 relative to the average 12 month return for the same sectors after the BOC implemented its first rate hike. The data to the left shows the individual averages for both occurrences.

These performance numbers do not include the impact of dividends. These five sectors: Energy; Consumer Staples; Financials; Telecom and Utilities, have outperformed their long term averages after interest rates started rising, leaving the other five; Materials, Consumer Discretionary, Health Care, Industrials and Information Technology lagging. The degree of variance in some cases is quite glaring and the reverse of what was expectedValue stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

 

While a rising interest rate environment may not be detrimental to equity market returns in general, historically there have been clear winners and losers. Canadian investors who invest in our very unique stock market have been doing things differently for quite some time as conventional wisdom (at least with regard to domestic rate hikes) is thrown out the window. Perhaps rather than focusing on our own situation, many Canadians may be overly fixated on what is happening elsewhere; say to the south of us perhaps

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Five Investment Mistakes

This month we look at some of the common investment mistakes made by DIY investors. Some are new, but most are not. Here are some traps to avoid:

  1. Don’t think “Invest big or not at all”

    While it is great to be able to invest a large amount at once, this is not always feasible and this should not be a deterrent. Investing what is possible early on may not yield big returns, it will start building a portfolio. Start early. As income increases, so will your investments.

  2. Don’t rely on past performance

    Past performance is no guarantee that an investment will continue with the same trajectory. Evaluate each investment individually and understand how it fits into your overall portfolio.

  3. Don’t focus on looking only for the next Apple or Amazon

    Everyone wants to be the first to discover the next big thing. The truth is, there is no quick fix for investment success. It is nearly impossible to identify the next huge stock so don’t get preoccupied with this task. Investing for the long-term and practicing patience will almost always provide desired results.

  4. Don’t get stuck looking only locally

    Many investors are afraid to invest abroad because of the perceived risk. Yes, there is some risk involved in currency, but global investments is another way to diversify a portfolio and lower risk. All investments bring an inherent level of risk, understanding what best suits your personal situation is the key both locally and globally.

  5. Don’t think higher fees mean better performance

    This is often a myth we tell ourselves to justify high fees but it isn’t always true. If a person pays three per cent fees, the fund would need to generate eight per cent returns to make a five per cent profit. If that fund, on the other hand, underperforms and remains below the benchmark the high fees are now an added cost on top of the loss. Seek a service that ensures excess fees are only charged when the portfolio shows gains – in essence make sure you only pay for performance.

WILL NEW DISCLOSURE RULES LEAD ADVISORS TO ABANDON SEGREGATED FUNDS

It is easy to understand why Segregated Funds are a favourite investment vehicle for many financial planners. They have a great market-ing gimmick, a rosy benefits story making them an easy sell, the payout to advisors is great, and currently they do not fall under transpar-ency rules like mutual funds with the Customer Relation-ship Model (CRM). Strate-gic Insight data shows that Seg Fund assets increased from $110.7 billion to $116.8 billion between June 2016 and June 2017. If we look at these products ob-jectively they do have some theoretically appealing fea-tures for certain clients, but many clients would be bet-ter served in other invest-ment vehicles. Now that the Canadian Council of Insur-ance Regulators (CCIR) is recommending greater transparency will Seg fund growth continue to be as robust as it has in the past?

This new disclosure frame-work seeks to ensure con-sumers are informed of not only the performance of their segregated funds, but also all of the details of what they cost. As well that disclosure provides a better understanding of this prod-uct. Are you ready for this discussion? Segregated funds are con-sidered to be like mutual funds with an insurance policy wrapper that give investors the following ben-efits:

  • Downside risk protec-tion. Guarantee of capi-tal after ten years and resetting privileges to lock in growth
  • Protection of assets from creditors
  • Guarantee of capital at death
  • Probate protection

