Investors could be in for a surprise in the new year as their annual investment statements roll in.
New rules that came into effect this past summer will finally kick in regarding disclosure on fees and performance.
As the final requirements of the Client Relationship Model — Phase 2 (CRM2), the changes are part of a larger initiative by the industry and regulators to increase transparency.
As an investor, what you will now see is how much you’re paying to the dealer in annual fees as a dollar amount. In addition, the statement will show a money-weighted return on your portfolio.
So, presumably, you will have a better understanding of the performance of your investments and the amount you’re paying for advice.
Of all the changes that have come into effect over the past few years — CRM2 has been phased in since 2014 — these final steps, which will be fully evident to investors in early 2017, are likely the most important, says Don Murray, the chairman of the Manitoba Securities Commission.
"These are going to bring a lot of things into sharper focus, particularly the compensation question," he says. "It will all be set there and will show up in a dollar figure."
And it’s likely some investors will not be pleased.
"It’s possible there will be some sticker shock," he says.
A good number will be questioning why they’re paying hundreds, even thousands of dollars a year for advice they may or may not be receiving.
While this may seem like a major headache for the industry itself, it is actually "onside with this because everyone agrees transparency and disclosure are good things, and it’s probably been too long coming," Murray says.
And investment firms have spent a lot of time preparing, including Investors Group, one of the largest mutual fund companies in Canada.
"We made a real conscious effort to get up to speed when we knew these regulations were coming in," says Aaron Margolis, vice-president of product management for Investors Group.
"We have really undertaken a two-year project to educate our advisers on what CRM2 is, while asking them to really think about why they’re in the business and what value are they providing to the client."
The latest changes actually represent a seismic shift for the industry, says Tom Bradley, president of Steadyhand Investment Funds in Vancouver.
"A lot of (investment firms) are already changing their bad habits," he says.
"They’re getting away from trailer fees, for example, so I would liken it to the financial management industry’s Y2K."
While the elimination of deferred sales charges is a welcome result, the new disclosure requirements are not a panacea. In fact, the new rules could lead to more confusion — especially when it comes to how much your adviser/planner is earning, says Doug Nelson, a portfolio manager and president of Nelson Financial Consultants in Winnipeg.
"It is important to note that of all the fees shown on an annual statement, only a portion of the fees disclosed is what is actually paid to the adviser."
That’s in part because the disclosed amount is paid to the "dealer," which refers to the firm that employs the adviser. The dollar figure is split between the company and the adviser.
And, in most cases, advisers have costs to pay out of the fees they receive, such as rent and administrative costs.
Ideally, Nelson says the statements should provide even more detail.
"The client should see the costs of the total portfolio broken down into meaningful components: the underlying cost of the products, administration and transaction fees, and adviser and dealer compensation."
The new disclosure will only reveal the compensation part (and arguably not all that well). And that can be misleading.
For example, $1,500 paid annually to a portfolio manager may not be equal to $1,500 paid to an adviser managing mutual funds.
That’s because an investor with the mutual fund adviser is still paying additional management fees that come with the mutual funds (which might be two per cent of assets a year), while the other investor may not have as significant additional costs.
The opaque nature of the fee disclosure aside, some investors will be gobsmacked by the dollar figure they’re paying, particularly those with large portfolios (six figures and up) who rarely see or hear from their adviser.
"There will probably be about half to a million Canadians who become free agents in January when they get a big shock realizing they’re paying $5,000 a year in fees and their calls aren’t returned, or they just hear from their adviser in February when it’s RRSP season," Bradley says.
"That won’t happen to everybody because there are a lot of good advisers who can justify their fees, but it will happen with a significant portion of the investment population."
Margolis agrees the new year could involve bumps.
"For companies doing a good job of making sure their advisers adhere to being transparent with clients at the beginning of the relationship, CRM2 is a non-event," he says.
"For those who have not done that good a job, that’s going to be a difficult conversation they will need to have with their clients."
Undoubtedly, most investors should already understand their adviser — often a financial planner — needs to be compensated for building them a financial plan and providing guidance picking and managing investments.
But soon they’ll know more about how much they’re paying, even though it will not be an entirely clear picture.
The same goes for performance.
The new rules make portfolio-performance disclosure on the annual statements mandatory, but the figure will be provided as money-weighted percentage performance, which may be confusing to some people.
"It will take into account money that you put in and took out over the year," Murray says. "It will show a change in dollar figures and also a percentage change."
This yardstick, however, can distort understanding of performance when money is added or subtracted from the portfolio.
For example, performance will appear even better when money is contributed in an up market, and losses will not appear as deep in a down market because of contributions. (And it would be just the opposite when money is being withdrawn.)
While this style of reporting will make it harder to compare portfolio performance to a benchmark index, the aim is to allow clients to compare the money-weighted return to their overall performance needs.
So, for example, if they require a five per cent return a year to achieve their goals, the money-weighted return would provide a good comparison.
It’s not perfect.
None of the new regulations are, but they will give investors more information than before.
"That’s not just in their best interest; it’s also in the best interest of the advising community because the additional disclosure and understanding will improve the relationship between investors and their advisers," Murray says.
"And, at the end of the day, that’s what this is all about: the client-relationship model.