Eenie.... Meenie..... Mynie.... Moe (How does an advisor pick their mutual fund firms).

The mutual fund industry is quite saturated with there being an array of different types of mutual funds, which might specialize in a specific sector, geographic location and/or asset class. Financial advisors, who choose to invest their clients in mutual funds, have a huge selection to choose from. As most mutual fund firms carry a wide selection of mutual funds, a financial advisor will typically only use the investment products of a few firms that he or she is comfortable with.


How do they choose which mutual fund firms to put their clients in? In order to get financial advisors to carry their investment products, mutual fund firms employ "wholesalers," whose job it is to persuade advisors to understand why their funds are better than the rest of the industry. Historically, "wholesalers" used what was called "soft dollars" to entice advisors to carry their products. These incentives could have been tickets to shows, games or even all-expense paid trips. As of late, these widespread "bribes" have gotten under control and have declined significantly over the years. However, they do still exist, but in a much toned down manner. Furthermore, a mutual fund firm can also offer higher trailer fees as an incentive to get advisors to carry their funds.


Looking at past performance does show a track record but do keep in mind that it is common place for mutual fund firms to merge bad funds with decent ones to make their history look better...Yes, this is permitted...and, yes, the next thing to wonder is how do we know how legitimate their posted returns are.

Deciphering Churning

Young and dashing...the young man looked every bit the Bay Street executive. A beautiful wife and home...he exuded a Canadian success story. Little did many know at that time that they were dealing with Bay Street's most notorious con man later made infamous in John Lawrence Reynolds' Free Rider: How a Bay Street Whiz Kid Stole and Spent $20 million. In just a few years, he manhandled his clients' accounts under the noses of his brokerages, who gave him plump titles and credibility. Smooth talking and charismatic, Michael Holoday was considered the ideal investment advisor by his clients until it all came crashing down. Holoday's favorite vehicle for his malfeasance was churning.

Churning, in the retail investment industry, is excessive trading in a client's account done with the intention of generating as much commissions for the advisor, while not focussing on the client's needs.

First and foremost, I'm grateful to say that the retail investment industry has improved to a point where instances of churning are becoming significantly less prevalent. Historically, the retail investment industry was filled with entirely commission (transaction)-based advisors where a commission was charged every time an investment product was bought or sold by a client. These commissions were the advisor's sole medium of receiving compensation, and they depended on it for their livelihood. Hmmm...I just realized I was talking in the past tense. Commission-based advisors still exist today and, most of them are honest and hard-working people. It is the industry, which they've adopted as their own.


Churning is rarely the reason for a clients' complaint. Usually, they complain about another aspect of their portfolio, such as losses, when churning is discovered. The problem was more common with commission-based advisors, whose drive for revenue may have interrupted their focus to give their clients the best.

A general way to assess churning: Add up the value of all purchases and sales (excluding Treasury Bills) in a year and divide the total by the value of your account in the beginning of the year. This is called turnover. If your turnover is less than 2, you are fine. If your answer is between 2 and 6, you should be conscious and start asking questions regarding the frequency of the buying and selling. Do be aware that the older you are, the closer to 2 you should be.
A more conservative method measurement of churning includes only the cost of purchases and not the cost of sales. If the answer is over 6 in this method, give your branch manager a call.

The Power of the People

Can consumer advocacy become a powerful special interest group? I certainly hope so. One of my favorite consumer advocates, Ellen Roseman, is one of the country's few unwavering constants. With a blog and a column in the Toronto Star, she cunningly points out injustices being committed toward the consumer. While for the most part it is teaspoons out of an ocean, she builds awareness on whatever issue, and we're all better for it, including the companies she outs.

Now, Canadians have long been the victim of higher prices. With a relatively small population and oligopolies galore, we only have a few wireless companies to choose from, a few phone companies, a few Internet providers....and wait, it's provided by all the same companies. Of course, such variables do put us in the position for higher prices compared to other consumers worldwide, and we, for the most part, have accepted it. Sure, we complain. But, more so as a conversation piece, not so different from talk of the weather or celebrity gossip. Rarely, has such a statement been proven wrong until recently.

