what to watch for when dealing with financial advisors
TRANSCRIPT
7 things to look for when dealing with Financial Advisors
• Fees• Fees on Fees (ouch!)• Closet Indexing• Over-diversification (di-
worsification!)• Low fund weights • Company managed funds (conflicts!)• High client count (Clients on clients!)
Fees• Thanks Captain Obvious!• Often cited and a ‘well-known’ issue
• One problem: Talk is falling on deaf ears• Canadians have the highest fees and expenses globally• …For third year in a row according to a Morningstar report*
• Average total expense ratio in Canada is greater than 2%• Highest amongst 24 countries• Italy is the only other country with a similar fee
• Investing with an Advisor in Canada?• Likely paying high fees• Need to understand and reduce the fees
*https://corporate.morningstar.com/us/documents/MethodologyDocuments/FactSheets/Global-Fund-Investor-Experience-Report-2013.pdf
Effect of fees over long-term
Source: Vanguard Investments https://personal.vanguard.com/us/insights/investingtruths/investing-truth-about-cost
Fees on Fees• Hard enough to understand Mutual Fund fees• Now need to decipher the ‘fee-only’ charges
• Fortunately, under new rules, fees in dollar amounts will need to be disclosed
• Many advisors now offer fee for services• Essentially a fixed charge on assets managed
• Problem: Still being placed in expensive funds• Being charged a fee for service on top of fund fees• Even if funds are ‘preferred’ rates, likely no better off after
service fees added to fund fees• Fees are often buried in statements
• Can be hard to understand total fee picture• Don’t know total fees, demand they show and tell you
• Ensure it includes fund MERs and advisor service fees
Closet Indexing• What is it?
– Saying you’re an active fund or can generate ‘alpha’ yet hugging a benchmark index
• This is a bigger issue in Canada• TSX 60 vs S&P 500• Hold over 40 large-cap securities? >> Closet Indexer?
• Why is closet indexing done?• Fear of sticking neck out on the line• Job security• Stay close to index, don’t risk severely
underperforming• Is this what managers/advisors are paid for?• Can you do this yourself with limited effort?
Signs of closet indexing• Fund performance very close to benchmarks• Over 40 individual securities• Large number of funds• Various funds held that shadow benchmarks
• Be aware of the benchmark• An active small-cap fund may shadow a small-
cap index, still closet indexing just not seen by comparing to a broad market. Can be replicated with a small-cap ETF
• Funds with high ‘active share’ are less likely to closet index
Over-diversifiction• AKA di-worsification• Personal pet peeve in managed portfolios• You are paying someone to use their
knowledge and resources to manage your money• Should be expected to make some unique or
interesting investments/allocations• Not paying them to match (at best) broad
markets• Otherwise, you can index yourself and do it
cheaper
Signs of over-diversification• Over 40 individual stocks• Over ten ETFs, at absolute maximum• If an ETF has at least 30 stocks and you own
ten ETFs, you actually own roughly 300 stocks!• Performance very similar to broad markets
or a broad diversified balanced fund• Large number of small positions• If you are not willing/comfortable enough to
own a 2.5%-5% position in your portfolio, why bother owning any of it at all?
Low weighted funds• Another pet peeve• As noted earlier, you are paying for expertise• MF/ETF weights below 5% show a lack of
confidence in position/asset class/investment thesis
• Require large market moves to have any material effect on retirement picture when diversified ETFs are held at low weightings
• Makes a nice ‘benefits of diversification’ talking point at year-end for the advisor, but that 2.5% fund position has little to no effect on your wealth
Company Managed funds• Not necessarily a ‘bad’ thing• Often advisors will place clients in
funds that their employer manages• There are reasons and benefits at times• Not always the lowest cost solution
• Something to be aware of and question
Client count• Each client is different and requires
specific attention and time• If an advisor already has 80 – 100 clients,
do you think they can/are providing the attention you deserve• They should be, but in reality, maybe not
• Varies with needs of the individual• If you have high needs, you may want to
consider an advisor with a smaller book of clients
• Be the big fish in a small pond
What to look for in an advisor
• Similar investment style/beliefs – disagreements otherwise
• Transparency in conversation with fees• If they are comfortable with the value they add,
should not be shy to disclose fees openly• Experience or part of an experienced firm
• Education, credentials, supporting infrastructure/resources
• Most importantly – Passion for investing. Is this just a pay-cheque to them, or something they love.• This should become apparent through conversation
About 5i Research• Investment research for regular people• Over 70 research reports• Three model portfolios• Timely investor Q&A• No conflicts – We own no Canadian
securities and cover only Canadian companies (ETFs/Mutual funds excluded)
• Learn more at www.5iresearch.ca