All these benefits are priced into Seg funds and with a greater focus on costs through the pro-posed disclosure rules clients are going to want answers. The Manage-ment Expense Ratios (MERs) of Seg Funds tend to be higher than mutual funds to cover the cost of the insurance fea-tures. The fund filter on Globeinvestor.com shows that the management ex-pense ratio for the 20 most widely available Canadian Equity Seg Funds range from 2.57 per cent to 3.25 per cent. MERs for the 20 largest Canadian equity mutual funds run from 2.05 per cent to 2.39 per cent. In order to deter-mine if the benefits are worth the extra cost let’s examine these features.The Canadian Council of Insurance Regulators recom-mends changes to Seg Fund disclosure rules to bring that information more closely in line with the information clients receive about their mutual fund investments. Specifically, the CCIR outlines a list of information that must be part of the Seg Fund investors’ annual statements, including:

  • all charges for the year, in dollar amounts, with the management expense ratio (MER) broken out to show management fees, distribution costs and insurance costs explicitly;
  • all remuneration paid during the year for the provision of services in connection with the contract; changes in the net asset value of the contract in dollar amount;
  • redemption value; and
  • total personal rate of return, net of charges, calculated using the money weighted method for the last year, three years, five years, ten years and since issue; among various other items.

 

Downside Risk Protection

Salespeople tell clients that Seg Funds are safer than mutual funds because they guarantee a certain amount of its principal to its investors, typically ranging between 75 and 100%, as long as they hold it for a determined period, usually ten years. If the fund value rises, some segregated funds also let you “reset” the guaranteed amount to this higher value (which also resets the length of time that you must hold the fund). This is an investment that has all the upside of mutual funds and no downside because your capital is guaranteed so why wouldn’t everyone buy these funds?

While they are appealing to an investor’s peace of mind, the first problem is that you have to lock your money in because if you cash out before the maturity date, the guarantee won’t apply.

The second issue is that since stock markets have historically risen over the long term, the likelihood of actually needing the guarantee to get your original capital back after 10 years is small. In fact, since 1900, the only two short-lived periods when the S&P 500 was negative over 10 years were the periods ending in the late 1930s following the Great Depression and those ending in 2009 at the lows of the subprime mortgage crisis. So 98% of the time, 10 year returns were positive for U.S. stocks. For Canadian stock markets, since 1960, more than 90% of the time the TSX has returned over 6% over 10 years. And in no 10-year period have TSX returns been negative. Consultants William M. Mercer found there’s a 2% likelihood of losing money in the stock market over ten years.

Protection of Assets From Creditors

Creditor protection is a key benefit for business owners in particular but has also served as a selling feature for individuals as well. The first issue with this is that there is a way to achieve creditor protection without paying a higher fee for your investments. Instead of structuring a business as a sole proprietor or a partnership, small business owners can incorporate or may already be incorporated. Seg funds are based on the market value of a portfolio and as it gets larger, the costs of managing a portfolio for a small corporation (which are mostly fixed), may be more cost effective than the additional cost within the Seg fund for this protection. If a business is big enough that it faces the chance of large losses, or if it is risky enough that there is concern with solvency, then incorporation may be more suitable.

Here is where the proposed disclosure requirements come into play. The more knowledgeable the consumer of Seg Funds is on this point, the more likely creditor protection will not be available. Seg Funds may not be able to provide creditor protection where it can be proved that the purchaser was in financial difficulty ahead of the purchase. Fraudulent conveyance, dependant relief claims, property claims in marriage breakdown as well as CRA claims are instances where creditor protection may be impacted so the feature is not as enticing as it is laid out to be.

Guarantee of Capital at Death
This is a benefit that makes a lot of sense for using Seg Funds…if you think you are about to die and you also think the markets are about to crash.

Probate Fees
Seg Funds have an addi-tional cost to the client of roughly 1% per year which they pay each year they are locked into the product. Probate fees charge a one-time fee of about 1-2%. As such, there is limited value in this feature.

