http://www.fundlibrary.com/features/col ... p?id=12276
The Investor Advocate
Ken Kivenko’s column is all about investor protection. Ken fights for investors’ rights and exposes violations and malpractices. He also runs an advisory business, Portfolio Analytics, assisting investors obtain restitution due to sales or broker abuses.
It's the client, stupid
By Ken Kivenko | Wednesday, October 10, 2007
Ideas for improving client focus in the investment fund industry.
“Mutual Fund Companies have forgotten who their client is. They’re focused on servicing financial planners who sell the funds rather than the investors who buy them. And that may prove life-threatening, because the very people who would be buying mutual funds are questioning whether they want to buy them at all anymore”
—Glorianne Stromberg [ Steve Maich, “Mutual Misery”, Maclean’s, Feb. 7, 2005 ]
An October, 1998 study by former OSC Commissioner Glorianne Stromberg Investment funds in Canada and Consumer Protection: Strategies for the Millennium examined the requirements — it wasn’t a pretty picture. She made a significant number of constructive recommendations to enhance consumerism about retail fund investors. It is available from the Industry Canada Web site
http://strategis.ic.gc.ca/pics/ca/mainbody.pdf Sadly, nearly 10 years later little progress has been made.
A September, 2004 joint CARP-SIPA Report, GIVING SMALL INVESTORS A FAIR CHANCE: Reforming the Mutual Fund Industry
http://sipa.ca/library/Documents/CARP_S ... 4Sep28.pdf urged for a number of major reforms to better serve and protect mutual fund investors. To date little has changed. A 2006 research paper led by Harvard Professor Peter Tufano, Mutual Fund Fees around the World found Canada to have the highest fees in the world, a strong indicator that all is not well.
http://papers.ssrn.com/sol3/papers.cfm? ... _id=901023)
Can it be shown that the typical Canadian mutual fund investor is not getting a fair deal from the mutual fund industry? Professor Keith Ambachtsheer did so recently in the article Losing Ground: Do Canadian Mutual Funds Produce Fair Value For Their Customers? (with Rob Bauer, Canadian Investment Review, Spring 2007)
http://www.investmentreview.com/archive ... ground.pdf
His CONCLUSION:
“The preceding financial analyses suggest that the vast majority of the 60% of the Canadian workforce who are not members of occupational pension plans will have a very difficult time generating adequate pensions by investing their retirement savings through the mutual fund sector. This is so despite the very high 20%-of-pay savings rate assumed in the example. The sales/investment expenses wedge being imposed by Canada ’s for-profit financial services industry is simply too large”.
Obviously, a retail highly regulated mutual fund will have higher expenses but now the gap in fees is so large that the entire Canadian investment fund sector’s value proposition is out of whack. Now, that is a national issue that should and could attract political attention. Maybe even open the doors to lower cost U.S. funds for Canadians?
An October 2007 Canadian Securities Administrators (CSA) Investor Study: Understanding the Social Impact of Investment Fraud
http://www.osc.gov.on.ca/About/CSA/csa_ ... y-full.pdf finds that investment fraud often results in a loss of trust between victims and those close to them, as well as a loss of confidence in the system as a whole. The CSA study shows one in 20 Canadians is a victim of investment fraud. A majority of 54% also agree that “As a result of the way authorities handled the case after I reported the investment fraud, I just don’t trust the way investments are run and regulated in this country.” Sounds like the industry IFIC has some work to do. The CSA study respondents likely didn’t even consider excessive fees, unsuitable investments, fund scandals and conflicted adviser advice as wrongdoing, let alone fraud.
The media and investor advocates have highlighted high fees, poor disclosure, adviser malfeasance, market timing scandals, soft dollars, the lack of an industry-wide NAAF/KYC form and of course the Norbourg fund governance breakdown and multiple fundamental issues surrounding the Portus fund collapse.
So there’s plenty of evidence that investment fund industry reforms are required. Here’s a few thoughts for the industry that we think are constructive and do-able:
Focus on the customer
Fund buyers are investors and customers. In every successful industry, customer satisfaction is at the core. Satisfying an investor requires knowledge of their personal situation, investment behaviour and goals. A much better job can be done here. Many issues and problems can be prevented. Unsuitable investments are the #1 cause of investor dissatisfaction.
Does the KYC (and NAAF) form need a revision, clearer terminology and industry standardization?
Are registrants required to have clients sign a completed KYC?
Are registrants required to provide clients with a copy of the KYC?
Do SRO’s check to see if KYC’s are properly completed and signed by clients?
