Mutual Fund

Describes motivation process for creativity with emphasis on intrinsic motivation by Corey K Katir

While the ongoing retirement and pension debate has focused on the existing three pillars — OAS/GIS; CPP/QPP and employer pensions and RRSPs — a whopping $1.7 trillion is held in non-registered investments and the new Tax Free Savings Accounts that the mutual fund industry calls the “fourth pillar.”

The Investment Funds Institute of Canada posted its submission to the Department of Finance on Friday and issued a press release yesterday. [Note the change of the senior communications manager.]

Its 23 page submission commenting on Ottawa’s consultation paper — Ensuring the Ongoing Strength of Canada’s Retirement Income System –  can be found by clicking on IFIC’s web site here. The Finance paper is here.

Methinks they protest too much on fees and value of advice

I wouldn’t call it an interesting read but it is fascinating in some respects. It spends far too many pages justifying the high Management Expense Ratios (MERs) on its (mostly) actively managed mutual funds. It spends just as much time defending the advisor-driven distribution system that contributes to those high costs.

On the other hand, I tend to agree with its top-line conclusion that the system works pretty well as it is and that all that’s really necessary is to tweak the tax system to introduce a little more parity between private-sector workers and government workers. Thus, IFIC provides four reasons why there’s no need to “enhance” the Canada Pension Plan (CPP) and reiterates a half dozen suggestions it made previously.

Solid arguments for boosting RRSP limits and flexibility

To recap, IFIC thinks RRSP contribution rates should be raised from the current 18% of prior year’s earned income to 34%, something the CD Howe Institute has also called for. It also makes some sensible suggestions to provide more flexibility through a lifetime RRSP contribution limit or letting people who temporarily leave the work force for childcare or job loss to accumulate more RRSP room. It thinks the self-employed and those whose incomes vary widely year by year should have RRSP room based on average income. And it calls for some unspecified “relief” for those whose RRSPs were torpedoed by market losses in 2008 — relief comparable to what members of DB plans enjoyed.

It also makes sense to reduce RRIF minimum withdrawal requirements and to increase limits for transfers between DB plans and RRSPs. As IFIC notes, Income Tax Regulation 7308 should be rejigged to reflect an older population, longer life spans and historically low interest rates. It also wants to eliminate the double taxation of dividends in registered plans.

It doesn’t appear to call for similar expansion of the new TFSAs, although this blog has previously noted suggestions to increase TFSA room through retroactivity or a similar lifetime contribution limit. Even so, it’s clear IFIC views the growing prominence of TFSAs as central to its future. In the press release, IFIC president and CEO Joanne De Laurentiis (pictured right and right in the top photo) notes that the retirement debate must include discussion of all potential retirement assets and “this fourth pillar, with its significant asset base, can only serve to enhance the retirement income of Canadians.”

If we’re at 90% replacement rate why are we debating retirement income at all? 

Even without the expansion of RRSP or TFSA room, IFIC thinks retired Canadians are doing pretty well. It cites data from the OECD that retired Canadians have an average income replacement of more than 90% (of the incomes they had when working). This beats the UK (73%, rounded), Australia (70%) and the US (86%). It also says that the OAS/GIS system has kept the elderly poverty rate at 6%, half the OECD average of 13% and well below the 24% of the US and 27% of Australia.

At the other extreme, IFIC cites data from Ipsos Canadian Financial Monitor that shows that assets held in the fourth pillar (non-registered and TFSA) rises with income level, due to “the limiting effect of RPP/RRSP dollar limits.”  Thus, in 2009, households with income of $100,000 or more had average non-registered assets of $157,717. 

Is this the place for the eternal debate on indexing vs active and value of advice?

IFIC then spends several pages explaining why Canada has “done so well,” and attempts (not convincingly, in my view) to defend its cost structure. It hotly disputes other comments in the federal consultation paper that assign “a zero value to the role that advice plays” in helping Canadians prepare for retirement. As evidence, IFIC cites a recent Ipsos Reid study that found households with financial advisors have almost double the participation in RRSPs, TFSAs, RRIFs and RESPs than households without advisors. It also cites the finding that these “advised” households had less money in “conservative” fixed-income investments — i.e. they had more in stocks and equity funds [which conveniently pay advisors more, but IFIC doesn't say that].

IFIC really falls into self-serving mode in sections 7 and 8, which cover the “value” of active management and “misplaced focus on costs rather than outcomes.” Every major book I’ve read on the topic has decidedly made the case against high-cost active management and in favor of low-cost passive investing. See for example my column on this earlier this year: A unanimous vote for index investing.  

IFIC nevertheless flails away with a number of obscure fine points that do little, if anything, to advance the general debate on retirement.