Conclusion
What an investor ends up with in segregated funds is a portfolio with higher than normal fees, marginal per-formance and features they may not really need. There’s a cost for peace of mind but has that cost be-come too high for Seg Funds? As exchange-traded funds and Pay-for-Performance pooled funds gain ground, Segregated Funds must hold their own if they want to carve out a place among the solutions offered to increasingly cost-sensitive investors. Mar-ket trends in the coming years indicate money management costs will be a greater focus. If you currently sell Segregated Funds, it is time to pre-pare for the inevitable disclosure requirements. It may also be time to re-evaluate your options and entertain alternative solutions.

The new disclosure initiative has the potential to create a scenario where creditor protection may be lost and a court can rule that you had set up the Seg Fund to avoid your debts. There are circumstances where the creditor protection may not apply:

  • The Seg Fund must be purchased in good faith. The creditor protection feature could be challenged if the investor purchases the fund knowing that they may eventually face financial difficulties. This falls under fraudulent conveyances provincial legislation.
  • Seg Funds may not provide creditor protection from the Canada Revenue Agency if income tax liabilities are outstanding in a non-bankruptcy situation.
  • Claims under Family Law may take precedence over creditor protection in a court of law to provide for a dependent.

Will new disclosure rules lead advisers to finally abandon segregated funds?

It is easy to understand why segregated funds – investment products similar to a mutual fund with an insurance component that offers certain guarantees – are a favourite investment vehicle for many financial planners. They have a great marketing gimmick, a rosy benefits story that makes them an easy sell, the payout to advisers is great, and currently, they do not fall under transparency rules like mutual funds with the Customer Relationship Model (CRM).

Strategic Insight data show that seg fund assets increased from $110.7-billion to $116.8-billion between June, 2016, and June, 2017. If we look at these products objectively, they do have some theoretically appealing features for certain clients, but many clients would be better served in other investment vehicles. Now that the Canadian Council of Insurance Regulators (CCIR) is recommending greater transparency of industry, will seg fund growth continue to be as robust as it has been in the past?

The CCIR recommends changes to seg fund disclosure rules to bring that information more closely in line with the information clients receive about their mutual fund investments. Specifically, the CCIR outlines a list of information that must be included on seg fund investors’ annual statements, including:

  • All charges for the year, in dollar amounts, with the management expense ratio (MER) broken out to show management fees, distribution costs and insurance costs explicitly;
  • All remuneration paid during the year for the provision of services in connection with the contract;
  • Changes in the net asset value of the contract in dollar amount;
  • Redemption value;
  • Total personal rate of return, net of charges, calculated using the money weighted method for the last year, three years, five years, 10 years and since issue;
  • Various other items.

This new disclosure framework seeks to ensure consumers are informed of not only the performance of their segregated funds, but also all of the details of what they cost. As well, that disclosure provides a better understanding of the product. Financial planners who sell seg funds need to be ready to have this discussion with their clients.

Segregated funds are considered to be like mutual funds with an insurance policy wrapper that give investors the following benefits:

  • Downside risk protection, that is, guarantee of capital after 10 years and resetting privileges to lock in growth;
  • Protection of assets from creditors;
  • Guarantee of capital at death;
  • Probate protection.

All these benefits are priced into seg funds, and with a greater focus on costs through the proposed disclosure rules, clients are going to want answers. The MERs of seg funds tend to be higher than mutual funds to cover the cost of the insurance features. The fund filter on GlobeInvestor.com shows that the management expense ratio for the 20 most-widely available Canadian equity seg funds range from 2.57 per cent to 3.25 per cent. MERs for the 20 largest Canadian equity mutual funds run from 2.05 per cent to 2.39 per cent. In order to determine if the benefits are worth the extra cost, let’s examine these features.

Downside risk protection

Salespeople tell clients that seg funds are safer than mutual funds because they guarantee a certain amount of principal to their investors, typically ranging between 75 and 100 per cent, as long as they hold it for a determined period, usually 10 years. If the fund value rises, some segregated funds also let you “reset” the guaranteed amount to this higher value (which also resets the length of time that you must hold the fund). This is a vehicle that has all the upside of a mutual fund and no downside because your capital is guaranteed, so why wouldn’t everyone buy it?

