October 22, 2010
There is now consensus that Canada needs a major overhaul of its retirement income system. One of the key enablers of this overhaul is a more investor friendly financial industry. Let’s look at three changes which would go a long way to a achieve this: fiduciary responsibility, low-cost asset management with decoupled fee-only advice, and mutual rather than public financial corporate organizations driven by customers’ best interests.
Vanguard founder John Bogle said “No man can serve two masters”. A fiduciary must act in the best interest of her client. In the U.S. financial advisors with RIA (Registered Investment Adviser) and CFP (Certified Financial Planner) designations are required to act as fiduciaries. Perhaps you thought that in Canada your broker, mutual find salesman, financial planner and insurance salesman were required to act as fiduciaries; but they are not.
In Canada, anyone can call themselves a financial advisor and there is no legal fiduciary requirement. Unless the advisor voluntarily undertakes the fiduciary duty or is bound by it as a condition of a designation which she uses as part of her practice (e.g. the global Chartered Financial Analyst or CFA designation pursuant to which they “must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests”), it is safe to assume that the advisor is non-fiduciary. Without the fiduciary duty, advisors may have to struggle with potential conflicts between their own interests, those of their customers and those of their employer.
Low-cost and decoupled fee-only advice
It might be more challenging to act in the best interest of the client when an advisor’s compensation is transaction rather than fee based, when it is embedded transparently or opaquely in the product and/or when they are restricted to offering the products supplied by their employers.
Jeremy Grantham said recently that “The (financial) business is a zero-sum game, he points out, and “we (financial industry) collectively add nothing but costs”. Costs have grown because there is no fee competition and the information advantage the agent has over the client is tremendous. Growing complexity has increased the client’s dependence on the industry.” (FT)
Canadian mutual fund management fees are still in the 2-3% range (according to one study they are the highest in the developed world), yet amazingly most people continue use mutual funds, rather than broad index-based Exchange-Traded Funds (ETFs) with fees in the range of 0.1-0.5%, to build their portfolios.
The market makes the same return available to all participants. There is no evidence that stock selection can add sustainable value after management fees. Over a 40 year saving period, having your assets face annual headwinds of 2% in excess fees will result in almost 50% lower assets and corresponding income in retirement. Some argue that the higher fees come with advice, but do you want the advice and if you do, do you understand what the advice is and whether it’s worth 50% of your assets?
In the past twenty years mutual insurance companies and privately owned fund management companies have converted into public shareholder-owned corporations. For the management and board of policyholder owned mutual insurance companies there was no confusion; their owners and customers were one and the same.