Exchange-Traded Funds (ETFs) are great products for investors only if: (1) they have rock-bottom fees, which means that investors keep what they don’t pay and (2) they have low turnover, which allows investors to create portfolios that are highly tax efficient. While they can nominally be called “ETF-based”, two new products fail to sport either of these advantages.
Jon Chevreau recently reported that AIM Trimark has launched ETF-based “target date” portfolios, which holds some fundamental index ETFs. A commenter posted the link to the Retirement Payout Portfolio prospectus and noted that the MER is likely to be around 2%. In addition, investors in these funds have to pay a sales load or opt for a deferred sales charge. It’s true that these funds are slightly cheaper than actively managed mutual funds that charge a MER of 2.5%. But, 2% is still too rich to pay for a smidgen of ETFs and a large dollop of mutual funds when an investor can construct a similar portfolio for 0.25% or less.
Investors can make their portfolios conservative over time simply by channelling new savings into the fixed income area. The AIM Trimark Portfolios incur unnecessary turnover by rebalancing their existing portfolio every year.
The other new “wolf in sheep’s clothing” is JovFunds tactical allocation portfolios constructed solely out of ETFs and charging a breathtaking MER of 2.25% (including a 1.25% trailer). And “tactical” is an euphemism for market timing, which even when it works (it hardly ever does), incurs devastating turnover.
Tom Bradley puts it best when he observes that “the marketing imperative of the wealth management industry is turning an effective and valuable investment product into something that makes no sense for the client”. On Bay Street, when the interest of investors clashes with the bottom line, the bottom line always wins. Why should ETFs be any different?
Bookmark: del.icio.us Digg StumbleUpon
13 responses so far ↓
1 Al // Jun 9, 2008 at 8:11 am
Fees, fees, fees. It’s not about securing the future of the investor, but securing the future of a bloated industry that does very little for society. And of course, people will buy these.
2 Canadian Capitalist // Jun 9, 2008 at 10:57 am
Al: Unfortunately, these funds are created to be sold, not bought. And it is just sad that advisors, who are paid to look after their clients’ interests, will push their clients to buy these products.
3 Charles // Jun 9, 2008 at 11:25 am
I agree that the “glide path” is not worth paying that extra fee. You could just lay out a course such as “I will start with X% bonds and that will increase 1% a year”, and then at annual rebalancing time, take that number into account.
4 telly // Jun 9, 2008 at 11:45 am
These “target date” portfolios have been very popular in 401k’s and other work pension plans in the US for a number of years. I’m surprised it’s taken so long to start seeing them in Canada.
Of course, the fees for these types of funds are much lower in the US. It’s rather embarrassing to see what’s available to us Canadians.
5 Daily Buy-Sell Adviser // Jun 9, 2008 at 4:36 pm
I think any ETF worth its salt can be defined by a its simple, comprehensive approach and low fees. The more “creative” an ETF, the more expensive — and less effective — it tends to be.
6 Yve // Jun 10, 2008 at 2:29 pm
Hi there,
I am rather new to investing (or rather engaging critical thinking skills when it comes to investments). I have had money in mutual funds for over 25 years (i am 45) and have not been overly impressed by the returns. I was always told it was the right thing to do and have been trying to do the right thing since I was very young. To be fair I have been in the market long enough to have been through a couple of (at least) market catastrophes and the bull runs have maybe not been long enough to make up what I would call substantial gains over the losses. Which brought me to ETF’s. I did a lot of research, lined up my questions and went off to my financial advisor who said “What’s an ETF? Never heard of them.” I was astonished, then skeptical at his ignorance. But as happens, similar to getting a hair cut, I somehow lose all personal will as if an alien being has taken over my brain and let him talk me into something I don’t want. I let him put $225,000.00 in mutual funds! Here’s the break down: $30,000.00 in AGF Canadian Balanced, $30,000.00 in AIM Canadian Balanced, $30,000.00 in CI Harbour Growth & Inc, $75,000.00 in Dynamic Value Balanced. $30,000.00 in FID Canadian Balanced Series A & $30,000.00 in TD Monthly Income A. My advisor an agent for Dundee Wealth Management fyi. I just want some advise from someone who isn’t self serving and just trying to sell me something. He defended high MER’s by saying that “hey, if the guy gets you a great return, them pay him the 2.5%, you betcha!”. Now that I am invested in these things am I stuck? He said that he felt that there could be some market volitility this summer so that’s why he was more comfortable with the above choices and we could revisit the allocations later this summer. Somebody please tell me what to do! All the reading I have been doing regarding EFT’s makes me think I’m missing the boat. Sorry for the long post and thanks.