While they are appealing to an investor’s peace of mind, the first problem is that you have to lock your money in, because if you cash out before the maturity date, the guarantee won’t apply.

The second issue is that since stock markets have historically risen over the long term, the likelihood of actually needing the guarantee to get your original capital back after 10 years is small. In fact, since 1900, the only two short-lived periods when the S&P 500 was negative over 10 years were the periods ending in the late 1930s following the Great Depression and those ending in 2009 at the lows of the subprime mortgage crisis. So 98 per cent of the time, 10-year returns were positive for U.S. stocks.

For Canadian stock markets, since 1960, more than 90 per cent of the time the S&P/TSX composite has returned more than 6 per cent over 10 years. And in no 10-year period have TSX returns been negative.

Protection of assets from creditors

Creditor protection is a key benefit for business owners in particular but has also served as a selling feature for individuals. The first issue with this is that there is a way to achieve creditor protection without paying a higher fee for your investments. Instead of structuring a business as a sole proprietor or a partnership, small business owners can incorporate. If a business is big enough that it faces the chance of large losses, or if it is risky enough that there is concern about solvency, then incorporation may be more suitable.

Also, the new disclosure initiative has the potential to create a scenario where creditor protection may be lost and a court can rule that you had set up the seg fund to avoid your debts. There are circumstances where the creditor protection may not apply:

  • The creditor protection feature could be challenged if the investor purchases the fund knowing that they may eventually face financial difficulties. In other words, the seg fund must be purchased in good faith. This falls under fraudulent conveyances provincial legislation.
  • Seg funds may not provide creditor protection from the Canada Revenue Agency if income tax liabilities are outstanding in a non-bankruptcy situation.
  • Claims under family law may take precedence over creditor protection in a court of law to provide for a dependant.

Here is where the proposed disclosure requirements come into play. The more knowledgeable the consumer of seg funds is on this point, the more likely creditor protection will not be available. Seg funds may not be able to provide creditor protection where it can be proved that the purchaser was in financial difficulty ahead of the purchase.

Fraudulent conveyance, dependant relief claims, property claims in marriage breakdown as well as CRA claims are instances where creditor protection may be affected, so the feature is not as enticing as it is laid out to be.

Guarantee of capital at death

This is a benefit that makes a lot of sense if you think you are about to die and you also think the markets are about to crash.

Probate fees

Seg funds fees are generally an additional charge to clients of roughly 1 per cent per year above a comparative mutual fund. This 1-per-cent additional charge is paid each year they are locked into the product. Probate fees, on the other hand, are a one-time charge of about 1 to 2 per cent. As such, there is limited value in using seg funds as a way to avoid probate fees, since clearly paying a fee once is better than recurring annual charges.

Conclusion

What an investor ends up with in segregated funds is a portfolio with higher-than-normal fees, marginal performance and features they may not really need. The peace of mind of seg funds comes with a cost, but has that cost become too high? As exchange-traded funds and pay-for-performance pooled funds gain ground, segregated funds must hold their own if they want to carve out a place among the solutions offered to increasingly cost-sensitive investors. Market trends in the coming years indicate money management costs will be a greater focus. If you currently sell segregated funds, it is time to prepare for the inevitable disclosure requirements. It may also be time to re-evaluate your options and entertain alternative solutions.

Chris Ambridge is the president of Transcend, a pay-for-performance service delivering sophisticated investment management for a low cost.

Robo-advisor irony is “quite laughable”

Robo-advisors may appeal to the younger generation but most people still want the comfort of a human expert to lead them through the nuances of investing.

That’s the view of Chris Ambridge, president and chief investment officer at Provisus Wealth Management, who agrees it is an “awesome concept” but said firms in Canada face a struggle to make it profitable.

