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April 17, 2001

A wakeup call for fund investors
Your asset balance, management fees worth examining

Jonathan Chevreau
Financial Post

Full-service stock brokers have come under considerable heat the past few weeks over questionable trading practices leading to losses for clients.

So far, with the odd exception over the years, the chickens haven't yet come home to roost for the nation's mutual fund dealers. Investment funds are far more diversified than individual stocks and there's less potential for catastrophic losses due to one or two bad trades. But that doesn't mean the equivalent of stock-churning doesn't occur with ill-advised switches of mutual funds.

If nothing else, the lessons stock investors are learning from scrutinizing their monthly statements could be applied by mutual fund investors.

If most of your nest egg is tied up in funds, you may want to ask yourself a few of the ten questions posed by fund consumer advocate Joe Killoran at his Web site at www.investorism.com.

For example, Killoran suggests investors ask themselves when they last reviewed their asset mix holdings in their investment portfolio. Oh sure, most monthly statements tell you at a glance that your portfolio now contains 45% stocks or equity funds, 45% fixed income and 10% cash [or whatever your personal mix is] but they rarely dig deep and adjust for the anomalies of bonds in balanced funds, cash in equity funds etc. And when, to paraphrase Killoran, "was the last time you compared your portfolio asset mix disposition against a prudent investment asset mix portfolio by your age, years to retirement and risk tolerances with a portfolio from a qualified pension actuary?"

Well, not lately, right? At best perhaps, when your advisor was rustling up his February RRSP contribution from you, you chatted about "rebalancing" -- most likely cashing out of some idle T-bills to snap up some bargain-priced technology funds.

Another red flag raised by Killoran five years ago is leverage. It's clear that a disturbing number of Canadian investors -- particularly seniors -- have been burned in recent months on margin calls in the current bear market. Killoran's 10 questions include this one, which I've condensed: "Do you know how much of a stock market hair cut correction it would take to produce a 100% loss of your money or a scenario where your home equity loan will be called?"

Hey, the stock market always comes back, doesn't it? Yes it does, but will it do so in time if you're deeply under water and facing margin calls?

Perhaps you're not such a gambler and happy to buy and hold funds over the long run, gradually dollar-cost-averaging your way to financial nirvana. If so, can you answer this: "Do you know the annual Management Expense Ratio (MER) deducted annually or quarterly by the fund manager from each of your holdings?"

And do you know the long-term impact of that MER on your investment returns? The answer to that can be found at Industry Canada's MER calculator at http://strategis.ic.gc.ca/SSG/ca01457e.html.

Or, and here we come closer to the parallels with the stock brokerage industry: Do you know how much of the MER you pay on funds is a trailer commission [annual service fee] paid by the fund company to the advisor for every year he or she convinces you to stay with the fund?

Why is this relevant? If your advisor is suggesting a switch of -- for example -- Templeton Growth to AGF International Value -- wouldn't one piece of information in your assessment of the switch recommendation be the resulting doubling of the trailer fee accruing to the advisor for the switch?

This is the kind of "disclosure" or "transparency" Killoran has been pushing Canada's fund industry to adopt for years. He's been ignored, laughed at and all but drummed out of the Canadian financial services industry for his trouble but suddenly, the questions he's been raising seem more relevant.

Another area where questions have been asked and largely ignored by the industry and regulators is self-regulation. More than two years ago, in her Investment Funds in Canada and Consumer Protection report [made to Industry Canada's Office of Consumer Affairs], Glorianne Stromberg asked penetrating questions about the effectiveness of self-regulatory organizations (SROs) in Canada. In stocks and bonds, the Investment Dealers Association has SRO status and in mutual funds the Investment Funds Institute of Canada is lobbying to be accorded similar status. Last week, the Mutual Fund Dealers Association, under the IDA umbrella, was given similar SRO status.

The investor abuses revealed in recent weeks at Nesbitt Burns call into question how effective self-regulation can be from a body that simultaneously serves an industry as well as the consumers who feed that industry.

"Is there too much 'self' in 'self-regulation?" Stromberg asked in her report. She posed 18 other questions, including "Do competitive interests interfere with or delay the rule-making process of the SROs?" She also asked how dependent are staff of SROs on the goodwill of the members and asked "should there be a separation of member regulation activities, market regulation activities and industry trade association or advocacy activities?"

I've no doubt 99% of Canadian stock brokers and fund dealers are honest practitioners who deliver much-needed advice in a confusing financial world. But if you're unfortunate enough to be in the hands of the unscrupulous 1%, ask yourself whether perhaps the fox may be in charge of your chicken coop.

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