7 Canadian Capitalist // Jun 10, 2008 at 2:54 pm
Yve: I am not a financial advisor and I have no clue what your asset allocation should be. But, I can tell you this: you should look for a competent advisor- some one who knows what he is talking about. Your current advisor who is asking “what’s an ETF?” is failing Investing 101 in my book.
Also, you don’t pay 2.5% if the guy gets you a great return. You pay 2.5% regardless of the returns a fund manager gets and there is no reliable way of picking the winning manager in advance.
Revisiting asset allocation based on market conditions generates turnover (great for the advisor, not so much for you) and hurts returns. One of the hardest things to do is timing the markets. I’ll have to say that you need to do yourself a favour and find a competent advisor.
8 Yve // Jun 10, 2008 at 3:34 pm
Thank you Canadian Capatalist. Part of my problem is how to find an advisor, someone who is soley interested in dispensing advice based on my current condition and has no interest in selling me a basket of products from which they derive their income. The banks all have them, but they sell financial products, same with all of the financial services such as Investor’s Group, Dundee etc. My advisor is a nice old guy, but in the end he doesn’t have to go to sleep at night and worry about the choices he’s talked me into. His money is already in the bank. Beyond a basic “risk tolerance” test, there’s not much in-depth analysis of what I should or should not be doing. The risk analysis strikes me more of an exercise in covering his butt, so if you go beyond a certain “beta” and you lose your shirt, the advisor can point to it and say, “Well is says here you were okay with that decision, based on your risk tolerance.” To me that isn’t really advice. It’s this sort of thing that has let me to these financial blogs and i have been really trying to figure out for myself the best strategy. I know that leaving it in the bank is disasterous, inflation alone will eat me alive, mutual funds have been the touted route to sucess, but they have their draw backs too, and quite frankly left me with less than stellar returns. But, here I am against my own judgement, jumping into more of them because I feel that I am not yet at the point where I should trust my own judgement, which leads me back to my financial advisor, which lead to more mutual funds, MER’s, taxes, inflation eating my gains etc, so what’s a girl to do? If anyone has any suggestions on what to look out for when vetting a new advisor, that would be great. I am trying to become more hands on with my financial planning, but the process is a little intimidating when dealing with complex things as the markets and advisors who in the end make a commission, no matter what they sell you. Thanks, and great blog by the way, I’ve been following it for a couple of years and have enjoyed it very much.
9 Canadian Capitalist // Jun 10, 2008 at 4:30 pm
Yve: Since you are uncomfortable investing on your own, you should look for a “good” advisor. Ask around, talk to your friends and get referrals. Interview some of them. You have a large enough portfolio that should allow you to hire a good advisor. How to find an advisor might make for a good blog post.
10 Canadian Capitalist // Jun 10, 2008 at 4:34 pm
Yve: You may find this article helpful:
http://www.mackenziefinancial.com/en/pub/tools/advice/index.shtml
11 WhereDoesAllMyMoneyGo // Jun 10, 2008 at 11:59 pm
Yves - you also need to figure out the cost of changing your portfolio to ETFs if you do decide to go that route. If those funds you mentioned were sold on a DSC basis (deferred sales charge) then you can get hit with as much as a 5.5% redemption fee which would be well over $10,000 in your case. If this is indeed the case, you may want to wait a few years for the redemption fees to decline (after 7 years they get to zero).
In the meantime, that may mean switching from the balanced funds from each provider into separate pure equity and pure fixed income funds - this will generally bring the MERs down since balanced funds tend to have MERs closer to pure equity funds even though there can be a significant fixed income component (which may be available purely and separately with a lower MER).
So for example if a company had an equity fund with an MER of 2.5 and a fixed income fund with an MER of 1.5 and a balanced fund with an mer of 2.35 and the balanced fund was 60% equity and 40% fixed income, you would be better off holding the 60% of your investment in the pure equity fund and 40% in the pure fixed income fund. Your blended MER would be 2.10% (versus 2.35% with the balanced fund).
Also, you will normally be able to redeem 10% of your holding in a fund family per year even though you are in the middle of your DSC schedule. This means you could slowly shift your portfolio to ETFs without incurring those redemption fees - there would still be a delay however.
If your funds are “no-load” you should be able to switch them all over right away with no cost (but be mindful of getting a projection on any tax liability first for a non-registered account).
Given the costs and general underperformance of actively managed funds, many “converts” are happy to pay the redemption fees (if applicable) since the costs are recouped over time through ongoing fee reduction, and more than likely long term outperformance as well (of ETFs versus active funds)
Ideally, your new advisor should be able to prepare a list of options for you to consider along with the costs of implementation and the pros and cons of each. They should be willing to openly discuss their compensation methods and disclose their compensation for each option as well.