This is a wonderful opportunity for the industry to move to the next level of maturity.
Move forward on fund governance
The thorny issue of fairly valuing securities was at the root of the infamous market timing scandal. It was also at the core of the Crocus LSIF fiasco. Between the Manitoba Securities Commission and the Auditor General of Manitoba, they allege that the Valuation Committee (a subset of Crocus Fund’s board of directors) did not meet for months while there were concerns voiced of deteriorating values. Investors paid heavily for this lapse of governance. Fund governance, a hot topic for years, remains limited to IRC’s with severe limitations on their mandate. In fact, IRC’s now have the power to legitimize prohibited transactions defined in securities regulations, an awesome responsibility. The industry lobby has “successfully” stalled every regulatory attempt at adopting a true fund governance regime. Nothing to be proud of — it’s time for a change of direction.
Reduce fund fees
The Canadian fund industry should take no pride at being identified as the most expensive fund provider in the world (the Tufano et al study). Take a closer look at fund fees and expenses and the underlying productivity issues that drive them. Canadian fees need trimming — not just for investors sake but because competitive ETFs are a calling. Are related-party services really hard-nosed competitive? Why not make F-class (or equivalent) funds available to investors without having to go through an advisor or charge lower fees for those who buy funds electronically, like TD’s eFunds? After all, we’ve been told that asset allocation is more important than the individual funds in the portfolio, so fees really do count. How about some disclosed price breakpoints if a larger sum is invested? A little innovation here could yield big results for fund buyers and sellers.
Take the mystery out of mutual fund fees
It’s time to move away from the outdated Out of sight, Out of mind approach to sales with opaque disclosure of fees. Pricing information is available for funds, but not in the same transparent way it is when you buy everything from a can of soup to a toothbrush, gardening equipment and an automobile. Investors need mutual funds to be sold with an easy-to-read price tag stuck to them and facts stated in plain language. Support the Joint Forum’s initiative to improve Point of Sale Disclosure
http://www.jointforum.ca/JF-WWWSite/consultation.htm. Stick the price of owning funds in big, bold numbers on the front of the Fund Facts POS document along with some language that suggests it’s really important that investors read the Document. Support regulators in preparing an unbiased Guide to Fund Facts use for investors. Why not provide a Statement of Portfolio Transactions if investors request it? [transaction visibility and associated fees can be useful to an investor or adviser who wants to examine the managers behaviour and style]. And, let’s treat segregated funds like mutual funds at least for fee disclosure, compliance and governance purposes.
NOTE: The 2007 IFIC Investor survey found that:
only 54% of investors were made aware of adviser compensation when buying a fund.
only 54 % of respondents were confident or very confident that mutual funds meet their financial goals.
Download survey at:
https://portal.ificmembers.ca/Desktop/E ... SFID=14590
Clarify and simplify share classes
Retail mutual funds are now available with a dizzying array of pricing models. In many cases, a single fund might offer 4 or 5 share classes, and the main difference among them is the cost. If the wrong fund class is selected, an investor could pay more than necessary. It wasn’t always this way. In the 1980s there were only two kinds of retail mutual fund shares: load and no-load. Load funds levied a sales charge (SC), or commission, when you bought units; no-loads did not. Naturally, investors didn’t like to pay loads. But instead of eliminating them, the industry made the loads less obvious. The first tactic was to create a reverse-load fund — investors paid the load when they sold their units instead of when they bought them. To distinguish these units from the original load funds, the back-load funds were called DSC units.
Today, fund investors must choose among Class SC, DSC, F, Low Load and Level Load and maybe a few variants in between. Depending on the fund class purchased, investors might incur a load when they buy, when they sell or annually. The load might disappear after a time, or it might remain forever. In some cases, there might be a lower load, but higher annual expenses, or vice versa. And in some instances, an investor might buy one fund class only to have his units automatically converted to another share class in the future!
Advisors need to spend more time with investors in assessing their personal situation. This involves consideration of the amount initially invested; the amount planned to be invested in the future; the timing of those additional investments; how long the investor plans to leave the money invested; annual withdrawal amounts; and how much other family members are also investing (both now and in the future). Advisors should assist in choosing the right fund class and the right fund appropriate for each situation. Too often we see elderly or critically ill folks stuck with expensive DSC funds, DSC funds in RRIF’s or a failure to reveal available options. Easy to fix — just comply with NAAF/KYC criteria and suitability. That would be professional.
Cost-benefit the advice being given — are investors really benefiting from the advice provided?
