The Flaws In Canada’s Financial Adviser System

OVERVIEW:

Recently, in the Report on Business of the Globe & Mail, there was an article titled, The Flaws In Canada’s Financial Adviser System.

This article stated that:

“In the investing industry, the line between what’s best for the client and what’s good for the adviser is easily blurred.

Advisers want their clients to enjoy high returns, but they need to make money, and the potential for large rewards is tempting.

That creates an inherent conflict of interest in many client-adviser relationships, critics say, and too many investors are left in the dark about the fees they’re paying to advisers and the effect those fees have on returns.”

WHAT’S THE ISSUE?

Having been in the investment management industry for over twenty years, I can tell you that this is THE ISSUE (ie: The Elephant In The Room) currently facing the wealth management industry globally.  Specifically, what is the standard of care that Advisors owe their clients?

The purpose of this article is not to debate the different standards of care but really a call to the wealth management industry that it’s time to wake-up!  After 10 years of volatile capital markets and paltry returns (as measured by broad market indices) and in some unfortunate situations, wealth destruction, clients are finally — and rightfully so — starting to ask more penetrating questions about the qualifications of advisers, how their hard-earned money will be managed and what are the fees & expenses that they’ll be paying.  This sentiment is across the board — family wealth, pension & group retirement assets and philanthropic organizations such as foundations & endowments.

Here’s a quote from an affluent investor that I was recently chatting with:

“When I started investing 15 years ago, most advisors said that conservative 5 to 7 % investing would have shown a doubling of my investments. Sorry….flat as a pancake over 15 years. I attribute this to dishonesty in management of financial advisory companies and a lot of marketing lies from investment firms!”

In the United States, the Edelman Trust Barometer examines trust in four key institutions — government, business, media, and NGOs — as well as communications channels and sources.  For 2012, the survey results showed that customers trust their car salesperson more than their financial adviser!

WHAT DO INVESTOR CLIENTS REALLY WANT?

Despite all of the complexities of the wealth management industry and the current debate about standards of client care, I strongly believe that investor clients of all types – families & institutions – are really only looking for four (4) things from their advisors:

1. Help me reach my financial goals.

2. Be honest.

3. Treat me fairly.

4. Don’t ‘blow-up’ my hard earned money.

SO WHERE DO WE GO FROM HERE?

Our industry urgently needs to get back to the basics of what this industry is really about — Stewarding client wealth in the diligent pursuit of their investment objectives.  This will require that the wealth management industry adhere to the following eight (8) principles. I’ve also included for each principle an example of a real life situation that we’ve witnessed in the industry in recent years which runs completely counter to these principles and explains why clients are so frustrated with our industry:

1. Objectivity:

– Advice that is free of conflicts and only in the best interest of the client.

Example: A Benefit Consultant switching group retirement plans from one insurance company to another one in order to scoop a 1% switching fee/comission, all unknown/undisclosed to the client/plan sponsor.

2. Transparency:

– Complete & full openness & transparency of all of fees & transaction costs in client portfolios.

Example: An insurance company refusing to disclose to a plan sponsor client all of the investment management & related fees (ie: the complete MER) within investment pools used for their Defined Benefit Pension Plan Portfolio.

3. Honesty:

– Being truthful and ethical in all client advice and interactions.

Example: An international bank only disclosing directly charged investment management fees but not additional, embedded investment fees in underlying pool funds.  As a result, instead of the client’s understanding of a 1.80% fee, they were actually being charged 4.50%!

4. Fairness:

– Being evenhanded, unbiased & reasonable in all client advice and portfolio management activities.

Example: A Portfolio Manager establishes a closed-end fund structure for underlying equity investments that are liquid.  Unlike many closed end funds that would trade on an exchange to provide investors with liquidity for future sales, this one doesn’t.  Instead, the Portfolio Manager has created a limited market amongst investors and allows investors to do small partial redemptions each year.  As a result, the Portfolio Manager has created an investment fund in which he’s effectively “Portfolio Manager For Life”. For clients who have experienced disastrous performance in recent years, it’s like watching a horror movie at a theatre, a fire starts and the fire exit doors lock so you can’t get out!

5. Goals Orientation:

– Structuring portfolios to meet clients’ real goals, which are typically some form of current and/or future funding requirements instead of perpetually chasing relative returns against market indices and peer group comparisons.

Example: An investment manager search firm that was so focused on recommending money mangers to an institutional client that would outperform the market indices, that the institution regularly missed required funding payments, given the heightened volatility of the portfolio.

6. Solutions Orientation:

– Providing real solutions to investor clients that are guided by a set of portfolio management philosophies & processes in helping them achieving their investment objectives instead of selling them investment products that are nothing more than a collection of investment ideas without any purpose.

Example: An affluent family client with an $8 Million portfolio loaded with 45 mutual funds, all sold on a 4.5% deferred sales charge commission structure that would have resulted in $360,000 of gross commissions to the Advisory Firm upon account setup.  This commission was not disclosed to the client.

7. Due Diligence: 

– A rigorous research & due diligence process should be completed on all investment products before they are recommended to clients.

Example: An investment advisory firm didn’t do a sufficiently deep due diligence on the people involved in an international hedge fund manager.  The investment advisory firm had directed clients to this international hedge fund manager, and the hedge fund manager stole the client assets and disappeared.  All client assets were lost!

8. Effective Governance:

– Prudent oversight of portfolio management activities within client accounts, by advisory firm management & securities regulators, to ensure client investment objectives are diligently being pursued.

Example: The investment committee of a financial advisory firm meets regularly to discuss administrative matters of their discretionary investment management programs but doesn’t have a formal process for overseeing if client investment portfolios are being managed in accordance with their Investment Policy Statements and in pursuit of their investment goals.  Unknown to management, one of their Investment Advisors places a huge, risky investment bet in client portfolios that violates investment policy.  As a result, client portfolios experience a 60% decline.

If we all focus on adhering to these principles, it will be a gradual process, but the wealth management industry will eventually earn back client trust.  If not, client trust levels will continue to fall to ‘carpet bagger’ status!