What is investment risk?

“What is investment risk” is both simple and complex and in order to assess the information needed to assess risk we first of all need to qualify the world view of risk and return and then the model we are using to manage the risks and their impact. All this is beyond the subject matter expertise of the individual investor and why point of sale documentation can only ever inform about the broad nature of risk and return but never be sufficient to allow the investor to fully own the decision. Ownership of the transaction decision resides with ownership of the process and the significance of risk assumed with respect to risk via structure, assumptions and costs.

At a very basic level, risk is what happens to a price between two points in time and the impact of that movement in price – it can be both positive and negative.  But what gives rise to risk is more important than a mere list of risk factors, or indeed a narrow quantitative measure of risk.

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Gravitational collapse and retrograde movements…is the Canadian regulatory system imploding?

OBSI, the ombudsman for securities and investments is looking to hand over the review of investment complaints involving segregated funds to the Insurance Ombudsman.

OBSI will refer the investigation and analysis of segregated funds to the Ombudservice for Life and Health Insurance (OLHI) even if they form a part of a larger portfolio that is the subject of a complaint to OBSI.

It is also looking to give up its mandate to investigate systematic issues, although the reasoning here is not exactly clear – something to the effect that because banking systematic issues need to be referred to the FCAC, in the interests of fairness investment related systematic issues should no longer be investigated.  This is an incredibly fudged and fobbed explanation.  Dealing with systematic issues was a major recommendation of an earlier Navigator report.

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Research suggests that investors might be advised to avoid fee based brokerage models!

According to a recent report by PriceMetrix, a Toronto based financial services consultancy:

Advisors who are more aggressive and move a significant percentage of their assets into fee-based accounts benefit more quickly from higher RoA, revenue, and assets. They also use the opportunity to part ways with small households and reawaken dormant ones. Continue reading

Suitability Requirements For Complex Products

The February 2012 ISOCO Consultation Report on Complex products is out!

My opinion: no one should be allowed to recommend complex products without a) the necessary expertise and b) accountability and responsibility for a decision that should only be entered into with full discretion over the advice and investment process. Continue reading

Fund Facts present that “empty ta da” moment!

As usual, when faced with insanity there are always a number of competing depictions of the moment’s apogee: I had thought of “the lowest common denominator and the killer of fools”, “wake up and smell the commission”, but that ““empty ta da” moment” won through.   Yes, Fund Facts comes straight from the magic box of procrastination and irrelevance to create a sleight of hand that passes the muster of the hear no, see no and speak no evil crowd.

Tell a Canadian that their financial advisor is merely a salesperson, and that they cannot rely on their verbal assurances, that they alone are responsible for the investment decision, and you will be met with the type of look reserved for doggy poo on the bottom of your shoes.   Try getting anyone in a position of influence to hammer home that fact, and well, its like asking them to tell the emperor he has no clothes.   People neither want to hear nor to tell the truth. 

So when we hear phrases uttered by the mutual fund distribution system about the new mutual fund point of sale “The answer to every advisor’s prayer … a compliant one-stop solution for fund info.” we know that the sales people at least kind of get it.  And please note, that I have piggy backed again on a recent Jonathan Chevreau blog article – Fund Facts — The answer to every advisor’s prayer-

Please note: these documents are meant to bind the investor to the investment decision.  They are “supposed” to hold all the relevant information needed for the investor to assess whether the fund meets their risk profile, their time horizon and their investment objectives.   You can in fact connect the dots between the KYC and the Fund Facts document, because that is all this exercise is: this ties the information provided by the investor (KYC) to the product and confirms the investor’s decision to buy the fund.   The advisor moves outside the loop.  It is disarmingly simple,  and if I were a distributor I would be secretly rubbing my hands in glee, for we have effectively, moved from a loosely regulated transaction industry to one where there are no loose ends and no doubt as to who is responsible.  The regulators have deemed that the information in the FF is sufficient to make an informed decision, and written at a level where everyone can validly lay claim to their decision.

The Fund Facts is a crazily simple, “join the dots”, “tie the knot”, “ta da”, “fait accompli” moment that will formally and finally confirm Canada’s absurdly low regulatory standards for advisory based retail financial services.   This cannot be what we have been waiting for since at least 1999: why not just bring back the lions and the amphitheatre?  We would get the point.  

Is there enough information in the Fund Fact document to allow an investor to make an informed decision?  Not in any reality, no.    

What does the fund invest in?   Try and find information about investment style, risk and asset allocation differences relative to their benchmark.  Try and find anything of substance that will give you some guidance as to why you need an actively managed fund and you will come up with well, rien!  

Take the Investors Group “Investors Dividend Fund – Series A”: it states that it aims to provide above average income yield.  What!  With an MER of 2.69% this is both mendatious and misleading!  What is the actual current yield?    Well, if we look at the March 2011 annual report, annual income was some 3.75% of the investments as of 31 March.  Net income after all deductions was some 1.34%: hardly an above average income yield, but then again no claim as to the comparison.

Top 10 Investments – if you are going to make an informed decision, and you are taking responsibility, you need the distribution of the entire portfolio, its sector, market cap, yield, risk and price relatives to ascertain its exact position in the firmament and not just the top 10.   But hey! It looks good, and if you do not have a clue as to how to research an investment, or where it may fit in your portfolio, it may even yield an aura of substance. 

