No! Not if (and this is a big if) clients receive value for their money. Value in this instance is defined as “the cost of something” and the key word is “cost” because the fee paid to own investments is not the end of the story. It is actually the starting point. t is actually the starting point. It is interesting to see the history of investment costs in Canada and how they may evolve.
For centuries, if an ordinary person had any liquid wealth the best they could hope for was some meager interest on their cash. Then, as the concept of companies came into being, the notion of profiting from equity investment emerged and stock exchanges were established in seventeenth century Europe to trade equities. Canada eventually got into the act with the incorporation of the Toronto Stock Exchange in 1861.
Once upon a time, being a stockbroker was a comfortable, genteel and very lucrative profession. By providing investors with access to markets, brokers earned commissions and also received trading fee rebates from exchanges. Brokerage commissions were fixed and it often cost 2% or more per trade. This lasted until May 1975 when negotiated commission was introduced. The development of investment funds increased competition and led to a decrease in direct share ownership. Currently only 17% of the Canadian financial wallet is invested directly in stocks, down from 30% in 1990 when it was second in importance only to short term deposits. As is often the case, nothing lasts forever. There were two significant changes to the commissions landscape that put downward pressure on trading costs. First, increased competition drove down then then standard commissions per share from the 14-16 cents per share in the late 1970s to just under 2 cents per share for institutions today. The second impact was the creation of discount brokers who gave regular investors access to very reasonable commission schedules.
Traditional asset managers charged investors significant fees, ranging from 1.0% to 1.5% of assets under management for high net worth clients, a practice that is still common today. For less well-heeled investors, the first modern mutual fund was created in Canada in 1932. They were slow to catch on and grew very little between 1930 and 1970. However this was reversed in the 1970s following the oil crisis. Equity and bond fund ownership continued to expand in the early 1980s but growth did not explode until the early 1990s, with average annual growth of 20-30%. Today, these investment funds now represent more than 30% of all Canadian investable assets, up from 6% in 1990.
The cost of owning mutual funds is made up of three parts: acquisition costs such as front-
end load commissions; ongoing costs both embedded and negotiated; and disposition costs such as redemption fees. The cost of ownership, rather than the Management Expense Ratio (or MER, which often contains trailer fees representing the commission paid to brokers and mutual fund dealers for advising clients to purchase the funds) is the most effective way to measure total investment expenses. The typical maximum front end load for a Canadian open end fund is 5%, although by 2011 98% of mutual funds did not have upfront charges or disposition costs. The typical investor in a Canadian fixed income fund pays an MER of 1.25% to 1.5% and for Canadian equity funds they pay MERs of 2.0% to 2.5%. MERs generally decline as the amount of fund assets increase. Specialty funds have higher expense ratios than equity funds, which, in turn, have higher expense ratios than bond funds. International funds have higher expense ratios than comparable domestic funds.
Recent developments have provided retail investors with the opportunity to lower investment costs due to the proliferation of no load funds, online/discount brokerage firms, fee based accounts and Exchange Traded Funds (ETFs) which have dramatically altered the investment landscape.
Now a new fee concept is coming to the market and it is one that is long overdue. It shifts power to investors by aligning fees to investment results relative to benchmarks. Clients pay a low 0.25% fee for the Provisus Corporate “O” Class Equity Funds which covers basic costs. Investors do not pay any more unless the performance of the Provisus funds exceeds specific benchmarks, in which case they pay 20% of the outperformance relative to the benchmark. The investment manager earns income only after they deliver superior returns. This is how Provisus’ Pay-forPerformance™ works and it is revolutionizing the investment landscape.
There is more scrutiny on fees than ever before. Studies have shown many investors either believe they do not pay anything or have no idea what they do pay (Hearts & Wallets: Wants & Pricing — What Investors Buy & Competitive Ratings — 2016). But everyone understands nothing in life is free. Clients should know what they pay and their three most important objectives should be: fees that are clear and understandable; fees that are unbiased and put the client’s interests first; and fees that are reasonable for the service provided.