–62–

For our “weekend read” on this blog, I’ve once again handed The Wealthy Boomer over to a guest columnist. David Christianson is a fee-for-service financial planner and portfolio manager at Wellington West Total Wealth Management Inc., based in Winnipeg. He’s also a personal finance columnist for the Winnipeg Free Press.

On Friday in his blog, Christianson published a piece under the title Why ETFs are starting to scare me. The newspaper ran it under the headline ETFs running off in all directions. The theme is similar to what I’ve written before — that ETFs are starting to replicate the sins of the mutual fund industry it seeks to displace. This week’s announcement of four new foreign leveraged ETFs only reinforces this trend.  On Twitter, I “tweeted” that there are now four more ways to blow up your portfolio.

But I’m not a fee-only advisor.  David’s essay speaks for itself. To make clear his authorship, I’ve put his essay in Italics, beginning with the text across from and below his photo. I’ve added a few subheads in bold. Over to you, David:

Most 20-year olds scare me just a little bit.  They are very clever, tech-savvy and often worldly, with opinions on almost everything.  They can even be intimidating, in that you think they must know something you don’t.
 
Many seem to believe they know an awful lot, and we old fuddy-duddies are either scared or lazy in our unwillingness to  jump off any metaphorical cliff they think looks attractive.
 
ETFs just turned twenty.  Like many human “youngsters,” they were pretty well behaved till about 16, then seemed to turn a little wild, using their new knowledge and tools to run off in all sorts of untested directions.
 
Exchange traded funds are a great tool.  We use them all the time in our investment management practice, and have for a number of years.  For many uses, I prefer them to conventional retail mutual funds.
 
They became popular for a number of good reasons. An ETF allowed you convenient access to a basket of stocks (or other investments) with one purchase.  That single stock or unit could be bought and sold on the stock market at any time during the trading day. 
 
The basket of underlying investments was picked on pre-set and transparent criteria (like the TSX 60 index, for example, which is published daily), so you could always know what you owned.  I contrast this with an actively-managed mutual fund, where the manager has to delay release of his exact portfolio, to keep trade secrets and keep competitors from stealing ideas.
 
Another contrast with mutual funds is the fees.  Traditionally, ETFs have charged between .30% and .50% per year for access to a passive index, while the average actively-managed fund costs more like 2% to 2.5% per year, including advisor compensation (or about 1% less without advisor compensation). Some cost more; a few cost less.
 
Index-based ETFs are also usually low turnover vehicles, and therefore quite tax-efficient.

Flavour-of-the-month ETFs introduced just because they will sell

So, why does this 20-year-old now scare me so much?
 
My main concerns centre around the explosion of ETF varieties, the use of misunderstood leverage in some ETFs, access to increasingly quirky and risky investments and the rabid introduction of flavour-of-the-month options, with no apparent raison d’Aatre other than being saleable. 
 
This recent movement by innovative product-developers uses the well-earned popularity of ETFs to sell access to things like water and agriculture investments, commodities, two and even three-times leverage returns (which provide unexpected results if not actually sold daily), hedge fund types of active management with performance fees in the fine print, and a batch of modified index ETFs that sell based on selective time-period track records.  As well, fees on some of these can approach mutual fund fees, and even exceed those of direct sale manufacturers like Steadyhand, and large account options like Standard Life Legend Series.
 
Many of these products are poorly understood by both investors and advisors (not to mention personal finance writers, who help hype these new introductions).
 
An ETF investor now needs to ask a whole bunch of new questions, like:

A*        Is this ETF currency hedged?
A*        Does it use leverage?
A*        Does it own derivatives?
A*        Will there be liquidity when I want to sell?
A*        Etc., etc. 

New ETFs stark contrast to traditional low-cost access to broad indexes

These new products stand in stark contrast to the traditional benefits of ETFs — low cost access to indices in which the risks are clear and understood — into fringe investments of the sort that have traditionally caused surprise and disappointment for investors who knew not what they had purchased.  I have seen many a marketer ruin a good basic product over the past three decades.  (They will also call me a fuddy-duddy.)
 
Some of these new ETFs are very innovative, and some are going to be very useful in our practice, if we can truly figure them out, and avoid future surprises.  I strongly encourage you to conduct that same research and due diligence, before you invest. Make sure you understand the product and how it will behave in a variety of situations, good and bad.
 
I sympathize with the marketers, who need new whiz-bang features to differentiate themselves from competitors.  My fear is that, like many 20-year olds who are out trying new things for the first time, they will make some mistakes, maybe write off a few cars, maybe worse. 
 
In this case, though, this 20-year old will be using your money. 
 
 
 –62–

Talk about timing. On the heels of yesterday’s blog about American mega-cap stocks — Best returns for next decade: would you believe American blue chips?  — a high-net worth survey released today from BlackRock Asset Management Canada Ltd found 67% of wealthy investors are “very confident” about the Canadian markets and “far less confident” about investing in the U.S.  Half thought emerging markets are a good investing opportunity right now while only 39% feel the same about the U.S.