When Rogers won the license to carry the Apple's IPhone, die-hard fans held their collective breaths. If a Canadian wanted an iPhone, they'd have little choice but to accept the fees charged. The fee schedules did finally come out and provoked wide-scale uproar. All of a sudden, Canadians, who had been the victim of higher prices for years, were furious. Passive Canadians, who had accepted their fate of higher cell phone plans, higher gas prices in an oil rich country and a number of other things, were all of a sudden in a fury. Why? Why now? Of course there can be several answers to this, but when people want what they cannot afford....

Most famously, a site (http://www.ruinediphone.com/) was set up with the intention of showing Rogers the frustration felt by Canadians. With over 60,000 people signing the petition, the fervour fuelled countless newspaper articles and negative publicity for Rogers and, by extension, Apple. Reading this commentary myself, I thought Rogers would simply yawn at the headlines, ignore the petition and life would continue. They did have exclusive control over the Apple iPhone.

Shockingly, they yielded. They adjusted the price points, and Canadians can now get an Apple iPhone at a value short of a rip-off.

Why do I care? Why am I writing about this? It's sort of this successful change from the grassroots...the bottom-up approach....that exemplifies probably the most untapped way to get change in this society. Why we haven't more efficiently harnessed it remains beyond me. The Leafs are horrible? We question management's commitment? Why...Why, instead of just fan clubs, do we not just have fan unions, which can boycott entire strips of games. For those sports enthusiasts, remember, when MLSE hired Mike Babcock as GM of the Raptors. A novice GM with no prior experience, we watched Vince Carter get traded away for nothing and a decent team reduced to subpar. It wasn't until the fans stopped attending...that people stopped watching...that Babcock was fired, and they decided to get a former Executive of the Year (now, a two-time Executive of the Year), Bryan Colangelo. The Raptors are a good team again.

I do realize it seems like I'm harping and perhaps I am. However, if this approach can be applied to the Apple iPhone, then why can it not be applied to lobbying for lower MERs (Management Expense Ratio) or boycotting Principal Protected Notes and other investment products that sound sexy but provide little value to Canadians. Lobbies that, if done successfully, will save a Canadian family thousands of dollars and make Bay Street conscious of our educated collective.

It cannot go past us that change from the bottom-up is possible in this country, and we have a responsibiliy to ourselves and future generations to adequately harness a power so far neglected.

Dow Jones officially in a bear market

Now, I try to avoid play-by-plays of the markets just because there are so many people who do it much so better than me. However, this is an occasion. The Dow Jones is officially in a bear market, which is characterized by a 20% decline. With the S&P500 and the Nasdaq flirting with a similar classification, there is a great deal of uncertainty in the market right now. Understatement of the century, right?

As the economy goes through an incredibly volatile period and is flirting with stagflation (high inflation, limited growth, high unemployment), it kind of makes me feel...that really...it's about time. It's about time this uncertainty reached the mainstream and played its toll on the markets. With high inflation, central banks have no choice but raise rates to keep it in check. However, a recessionary environment is best fought with lowering interest rates. Not since the 1970s have so many brilliant men and women been so doubtful of what the central bank should do. It appears there's no clear answer. With these issues with liquidity (our "credit crisis"), we're learning as we go along.

Remember, although a recession has been declared by many pundits, it has not yet reached a consensus yet. With the second quarter over, companies are beginning to come out with their second quarter earning's numbers. Perhaps with this, we'll be able to assess our two consecutive quarters of declining GDP (and, hence, declare a recession).

Remember, folks, be brave. For every recession, there is a recovery. As retail investors, we have to be concerned with the long-term and not selling on weakness. Hang tight. If you guys have an Investment Policy Statement and a full financial plan, you have all the insight you need going forward. The more transparency in your relationship with your advisor, the more confidence you have in your portfolio during uncertain times.