Celebrating our industry successes in the wealth management industry

The sheer size of the market south of the border gives the US a 10-fold advantage, said Ambridge, who claimed the Canadian market is yet to top $2 billion in assets, meaning the pressure is on to grow even faster or increase fees, something that is “counter to the robo psyche”.

He said: “You are seeing a migration in Canada to robo 2.0 where the robos that are in existence are trying to partner or develop referral arrangements with other channels so that the advisor community can refer to the robos, which if you think about it, the irony is quite laughable.

“When the robos came out they wanted to slaughter us and [people] said how terrible advisors are, and now they want to partner with them, realising that you can’t have a business without profits and you can’t have profits unless you get clients, and the only ones who have clients are advisors.”

A recent survey by Young and Thrifty, a website dedicated to personal finance for millennials, revealed that, of the about 400 people asked, 77% preferred robo-advisors to traditional banking, whereas only 3% prefer the latter.

It’s a sign of the allure technology has with younger people but Ambridge, speaking before the results of the survey were known, believes millennial accounts will not help a robo company turn a profit.

“We originally thought [robo] would be very meaningful [to our company] because they were promising the moon, the stars and the sky, but at the end of the day what they are getting is the younger population for the most part; very small accounts.

“As a result, as everyone knows, small accounts are difficult to turn a profit on and a start-up business that’s unprofitable to start with, getting unprofitable accounts can only lead one way, and that’s out of business.”

Ambridge said his firm’s pay-for-performance model represents the lowest fees in the country, including its ETFs, where its rates are below the traditional equity market. He believes robos will eventually be absorbed into other providers and says the majority of investors still prefer human guidance.

“Like most people who are not in the investment industry, they’ve chosen their life and what they want to do – they really don’t want to know everything there is to know about investments and how to make RRSP contributions. They want someone to help them.

“Investment and finance is not something that is easy to pick up or you want to spend a lot of time with, so people need that guidance and the robos simply have not provided it in great leaps and bounds.”

Seg funds targeted

Although insurance advisors may have a more difficult time selling segregated funds as regulators move to harmonize the disclosure regime of seg funds with that of mutual funds, investors will benefit from the shift toward greater transparency.

In December, the Canadian Council of Insurance Regulators (CCIR) published a position paper highlighting the regulators’ new expectations surrounding seg fund-related disclosure and sales practices. The regulatory body’s paper calls for several changes, including new annual disclosure requirements related to seg fund costs and performance, a standard of care for insurance advisors equivalent to the one facing mutual fund advisors, and requiring advisors to follow needs-based sales practices for seg funds.

The proposed framework stems from stakeholder feedback received following a May 2016 CCIR paper that outlined gaps between the regulatory requirements facing mutual funds and those facing seg funds.

“Seg funds have been a laggard in transparency and compliance,” says Chris Ambridge, president of Transcend Private Client Corp., a subsidiary of portfolio management firm Provisus Wealth Management Ltd. (Both firms are based in Toronto.)

The move toward greater transparency is “a good initiative and an improvement over what currently exists,” says Harold Geller, associate with MBC Law Professional Corp. in Ottawa. “Compliance in seg funds is largely non-existent.”

“The insurance industry is in full agreement with greater disclosure if it permits consumers to make informed decisions,” says Lyne Duhaime, president of the Quebec chapter of the Canadian Life and Health Insurance Association Inc.

Mutual funds and seg funds are similar in their investment objectives. But seg funds are sold as insurance contracts and include: a minimum guarantee, usually 75%-100% of invested capital at maturity of the contract, which is at least 10 years from the date of purchase; a guaranteed death benefit that’s not subject to probate; and creditor protection in cases such as bankruptcy and lawsuits.

However, these additional benefits come at a cost. Seg funds’ management expense ratios (MERs) typically are 50 to 150 basis points higher than those of an equivalent mutual fund, according to the CCIR report.