The investment fund industrypays billions of dollars each year to compensate advisers and planners for their sales efforts and advice they provide small retail investors. The management fee charged to investors via the MER provides the source of funds. These vulnerable investors are heavily dependent on this advice for their financial well-being.
But does this expenditure result in improved financial performance for the investor or increased commissions for the advisers?
Do firms periodically poll investors for satisfaction? Are they aware of complaints?
Do they check if advisers have the necessary professional qualifications and competencies?
Is there evidence that client statements provide basic personal rates of return, the most basic performance indicator?
Are seniors being treated right? Are funds being recommended really suitable?
Are commercially available software tools being used to assess compliance?
You’d think the industry would have a firm handle on the answers to these questions before mailing out all those commission cheques.
Bottom line: Do trailer and other commissions cost-effectively help investors make better decisions?
Litmus TEST: Do fund companies mandate the use of IPS’s and other professional advisory tools?
If the answer is NO, then why not?
According to the 2007 CSA Investor study, more Canadians trust investment professionals than not, but that trust is expressed tepidly and many Canadians are uncertain of their view. When presented with the statement:
“I just don’t trust investment professionals”,
one-in-four (24%) agree
nearly three-in-ten (28%) neither agree nor disagree.
Sounds like an industry-wide checkup is called for.
Monitor investment “educational seminars ” for seniors
Seniors were raised at a time when it was believed a person’s word was their bond .The most frail and lonely seniors are often open to anyone who will chat with them. They are vulnerable because of that loneliness and advisers know it — they become a senior’s new best friend. There are simply too many horror stories of the elderly being exploited by financial advisers. U.S. securities regulators are rightfully concerned with investment “seminars” targeting seniors, according to a report released Sept. 10th. During the second annual Seniors Summit held Sept. 10 at the U.S. Securities and Exchange Commission in Washington, D.C., the SEC and state securities regulators (members of the North American Securities Administrators Association) revealed the findings of a year-long examination that scrutinized 110 securities firms and branch offices that sponsor so-called “free-lunch seminars”
http://www.sec.gov/spotlight/seniors/fr ... report.pdf.
They found that:
100% of the “seminars” were actually sales presentations;
59% reflected weak supervisory practices by firms;
50% featured exaggerated or misleading advertising claims;
23% involved possibly unsuitable recommendations; and,
13% appeared to be fraudulent and have been referred to the most appropriate regulator for possible enforcement or disciplinary action.
Source: SEC Report, Sept. 10, 2007 [46 pages]
Is Canada any different? We think not. Treatment of the elderly, pensioners and retirees is not just a financial issue, it’s a social issue and our trusted wealth management industry should be at the forefront of the demographic change that’s underway.
Manage Leveraging — it’s a conflict-of-interest for advisors
Offering an investment loan to help finance a client’s mutual fund purchases might seem like a good idea, but offering a retail investor an investment loan can be a conflict-of-interest. The more money advisors put into products, the more they make on sales/trailer commissions. Rarely do mutual fund investors clamor to take on more debt — mutual funds are sold, not bought. Companies offering investment loans through advisors report a strong rise in these things being sold. That’s a clear indication that the clients aren’t questioning this; it’s the advisors recommending it. Leveraging may be appropriate for some but for seniors, retirees and the risk-averse all that happens is that the risk of the mutual fund is magnified by the risks of leveraging. How often do we hear cases where widows are advised to leverage their investments for greater income. When the investment loses money, margin is called, draining the life out of irreplaceable nest eggs. The industry recognizes that these loans are advisor-sold so they should manage conflicts-of-interest, not turn a blind eye or worse, incentivize unsuitable transactions.
Help investors tame currency risk
Today nearly every fund has some currency risk, some a lot more than others. Currency risk isn’t a minor risk yet the industry is cavalier about it. The Loonie has appreciated in value over 60% over the last six or so years, with exchange rate moving from US$0.62/CAD to parity. Portfolios are often constructed without careful consideration of currency movements. Individual funds are pretty lousy at disclosing their approach to currency hedging. It doesn’t have to be this way. Why not disclose the approach in the prospectus and updates in the MRFP? Then, investors could decide how much risk they want to take instead of flying blind. Barclay’s Canadian international ETF’s are in fact hedged and this is fully disclosed. And dealers should allow foreign currencies in registered plans — the CRA does — instead of unnecessarily extracting fees for currency conversions. Fix information systems to allow this rather than issue new disclosures that you say you won’t.