I don’t know about you, but I’d think such data suggests the contrary view espoused by Odlum Brown’s Murray Leith [pictured, left] may turn out to be right. As noted yesterday, while enthusiastic about the Emerging Markets/China story, Leith was loath to put all his eggs into that one basket. Canada is itself a play on China, he noted, but he wants to hedge his bets by investing in the many good-valued U.S. megacaps that can be found today.

Appalling financial literacy from the wealthy

Whether or not Leith’s call turns out to be correct, I was appalled at the level of financial literacy revealed in the BlackRock survey. While almost 80% of High-Net-Worth (HNW) investors place “a great deal of importance on learning about new financial products and solutions from their advisors,” almost half (47%) of the HNW investors who owned mutual funds believed their funds did not charge management fees. Another 9% were unsure. 

Earth to HNW investors: if you’re still investing in broker-sold mutual funds charging 2.5% a year as a Management Expense Ratio, then you’re paying $25,000 a year on each $1 million of assets.  You’d think these financial advisors they appear to value so much would at least acquaint these well-heeled clients with the basics of how they’re compensated — and the extent to which this “embedded compensation” derives largely [completely?] from the clients’ wealth.

True, BlackRock — via its iShares exchange-traded funds business in Canada — is largely in the business of providing low-cost ETFs that make most mutual funds look like highway robbery by comparison. As iShares managing director Heather Pelant [pictured, right] says in a press release, advisors should be elevating the conversation with their clients by “carefully explaining different and/or other sound investment vehicles, such as ETF.”

It seems ETFs are still a foreign concept to many wealthy investors: one in four didn’t know if they are a good investment or not and only 27% of wealthy investors with an advisor or broker said an ETF had been recommended. Worse, only 12% already own ETFs in their portfolio.  Among investors 65 or older, 71% were unfamiliar with ETFs, compared to under a third of investors 50 or younger.

New Hybrid Funds will cloud waters further

But that’s about to change and the timing gets stranger still. At the start of this week, this blog reported on the second new major entrant to hybrid ETFs by a major Canadian mutual fund company. Both Invesco Trimark PowerShares Funds and now BMO Guardian provide a way for compensation-hungry financial advisors to introduce the idea of ETFs in a way that will compensate them more than “pure” ETFs.

Because of course these mutual fund/ETF hybrids have built-in trailer commissions [I use this phrase instead of trailer fees in deference to a request by fee-based advisor John De Goey] of 0.5 to 1%. The result of this embedded compensation is MERs that are much higher than what a discount brokerage investor would pay for ETFs directly, albeit a tad below the MERs of most actively managed mutual funds. 

No doubt a year from now the followup survey will reveal the wealthy flocking to these hybrids and still declaring that, like other mutual funds, they charge no management fees. So much for the popular notion that wealthy investors are “trendsetters.” As Pelant notes, HNW investors “have as many questions and concerns about their financial situation and investment trends as anyone else.”

Certainly this group has become more cautious in the light of the 2008 crash and subsequent shaky economy: as the slide at the top of this blog illustrates, 73% said they had changed their investing style, with most “becoming more cautious.”

60% of young investors thought advisors provide no more value than the Internet

Ominously for advisors, a majority of those under age 35 agreed it’s ” not worth paying advisors or brokers for fees or transactions” while only a minority of older investors felt that way. About a quarter of the under-35s already use only a self-directed online discount brokerage account. 

The study of 500 Canadians with at least $500,000 in financial assets was conducted in the second half of March by the Gandalf Group. If you’re an advisor counting on older clients not knowing mutual funds or hybrid funds charge management fees, you’d better hope this study is not “statistically significant.”

–62–

BMO Guardian Funds is launching six new ETF mutual fund classes today, the second major Canadian mutual fund company to embrace a hybrid ETF structure. Invesco Powershares Funds were the first, as we reported here in November 2009

In a press release, BMO said the new fund classes “combine many of the benefits of ETFs with a mutual fund in a simple, easy to use investment option.”  The funds are available for sale today (Monday).
 
They include two tactically managed funds and four strategically managed risk-differentiated portfolios. Each BMO Guardian ETF Mutual Fund is a series of BMO Global Tax Advantage Funds Inc, which allows for switching among other Class Advisor Series Funds without incurring a taxable event.