Ambridge contends that the additional benefits of seg funds “are illusionary and, to a large degree, more of a marketing gimmick.” He says the guarantees are not needed in a vast majority of cases because a decline in the value of the underlying investments over a 10-year period is rare.

However, says Raymond Yates, senior partner and financial advisor with Save Right Financial Inc., a managing general agency in Brampton, Ont.: “Most investors see the guarantees and added cost of seg funds as an investment in peace of mind.”

Despite seg funds’ similarities to mutual funds, the former are held to a lower standard of disclosure, the CCIR paper notes. That’s because of the second phase of the client relationship model (CRM2) – a comprehensive set of disclosure rules for compensation and investment returns that applies to mutual funds, but not to seg funds.

The CCIR’s paper recognizes that the differences between mutual funds and seg funds and their distribution models means CRM2 disclosure can’t be applied across the board to seg funds.

The CCIR’s paper recommends that seg funds must provide full cost disclosure annually, including: a breakdown in dollar amounts of the MER to state management fees; distribution costs, such as trailing, front-end and deferred commissions; administrative expenses; and insurance costs. The proposed changes also include requiring an explanation of the costs. These proposed disclosures are more onerous than those required for mutual funds, which are required to disclose distribution costs only.

The CCIR’s paper also recommends that seg funds provide investors annually with a personal total rate of return, net of charges, using a money-weighted method for periods of one year, three years, five years, 10 years and since contract inception.

As well, the paper recommends that seg funds provide seg fund investors with comprehensive details of their insurance contract, including guaranteed redemption amounts at different phases of the contract, any bonuses added to the protected value of the account and information on automatic resets of guarantees.

In addition to product-specific information, the CCIR paper states that the value of sales incentives, such as travel and accommodation paid for intermediaries to attend conferences, must be disclosed to clients.

The CCIR’s paper reiterates that insurers are legally responsible for oversight of their intermediaries, and that those intermediaries must follow needs-based sales practices. The latter process must be documented and copies of the needs analysis and product recommendation documentation must be provided to investors.

The CCIR’s paper states that although anecdotal statements indicate that regulatory arbitrage is taking place in the mutual fund and seg fund industries, no supporting evidence has been found. The paper notes that in order to protect consumers, the CCIR will seek “to proactively amend standards, where appropriate, to ensure that intermediaries have little incentive to prioritize their interests over those of their clients.”

The CCIR’s position paper also recommends that the standard of care for dealing in seg funds should be equivalent to that for mutual funds. Accordingly, the paper urges provincial insurance regulators to consider harmonization with the securities industry of “know your product” and due-diligence requirements for intermediaries.

Regarding the “know your client” (KYC) document required for mutual fund representatives, the CCIR paper concludes that a similar questionnaire is not necessary for insurance intermediaries because the principles of KYC are embodied in the needs-based sales practices required for seg funds.

Although greater disclosure might be good for investors, it will create new challenges for advisors, Yates says: “[This] definitely will have an impact on the sales process, especially if you have to justify your compensation. [It] would not be more difficult, but [would be] more onerous to explain the value you bring to the table.”IE

“Greater disclosure for seg funds definitely will have an impact on the sales process for insurance advisors”

Shifting Importance

Eventually this bull market will break its long winning streak but that does not mean you should be abandoning everything and running for the hills. What it does mean is that you should consider shifting your portfolio’s emphasis. Not all stocks react equally during good and bad times so the secret is to rearrange the deck chairs to ensure smoother sailing.

transcend-december

History never repeats itself exactly but similarities do exist, particularly in the timing of economic events or cycles. These recurring ups and downs in economic activity (or market/business cycles) are made up of several years of peaks, recessions, troughs and eventually a recovery phase. The peak is when business activity has reached its maximum level followed by a slowdown or recession during which business activity reaches its lowest level. The final phase or recovery is when the economy again expands towards maximum output. The movements of the markets are closely linked to the business cycle. Stocks, bonds and commodity prices are heavily influenced by investors’ expectations of the future. Each financial market tends to peak and bottom at different points in the business cycle. An expanding economy is generally favourable for the stock market; a weak economy for bond prices; and an inflationary economy for commodities. The overall stock market tends to lead the general economy with stocks going up before the economy peaks and falling before a recession begins. However, the stock market is made up of companies from many sectors which rotate in and out of favour during the phases of the business cycle. The image below shows a typical market cycle and indicates which sectors tend to outperform the broader market at particular times.