Most people are not experts in matters related to investing. They need professional advice and luckily there are many options available. One of these options is to use a robo advisors also known as a digital advice solution, and they are proving to be increasingly popular and disruptive to traditional wealth advisors. Robo advisors are automated investment services that offer low cost solutions through web based and mobile applications. They are designed on the concept of providing the lowest cost approach by relying on cheap passive allocations. Normally there is nothing wrong with making purchases as affordable as possible and we are conditioned to search for the best deal. For things like gas, groceries or low cost passive funds, cheaper is better. But active investing is not about being low cost; it‘s about getting the best value.
What is considered good value is subjective and depends upon each individual’s needs. What may be a good deal for one person might not have the same value for another. Robo advisors might be appropriate for someone who has simplistic investing needs or is new to investing but for most investors it is important to understand what you’re getting.
The service isn’t personal
Robo advice is not tailored to you as an individual. They are low cost because they use a one-size-fits-all approach and there is very little personalized service provided. This is a problem because what computers cannot account for is human intuition. Robo technology uses computer algorithms and software to automatically allocate your wealth across different asset classes. They are cookie cutter solutions based on simple questions to get a basic understanding of your financial situation. With a person as your advisor you have more opportunities to share your concerns, goals and plans. People are not identical so it doesn’t make sense to provide wealth advice based on automated solutions. For example, as a family grows financial complexities usually follow suit. Some clients need to determine whether children from previous marriages should be treated the same as children from the current marriage, and whether arrangements should be made to provide financial gifts to grandchildren. A real relationship with open conversation is vital for developing a tailored portfolio.
The options are limited Unlike a human, robos lacks the ability to consider how all of a person’s assets, tax liabilities and other factors correlate with each other. Estate, retirement and tax planning are just some topics for which people need expert guidance yet robo advisors are not designed to provide advice on these important issues.
Investors need coaching
Many people are not honest with themselves when it comes to self appraisal. When answering an investor profile questionnaire, many will say they can handle risk if it gives them more potential for higher returns. Yet in reality some investors get preoccupied and can’t sleep when their $500,000 account drops $100 in a day. Many need guidance and reassurance in order to have peace of mind. Financial advisors need to set expectations and help their clients plan ahead, but they also need to be able to help them adjust to unforeseen life events. Job changes, marriage, children, divorce, moving, family members with special needs, illnesses, accidents and the need for long-term care are some life circumstances that can cause dramatic changes in a person’s financial needs; not to mention their psyche. Professional advice is about more than investments. Humans can also have deep conversations with clients about their goals and are able to help with the emotional side of financial planning.
A computerized advisor will not ask clients about their kids or treat them to lunch or chat about their favorite hobby. Conversations may not add to performance numbers directly, but they build relationships and relationships build trust. Clients who trust their advisors have peace of mind, even when markets are volatile. Investors are not rational as numerous studies show that they get out of the markets when they shouldn’t get out and get into the markets when they shouldn’t get in. An advisor who has built trust can help clients stick to their tailored plan rather than make decisions based on emotion.
It is important to consider these factors when deciding between using a low cost robo advisor and a real financial planner. Robo advisors may be appropriate for those with small accounts who have uncomplicated portfolios and can get by on basic advice, but for many investors a cookie cutter approach does not work. A true financial planner is going to get to know you, your family and will focus on your goals and objectives. The right advisor will assist you with, not only your investments, but also with your taxes, retirement, and just about any financial consideration you may have.
When it comes to protecting your future and that of your family, do not base your decision solely on cost. Instead, select what has the best value for your needs. While it is important to consider your costs, it is more important to determine what you are getting for those low fees. What would be the benefit of saving 1% on fees if you are losing 15 to 20% in poor tax planning? We must be careful not to be penny wise and pound foolish.
The imposition of a fiduciary standard on financial advisors in Canada is looking more likely. Higher standards are already in effect in the U.K., where all registrants must act honestly, fairly and professionally in accordance with the best interest of their clients, and in Australia, which has a qualified statutory best interest standard.
