PWL Capital March 23, 2015 Market Research Canada Sleeps (Part 1) A recent study concludes, on average, financial advisors provide poor value to Canadians. Recently an investor came to us concerned about his portfolio which was managed by an investment advisor who was a Vice President at a bank brokerage. We were puzzled by the portfolio design as it did not obviously relate to the investor who was risk averse and needed only a modest portfolio yield to supplement his pension income. Reading the advisor newsletters made it clear that the advisor had been forecasting a severe market downturn for a number of years and was a strong advocate of investing in precious metals and betting against equity markets. His view, no doubt sincerely held, seemed to take precedent over the client’s circumstances and needs. This case came to mind when reading a recent study that asked the simple question: are financial advisors good for Canadians? The financial industry speaks loudly about the advantages of having a financial advisor and investors seem to agree: roughly 80% of the $876 billion in retail investments in Canada are in advisor managed accounts. However, actual evidence about the impact of advisors has, until recently, been elusive. The main conclusions from the study, which was winner of the 2015 Canadian Investment Research Award, were: Advisors induce their clients to take more risk, raising expected returns An investor who uses an advisor will, on average, have a portfolio with a 30% higher allocation to equities than one who does not. Clearly this increases the risk to the investor and might be appropriate if the investor gains through higher returns and the investor needs those higher returns to meet his or her objectives. Alternatively the advisor could be biased by higher compensation from selling equity funds or equity trading that typically enjoys higher commissions than fixed income investments. In this case, more risk taking with the client’s money is motivated by gain to the advisor, not to the client. Advisors pay little attention to client’s risk preferences or their stage in life Advisor’s personal beliefs are more important than the client’s situation when designing the client’s portfolio. From the study, only 13% of the variation in the risk in a portfolio could be explained by the client’s risk tolerance or age. This is disturbing; a client’s portfolio should reflect the client’s objectives and ability to take risks to achieve those objectives. An advisor’s own portfolio is a good predictor of the client’s portfolio More important in predicting the risk in the client’s portfolio than the client’s situation is the advisor’s own beliefs and preferences (as we saw in the example in the opening paragraph). Some may even feel this is a good thing that advisors “eat their own cooking” but it would be rare for a client to have the same risk preferences, financial goals and income as their advisor. The average client pays 2.7% each year in total fees and consequently gives up nearly all the gains from increased risk taking to the advisor or his fund managers. With expected returns currently around 5.35% for a balanced equity and fixed income portfolio then the net return to an investor paying annual fees of 2.7% is 2.65%, or about half the market return. For an investor who puts up all the capital and takes all the risk this is a deeply unattractive proposition. Estimates of fees are always controversial so it is worth highlighting that the researchers had access to the transaction level records of 800,000 clients of 10,000 financial advisors across four large Canadian financial institutions. To get to an estimate of who benefits from the increased risk taking noted above, the authors assumed the additional return from equities was 6% over bonds. An additional 30% allocation to equities therefore increases expected returns by 1.8%. Thus if an investor could self-manage for portfolio costs of less than 0.9% then there would be no advantage, net of fees, to having an advisor. The authors conclude “for the average investor, investment advice alone does not justify the fees paid to advisors” The study concedes that advisors may add value through retirement strategies, tax planning and estate planning as well as acting as a behavioural coach (although some advisors may need their own behavioural coaches). Nonetheless advisors, by offering expensive one-size-fits-all advice dominated by their own prejudices, are weighed, measured and found wanting in the central task of improving the wealth of Canadians. It will come as no surprise that we suggest that Canadians should look for advisors who: Act as fiduciaries and by their actions put their client’s interest’s ahead of their own. Rely on evidence based investment processes, rather than individual views or forecasts about market direction. Have total fees considerably lower than the national average1. 1 See blog for a discussion of fees Share: Facebook Twitter LinkedIn Email