Economic recoveries are often led by consumer spending so the retail sector is considered a leader of the broader stock market. It is usually one of the earliest sectors to peak and also to bottom. The same holds for the banking, housing and construction industries which are heavily influenced by interest rates. As interest rates are cut, demand in these sectors grows, as does their stock price.

The table to the left shows the performance of each sector during and after the tech bubble burst in 2000 and the financial meltdown in 2008. The first column has sector performance during these bear phases and the second is the initial recovery phase. The inverse relationship in this case is striking. Those sectors which performed the worst in the falling market tend to increase the most when the market rebounds. Conversely those that had done well during a falling market returned a relatively flat performance when the market recovered. There is a pattern to these rotations which investors can exploit. The industrial and manufacturing sectors usually follow the movement of retail and construction. As inventories become depleted, demand for more manufacturing and industrial output increases. Because the economic environment and news is often bad at this point, investors tend to be cautious and initially invest in companies with good earnings and cash reserves. As the bull market grows, investors tend to place money into relatively speculative stocks such as technology companies. In the later stages of expansion, when interest rates are rising, the capital goods, basic materials, and energy industries tend to thrive as they expand capacity and bid for increasingly scarce resources.

Value stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Why advisors should brace themselves for CRM3

Advisors had better get used to CRM2 because CRM3 is in the pipeline, according to one industry insider.

The recent Mutual Fund Dealers Association (MFDA) CRM2 compliance report said that a “reasonable” number of its members adhered to the regulations but that there were concerns, including the bundling together of Deferred Sales Commissions and trailing fees, and ambiguous definitions provided to clients about DSCs.

Chris Ambridge, president and chief investment officer at Provisus Wealth Management, said that while, for many, the change has been painful, advisors must accept that this age of regulation is here to stay.

He said: “The industry got away with a lot 20-30 years ago, and I’m not saying they are getting their comeuppance, but they are just being forced to now be held to a world standard. At the same time, change is painful, it’s costly, [but] it’s necessary because there have been a lot of individual clients who have been hurt over the years.”

Celebrating our industry successes in the wealth management industry

Ambridge said that CRM2 was needed because digging up the fees your advisor was earning was difficult. And allowing clients to look under the bonnet at the fee breakdown led to some difficult questions.

Ambridge said: “It’s made it more transparent and it’s given clients the notion that for the first time, I am paying fees and I am paying that amount. Why am I paying my advisor when I see him never and talk to him once every two years and he’s earning this?”

While CRM1 fact sheets disclosed what fund manufacturers were earning and CRM2 laid bare what the advisor earned, Ambridge said CRM3 will bring the two aspects together.

He said: “For an average client out there, well, Jonny is earning this and Jonny’s company’s manufacturer is earning this; they have to dig that out. Why can’t it be in one spot so clients can see what they are truly earning? That’s going to be CRM3 and that’s going to affect seg funds, which are extremely overpaid in terms of fees.

“Now they are going to get the same treatment which I think is going to have a very large effect on a lot people as well.”

He added: “I would assume it’s in the regulatory pipeline that they will expand – there’s a lot things still to be worked out. The regulatory oversight of the robos has not been finalised; they are still held to the same standard as other portfolio managers and a lot of people think they should be held to a [standard] more suitable to an online platform. We’ll see what happens there.

“I don’t profess to know what it’ll end up being but if you don’t have a level playing field, someone else will want to get in there and cause some mischief.”