Survey finds 56% of Canadians have never heard of ETFs

A recent survey conducted by Leger for BMO found 92% of consumers are familiar with mutual funds but only 44% have “some level of familiarity” with ETFs and only 7% are “quite familiar” with them.  In fact, the majority of Canadians — 56% — have never even heard of ETFs. That’s a sad commentary on the current state of financial literacy in this country, given the long-term wealth creation potential of ETFs — not to mention their cost advantages and tax efficiency merits relative to regular mutual funds. Indeed, the Leger survey found 62% would be more likely to add ETFs to their portfolios once they understand these benefits.  [While on the topic of ETFs and low levels of financial literacy, I might add that ETFs are explained in my financial novel, Findependence Day, as are the new Tax Fee Savings Accounts].

No surprise then that BMO believes the more Canadians learn about the benefits of ETFs, “the more likely they are to consider including them in their portfolios.”

Serge Pepin, Director of Investments at BMO Investments Inc. [pictured above] says ETFs have received much attention from the media as investors look for additional investment options. BMO is already the first and so far the only Canadian bank to offer ETFs through its BMO ETFs unit, even though it already sells its own no-load mutual funds and actively managed BMO Guardian Funds. TD Bank briefly offered a small family of ETFs but subsequently withdrew from the market.

An early experiment in mutual fund use of ETFs was the Spectrum Tactonics Fund, which held several ETFs but which slapped on a Management Expense Ratio that effectively eclipsed the cost advantage of the underlying ETFs. The next major move was Invesco Trimark’s PowerShares, which introduced the usual advisor compensation device of the trailer fee. The result was again a product that was more expensive than regular ETFs, although somewhat lower cost than Invesco Trimark’s regular actively managed mutual funds. 

As I wrote at the time, regardless of what you think about higher-cost ETF/mutual fund hybrids, the PowerShares Funds were a watershed development if only because it showed how the mutual fund industry had at long last “blinked” when it came to the ETF threat. You could argue that the rationale for Invesco Trimark and now BMO Guardian is that if you can’t beat them, join them. When PowerShares was alone in the market, the product seemed a strange anomaly but now that BMO Guardian Funds has joined them, the trend is clear. 

Normal trailer fees paid to advisors

The press release makes no mention of advisor compensation but focuses on the need for investors and advisors to access “the growing ETF market.”  However, in an interview on Friday, Pepin confirmed that — as with Invesco Trimark PowerShares Funds and Claymore Investment’s Advisor Class ETFs — the new BMO hybrids pay normal trailer fees to advisors: 1% for front-load and low-load; 50 basis points for Deferred Sales Charge funds. The underlying ETFs are BMO’s own family of 22 BMO ETFs. Each hybrid is in effect a fund [or "portfolio"] of ETFs, with the number ranging from five to eight depending on the portfolio.

The MERs on the A series range from 1.58% to 1.73%, Pepin said an on the F series (fee-only) 0.74% to 0.89%. Those fees are “competitive” (i.e. slightly lower than) Invesco Trimark’s PowerShares Funds, Pepin said.

–62–

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• The course is designed for attorneys, compliance officers and professionals, and anyone else involved with counseling or operating mutual funds or their service providers (advisers, distributors, transfer agents, and administrators).
• Multidisciplinary panels of leading faculty experts unpack the major securities laws and their practical impact on fund disclosure…

Why Attend?

This is the most comprehensive CLE program on mutual fund compliance and regulation.

• The course is designed for attorneys, compliance officers and professionals, and anyone else involved with counseling or operating mutual funds or their service providers (advisers, distributors, transfer agents, and administrators).
• Multidisciplinary panels of leading faculty experts unpack the major securities laws and their practical impact on fund disclosure…

Why Attend?

This is the most comprehensive CLE program on mutual fund compliance and regulation.

• The course is designed for attorneys, compliance officers and professionals, and anyone else involved with counseling or operating mutual funds or their service providers (advisers, distributors, transfer agents, and administrators).
• Multidisciplinary panels of leading faculty experts unpack the major securities laws and their practical impact on fund disclosure…

Why Attend?

This is the most comprehensive CLE program on mutual fund compliance and regulation.

• The course is designed for attorneys, compliance officers and professionals, and anyone else involved with counseling or operating mutual funds or their service providers (advisers, distributors, transfer agents, and administrators).
• Multidisciplinary panels of leading faculty experts unpack the major securities laws and their practical impact on fund disclosure…

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Investors who see opportunity in Asia’s growth typically think of China first. That’s one reason why there’s no shortage of options for U.S. investors looking to buy a stock mutual fund that focuses on China.

Investors who see opportunity in Asia’s growth typically think of China first. That’s one reason why there’s no shortage of options for U.S. investors looking to buy a stock mutual fund that focuses on China.

Long-term growth prospects in India are drawing the attention of mutual fund companies in the U.S. Ten U.S. funds specialize in Indian stocks, and half of those have been launched over the past year and a half. The number of exchange-traded funds focusing on India has also grown to 10, and most are less than two years old. That growth …

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