Good luck finding an advisor - it is not easy. Even referrals from friends may not be enough because your friends may not be capable of making that determination on their own. They may very well think they are passing on a good advisor to you, but they might not know better themselves.
Disclosure: I am a financial advisor, so really you should take my comments with a grain of salt.
12 Onus Consulting Group // Jun 11, 2008 at 4:25 pm
I have to say you have a great deal of maturity in your regard to this matter. Your observations are incredibly fair. What should your look for in an advisor? I have devoted a year and a half to filtering out what makes an incredible advisor. Indexing hundreds and interviewing dozens, it indeed has been a cumbersome ordeal. So, of course, I do have a few suggestions.
One suggestion is considering a fee-based relationship with your advisor. In this method, the advisor charges an annual or quarterly fee, which is usually expressed as a percentage of your portfolio size. You won’t be charged for individual trades and the mutual funds (known as F-class) invested in have significantly lower MERs (this is to…and should…off-set these annual fees). This gives your financial advisor an incentive for your portfolio to grow, as their compensation will also increase. With this, the advisor has no incentive to suggest one type of investment over another or to solicit you to make trades more than you should. However, as you’ve committed to paying the advisor a certain fee, a negligent advisor can stop monitoring your portfolio and still be compensated. While this is possible, you can easily avoid advisors like this with a little due diligence and a comprehensive Investment Policy Statement.
Whether entering or staying in a relationship with a financial advisor, make sure your advisor sets up two things for you: an Investment Policy Statement and a full financial plan.
The Investment Policy Statement is a document that details the dynamics of a client’s relationship with their financial advisor. It is a strong catalyst in bringing transparency into your relationship with your financial advisor. It should include:
i) the target and expected rate of return for your portfolio.
ii) the asset allocation and its permissible ranges
iii) the benchmark that will be used to evaluate actual performance
iv) investment constraints
v) all fees that will be charged
vi) frequency of contact
vii) topics to be covered in the quarterly review meetings
With the investment policy statement being filled out thurrerly, it will be an incredible tool in assessing the performance of your advisor.
During the process, it’s a great idea to set absolute and relative benchmarks with your advisor. Regarding your absolute benchmark, have they taken your income, risk tolerance, annual expenses and the age you wish to retire and given you the annual rate of return needed to achieve your financial goals? This is known as your absolute benchmark and making this rate of return understood holds the advisor more accountable. Keep in mind, this number is come up with by your advisor and yourself strictly paying attention to your personal circumstances….the ups and downs of the market are not to be taken into consideration, just your needs.
On the other hand, the relative benchmark tells you the performance of your investment portfolio relative to a market index. As a client paying for full-service advice, you’re looking for investments to do better than their respective index, otherwise you could seriously reduce your fees by investing in index funds or ETFs and also get better returns in the process. Has your advisor set appropriate benchmarks with you? If not, visit http://www.showmethebenchmark.ca set up by Warren MacKenzie and a collection of other fee-only advisors.
By comparing your relative benchmark to your returns, it is an excellent way of judging your financial advisor’s performance, while the absolute benchmark makes your expectations clear. These tools help greatly in assessing your financial advice.
Canadian Capitalist has a point: It is a little disturbing that your financial advisor isn’t sure what an ETF is. While I’m going to refrain from revealing which side of the debate I fall into, I have found that there are advisors that totally ignore the passive management argument (ie ETFs and index funds). While every argument has their pros and cons, it is bad for business if clients are switching to advisors who believe in this approach, as opposed to proponents of active-management, who in many ways have built this industry and make up the mainstream. Imagine not needing fund managers! What would it do to the financial services industry? Any one? Any one?
I think you might not be off base by looking at other financial advisors. If anything, it’ll give you a higher standard to assess the quality of financial advice you’re getting. Onus Consulting Group is an investor awareness group and a financial advisor referral service. If you’re based in the Greater Toronto Area, it wouldn’t be a problem to book a no-cost, no-obligation with one of the advisors on our roster (disclaimer: our business model is centered around collecting a referral fee for a successful match). We began indexing the advisors in the area a year and half ago and while we haven’t covered everybody….we certainly have a very good sample size of advisors that we’ve filtered through. If you don’t live in the Greater Toronto Area, give us a call toll-free (1-866-690-0088) if you need any additional feedback. Our investor awareness campaign is to improve the transparency in the retail investment industry for all Canadians…it’s the reason we exist and keeps us passionate.
Zahid
13 Thicken My Wallet » Blog Archive » Top personal finance stories for 2008 (so far) // Jul 3, 2008 at 4:55 am
[...] that the mutual fund industry is trying to turn the same trick in new clothes by offering exchange-traded funds with outrageous MER. Not all exchange traded funds are created the same. Check the MER’s carefully. Anything over [...]
Leave a Comment