Don’t oversell Wrap accounts
Wraps are growing like a wildfire. The question is... why? Wrap programs are generally not integrated with non-investment assets such as pension assets, business interests, Company stock options and other income sources and they have difficulty incorporating external assets, such as individual GIC’s/bonds, that are not in the wrap program.
Wraps for the most part are more expensive to own than mutual funds — typically the management expense ratios reflects a premium above the weighted average MER of the underlying funds: 2.4 % vs. 2.01 % for a stand-alone fund portfolio according to an Investor Economics study. Reputable advisers should be developing Investment Policy Statements (IPS’s) and assisting with rebalancing and tax optimization as part of their regular job independent of a wrap (mutual fund fees already provide commissions to provide sound advice). Unless investors are receiving much broader quality advice, wraps just don’t deserve to have grown the way they have. Professional advisers and do-it-yourself investors can readily create portfolios that cost much less to own than wraps and deliver risk-adjusted returns that are at least as s good. The most successful wrap products of recent years are those that don’t charge a fee premium. That’s a positive development. The answer to our question appears to be -- higher sales commissions and management fees. Not a good answer for an industry striving to obtain trust, respect and professionalism.
Dramatically improve dispute resolution
It’s time to part ways with the 3 D’s — the Deny, Delay, Defend approach to complaint handling. This causes undue investor frustration, anger and stress. Investor advocates argue that the true values of a firm are revealed when there is a dispute not when they advertise to attract investors. Develop robust processes for timely, fair resolution of investor complaints. Provide some oversight controls and measure results. Dispute resolution is among the top 3 priorities for retail investors. Just look at the results of the 2005 OSC Investor Town Hall.
http://www.osc.gov.on.ca/Investor/Forum ... report.pdf
Investors made it clear they are having terrible troubles navigating the convoluted complaint process and receiving restitution. There’s been no discernable improvement in over 2 years. Why? In at least one big case, the industry is attracting national negative attention by the action of one fund dealer. And why does OBSI have to keep mentioning that dealers are not routinely advising investors of OBSI’s free resolution service when the firm’s stifling complaint process has been exhausted? This year marked the first time a fund dealer was publicly chastised by OBSI for not agreeing to its settlement recommendations. To some, it appears things are getting worse. The 2007 IFIC Investor Survey all about ignored complaint handling — it spent most of its time trying to find arguments to derail new proposed POS regulations that attempt to better communicate important fund facts. It also ignored seniors’ issues entirely. Where’s the leadership?
Vote proxy shares with integrity and thought
Like the U.S., mutual funds in Canada overwhelmingly support corporations’ positions and oppose shareholder resolutions on annual shareholder proxy votes, a new study has concluded. A report A Survey of Canadian Mutual Funds on Proxy Voting: issued Sept.18 by the Toronto-based Social Investment Organization, a trade association for socially responsible investment funds, found mutual funds voted a whopping 67 % against shareholder resolutions in 2006. Socially responsible funds were most likely to support shareholder resolutions, with 79 % voting for the proposals, compared with 31 % support from conventional funds. Three fund companies voted with management on every single issue. The 36-page report is the first broad study of mutual fund voting since the CSA introduced mandatory rules [per NI81-106] requiring mutual funds to disclose their annual proxy votes and it’s not encouraging. Source:
http://www.socialinvestment.ca/document ... Voting.pdf. Is this “people’s capitalism” in action? Pay more attention to your voting, those shares are powerful instruments of shareholder rights and positive change.
Conclusion
We could go on, mentioning such bad habits as unsupported and misleading claims, fund churning, failing to provide meaningful client statements or treating income tax and after-tax reporting of returns as some sort of unreasonable activity. Paying trailers to discount brokers is a nasty waste of fund assets. Inadequate adviser supervision — as even a cursory glance at IDA, MFDA and OBSI statistics reveals — is a big and costly problem for retail investors. MRFP’s are not explaining what went right, what went wrong or what’s the outlook. Make them useful to investors, not boilerplate stylized babble.
The industry manages about $700 billion in assets — how well it does this can impact not only the Canadian economy but also our social structure. If the industry voluntarily introduces reformed business practices it will be a demonstration of respect for trusting and loyal retail fund investors. The wealth management business is big, growing and profitable enough for a new approach to be win-win. Some firms are clearly willing to be leaders and support fair-dealing. Let the whole industry join in.
SPECIAL THANKS to Dan Hallett
http://www.danhallett.com/ for his invaluable and constructively critical comments on a draft of this article.
Ken Kivenko
October, 2007
http://www.fundlibrary.com/features/col ... p?id=12276