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By Jonathan Chevreau
National Post
FP Investing Section
Thursday, July 29, 2004 |
You don't get something for nothing. You don't get freedom for free -- Rush, 2112
I don't know how Neil Peart and his bandmates invest their money, but based on their lyrics these Canadian rockers probably don't begrudge paying for good financial advice.
Adrian Mastracci, investment counsel at Vancouver’s
‘fee-only’ KCM Wealth Management, says, "many mutual-fund investors still labour under the illusion they're paying no fees, even if the funds they own sport management expense ratios (MERs) of 2.5% or more.”
Recent columns on fee-only planning and the ongoing tug of war between active and passive investing camps generated much advisor feedback on advice and how they charge for it.
Vancouver fee-only advisor Adrian Mastracci of KCM Wealth Management says many mutual-fund investors still labour under the illusion they're paying no fees, even if the funds they own sport management expense ratios (MERs) of 2.5% or more.
Thus, someone with a $500,000 collection of funds may believe that because they are not presented with an invoice for $12,500 each year (2.5% of $500,000) that the advice they're receiving is therefore "free." Ask them to cut a cheque for independent advice, though, and they run like scalded puppies.
John de Goey, senior advisor at Assante Corp., agrees the impression has taken hold that advice is free. "Many advisors have perpetuated the myth," he adds, "Advisors are going to have to admit that compensation is a factor in the recommendations they make and that advice is not free."
It's not hard to see how this misperception arose. In its heyday, Altamira did such a good job promoting its "no-load" funds that many investors interpreted this as "no-fee."
While no-load funds don't charge front or rear "loads" (sales charges), many carry MERs well north of 2%. This is true of bank no-loads, although independents like Phillips Hager & North Ltd. and Saxon Funds have MERs below 2%.
When load firm Mackenzie Financial pioneered the deferred sales charge (DSC), investors welcomed the end of front loads, which once reached 9% of the sale. DSC fund salespeople tell clients "100% of your investment" goes to work for you (rather than the 91% inherent in 9% front loads).
Little wonder investors thought they weren't paying for advice. But the MER was there all along and gradually rose as the industry moved en masse to DSC.
Asking your advisor about the merits of active versus passive investing is futile, since the debate goes to the heart of how they are paid. Most DSC funds are actively managed. Those who sell them profess to believe in active management because that's who pays them.
High MERs make possible their annual trailer fees, called "embedded compensation." De Goey, who is on a committee for Ontario's Fair Dealing Model, favours prohibiting embedded compensation, but is resigned to the fact his industry will instead opt for more disclosure of it.
Fee-only or fee-based advisors (they're not the same) are more likely familiar with the vast research (see www.ifa.com) showing the superiority of indexing to active.
MERs of index funds or exchange-traded funds (ETFs) are far lower than 2%, but they aren't zero, either. They range from the 0.17% of the Barclays i60 to the 0.55% of other Barclays iUnits and up to 1% for certain foreign ETFs.
That's just for the passive investment products. If you want advice as well as access to these products, you'll pay more one way or another. If from a broker, you'll pay normal commissions to buy or sell the ETF. Or you'll pay a fee to fee-only or fee-based advisors.
Since they aren't paid by DSC funds, fee advisors are more likely to recommend low-fee no-loads or indexing. This is the model of Mastracci's KCM Wealth Management, Toronto's T.E. Financial Consultants and Montreal's PWL Capital.
These firms keep client costs down with (mostly) passive funds, but also charge perhaps 1% a year on the total value of portfolios (varying with client wealth.)
Clients receive invoices for these fees (but not on the portion accounted for by fund MERs). The fee may be tax deductible.
Some fee-based advisors, including de Goey, straddle the line by selling actively managed F class funds as well as ETFs. F class have lower MERs because they pay no trailers, but when you add back the advisor fee, the cost is similar to DSC funds.
To further cloud the picture, the American Stock Exchange expects a U.S. issuer to create an actively managed ETF before year-end.
It's almost impossible to get the DSC crowd to look at indexing research. If they do, they respond irrationally. One reader/advisor dismissed index funds as a "scam," resorting to the tired example of Nortel scuttling the TSX index.
Another DSC salesman -- who declined to be identified -- made this incoherent argument: "If every person in every market purchased the index, the market would cease to exist because markets are moved on a daily basis on emotion and trading. Thus, the indexers receive a free ride on the back of the active people. They're like people going to a pot luck dinner and not bringing anything to eat."
There you have it from an active advocate: there is a free lunch after all and it's indexing. This advisor later softened his stance: "Indexers and active managers can co-exist in this world because we need them both to make markets more efficient."
Financial planner Jim Otar provided the most cogent summary of the trade-offs of the two modes: "Don't give up active trading if you have the required discipline. Otherwise, yes, passive portfolios are better than random acts of active trading."
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