More recently, a financial media firestorm erupted in the U.S. as their Department of Labor (DOL) released the final version of its Fiduciary Rule that will impose a best interest standard on those providing advice with respect to many retirement plans. Some have wondered why the Securities and Exchange Commission has been missing on this file. The reason is that the DOL oversees employee savings plans and they have been proactive in managing apparent conflicts of interest among brokers who were advising on the rollover of employer managed plans to broker-managed accounts. The equivalent in Canada would be an advisor advising on a Locked-InRetirement-Account (LIRA) which had previously been managed by a portfolio manager. If and when the fiduciary rule survives several legal challenges, the small and midsize 401 (k) plan market stands to be revolutionized in the U.S.
The new regulations will likely accelerate a number of challenging trends that advisors are facing, not just in the U.S. but in Canada as well. Morningstar, a Chicago-based rating agency, has thoroughly studied the effect of these new DOL rules and concluded that they will drive three primary trends. Firstly, it will shift customers away from commission based arrangements to fee based ones; Secondly, robo-advisers will likely pick up a large percentage of the $600 billion in low-net-worth IRA balances in the U.S. that are now being managed by full service wealth managers; Lastly it could lead to a significant increase in the use of passive investment products.
In October of 2012, the Canadian Securities Administrators (CSA) published a number of reports beginning with a Consultation Paper, The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients. The CSA has taken the view that the current Canadian registrant regulatory framework requires improvement and seeks to introduce a fiduciary standard in order to address issues they have identified in the clientregistrant relationship, “including to better align the interests of registrants with the interests of their clients, to improve outcomes for clients, and to clarify the nature of the clientregistrant relationship for clients.”
According to the financial press there is some apprehension among nonfiduciary advisors that their reputation may be tarnished if they are perceived as acting in their own interest. The requirements may cause an unintended focus on fees, particularly as the media has demonized the practice of charging commissions and deferred sales charges (DSC). Although it isn’t the intention of the regulations, some advisors may find themselves forced into a fee-based compensation structure and a relatively limited product selection. Advisors are divided on the implications for investment management fee structures, as those who are already feebased see the new rules as formalizing an inevitable market shift and some commission-based advisors are concerned that commoditizing their services puts them at risk of being undercut by cheaper automated advice services. The impact of technology, irrespective of what happens on the regulatory front, will continue to make it cheaper and easier for investors to get investment advice that’s not conflicted. That is a trend that will have a big impact on the investment industry over time.
The reforms under consideration also include amending rules to require firms and advisers to respond to identified material conflicts of interest in a manner that prioritizes the client’s interest, increases the requirement for an adviser to understand a client’s financial circumstances and risk profiles which may be extended to better quantify loss aversion, and limiting titles that can be used by advisers. Advisors are also concerned about the burden of internal scrutiny and compliance due to the increasing volume and scope of regulations which is leading to a feeling of being monitored rather than supported by their firms. At the end of the day, the burden of having to document all aspects of the advisory consultations could add an unintended toll on an advisors’ ability to work effectively on behalf of their clients. Both the proposed targeted reforms and proposed regulatory best interest standard, if introduced, would apply to all advisers, dealers and representatives, including those who are members of IIROC and the MFDA.
With so much at stake the CSA has sought further comments on the proposed regulatory action. They have confirmed that no final decision on the implementation of a best interest standard will be made without a thorough review of the comments received following their recent public consultation and discussion. The most recent comment period closed on August 26. Even within the CSA there have been concerns about the proposed legislation as the BCSC noted, “given the current regulatory and business environment, imposing an overarching best interest standard may not be workable and may exacerbate one of the investor protection issues identified, that being misplaced trust and overreliance by clients on registrants. Further, the introduction of a regulatory best interest standard over and above the proposed targeted reforms is vague and unclear and will create uncertainty for registrants.” This leaves open the possibility that some provinces, most notably Ontario and New Brunswick, may proceed with best interest standard legislation on their own.