How has the fund performed? – there is no risk of the client finding out where the fund stands relative to others as well as to its comparative benchmarks.   So there is no choice and no panorama for an informed decision, merely a scrambling around in a dark and nebulous region.   Enlightenment is not the objective of the Fund Facts: do not look here for any form of financial renaissance.

How risky is it?  There is a range of risk from low, low to medium, medium to high and finally high but no framework or benchmark in which to place these benign captions.  Risk is a multi faceted character and there is really nothing here that the investor can use to  verify and quantify the risk of the fund, let alone the risk of the fund within their portfolio.   Again with reference to the Investors Dividend Fund, the fund is 80% equities and yet is placed in a low to medium risk compartment: the Morningstar report on the fund states that its risk is high relative to its category and its performance low.  Quite frankly I do not know what they mean by low to medium risk: if I was wholly exposed to this fund I would have thought I would be exposed to quite a lot of risk, would’nt you?  In which realm do the risk categories reside?  

The warnings in this section seem wide, general and vague: I looked at another fund, the Imaxx US Equity fund, which had returned 0.11% per annum since 2002, which invests in US growth stocks.  The warning was “do not buy this fund if you have a low tolerance for risk and want to preserve capital”: I would have thought that this warning would apply to practically every equity fund, and not just this equity fund.

Who is this fund for?  Here we are: the cover your backside moment! 

“Before you invest in any Fund, you should consider how it would work with your other
investments and your tolerance for risk.”

Surely not the investor?  Is this not the advisor’s job?  No it is not, at least under current regulation, even if your advisor makes it look as if they are personally recommending this as a damn good investment.   You the investor are making the decision, so you better be damn sure you are getting what you are paying for and that there will be minimal surprises.   What this really means is that you need to get off your backside and drill deeper into the fund and how it fits with your other assets, so good luck getting all the information you need.

Sales charges and expenses – it is interesting that for some fund facts, the sales charge option has already been decided by the time the FF is delivered – others do provide a range of costs and options.  The FF also only frames costs in terms of the capital and not the return.  An annual MER of 3% of capital may not sound large, that is until you frame it as a % of historic average return, and then you are talkin’.   If we do not frame costs in terms of impact on return over time, then we are really not providing any insight at all.

Fund expenses – not paid directly: course they are, just not direct from your wallet or bank account, but direct from your investment capital. 

Trailing commission – pays for services rendered?   The FF does not explicitly state what these services are, let us hope your advisor does!

There is not enough info to make an informed decision, only sufficient to link the recommendation to the KYC.   Of course, a separate sheet with much more detailed information on risk, asset allocation style, historical risk and asset allocation (detailed sector, market cap, P/E, P/B, yield relatives) and performance to a number of relevant benchmarks needs to be provided.  Not that I think many investors would be able to make head nor tail of the data and the stats, but it would provide the type of information that a small number of investors could use to accurately assess the efficiency and relevance of the recommendation.  We would still be left with the majority of investors who in reality do depend on their advisor to act knowledgeably and proficiently in their best interests, and for whom the current system cares not whether they serve that need or not.  To be exact, as stated in my previous post on the subject, Banking on our lack of financial savvy, advisors do not have to act in your best interests.

As it stands, under regulation of minimum standards in the retail advisory segment, investors are fair game and the new FFs codifies this state of affairs.  Shameless really, but not enough who know better actually care and not enough who could force change have the integrity and sense of justice needed to take to take this ball to hand.    

I wrote a detailed report into Canadian regulation and the new Point of Sale documentation with international comparisons in September of 2010.  If you really want to get into the nitty gritty (are you insane?), once you start looking at the detail and structure of financial services and their regulation it can get very dense, then read this document: Point of Sale Disclosure and Regulatory Failure in Canada

Annuities: the variable kind with the guarantees..

I have excoriated, in the past, these beasts of the financial services industry, especially in the “trough heavy”, high fees universe of Canadian retail financial services.  But what of new lighter, lower cost versions in the US, for example the Vanguard guaranteed lifetime benefit product?   I will address this deeper into this post, but first:

These products main claim to fame is that they guarantee a minimum withdrawal benefit over the lifetime of the product.  My main point has been that the costs of these products, in Canada especially, murder the benefits, are more likely to trigger the guarantee, and you are likely to be better off taking a low cost passive investment approach.   

In fact, referencing the negative scenarios often depicted in insurers’ glossy marketing brochures, you would be much better off selecting an equity only low cost index investment (absurd!).

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Leveraged ETFs

Seems people do not fully understand the dynamics of leveraged  bull and bear ETFs!  They seem to think that they should mirror the market movement in terms of its multiple.  For example, if an index is down 20% over 6 months they expect that the reverse or bear ETF would show a gain of 60% and vice versa a loss of 60% for the bull.  Unfortunately it has nothing to do with the total return over a period but the daily ups and downs over that period.    In fact, these instruments are not designed to provide long term returns and should only be traded.

The following analysis assumes no change in an index over the period in question, but daily 20 point swings starting from an index base of 100.  As you will note a 20 point swing down from 100 is 20% and a 20 point swing up from 80 is 25%, or 60% and 75% if leveraged 3 times.   Carry this forward a few days and it is clear that a reverse leveraged ETF will lose money over the period (the loss day % is higher than the down day percentage).


The first day is a negative day, so let us see what happens to a triple leveraged bull ETF under this scenario: a loss too.


So what if the sequence starts off with a gain: what happens to the leveraged bull ETF?  A loss again.


Obviously these are extreme examples, but it is the mathematics of point movements relative to percentage changes that impacts these investments.