Winnipeg Free Press - PRINT EDITION

Purposefully passive

New firm represents a revolution in investing

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Som Seif is as close as you can get to a revolutionary in Canada's investment industry. The under-40, avid swimmer has been going against the current of the mutual fund landscape ever since he headed up Claymore Investments in 2005, a pioneer in low-cost exchange traded funds (ETFs).

Since then ETFs have become all the rage with investors who are increasingly disillusioned with mutual funds. By 2012, Claymore had billions of dollars in assets under management when it was swallowed up by its much larger competitor Blackrock, whose iShares brand of ETFs dominates the Canadian market.

Quick facts

The lineup: Purpose Investments' ETFs and mutual funds all have unique features setting them apart from other products in the market. Here's a look six of them.

High Interest Savings ETF: This ETF functions like a high interest savings account, only its units are traded on the TSX, allowing investors to keep cash on hand in their brokerage accounts while earning a steady, conservative return that outperforms a money market fund. Net of its 0.1 per cent management fee, the yield is 1.35 per cent, distributed monthly.

Core Dividend Fund: This ETF contains the top 40 North American firms based on fundamentals like growing earnings and a history of dividend growth. The management fee is 0.55 per cent year and 1.55 per cent for its 'series A' mutual fund sold through advisers compensated by commission. The annual yield is about 3.5 per cent.

Total Return Bond Fund: This fund tactically invests in government, investment grade corporate and high yield bonds in Canadian and U.S. markets, primarily through exposure to three ETFs: the iShares U.S. High Yield Bond Index, the iShares DEX All Corporate Bond Index and the iShares DEX All Government Bond Index. The fund also uses options contracts and other derivatives to hedge against interest rate and duration risk. The management fee is 0.45 per cent and it pays a yield net of fees of about 2.4 per cent. The 'series A' mutual fund fee is 0.95 per cent.

Tactical Hedged Equity Fund: Marketed as a way for investors to defensively hold equities, the ETF holds 70 North American stocks using a strategy called "risk parity," Purpose Investments CEO Som Seif says. The fund decreases exposure to stocks at higher risk of falling in value while increasing exposure to sectors with a higher probability of increasing in value. Seif says the ETF offers a hedge fund-like strategy to the average investor, only without the high fees. For example, the top tactical mutual funds charge about 2.5 per cent a year while actual hedge funds -- available only to big money investors -- charge "two and 20." That's a two per cent annual fee and 20 per cent of returns above a fund's high watermark. In contrast, the Purpose offering has a management fee of 0.8 per cent and the 'series A' mutual fund charges 1.8 per cent.

Diversified Real Asset Fund: The ETF offers investors a strategy to preserve purchasing power against inflation by investing in the real assets sector, owning mostly real estate investment trusts (REITs) and companies involved in the production of agriculture, mining and energy. The ETF contains 60 companies and trusts, charging a 0.6 per cent annual management fee. The 'series A' mutual fund carries a 1.6 per cent management fee.

Monthly Income Fund: This is a balanced income fund made up of about 90 investments, including dividend stocks, fixed income ETFs and other income producing investments like REITs. The fund is rebalanced and reconstituted monthly and yields about 4.9 per cent. The annual management fee is 0.55 per cent and 1.55 per cent for its 'series A' mutual fund.

-- Based on data as of Nov. 6; all funds except High Interest Savings ETF have 'series F' mutual fund versions for fee-only advisers and charge the same management fees as their counterpart ETFs.

Seif found himself at a crossroads. He still saw a need for continued change in the industry, but the mission of how to democratize low-cost, passively managed funds was largely complete.

The marketplace had become very crowded. Blackrock's iShares now owns the lion's share, but Horizons, PowerShares, Vanguard and the big banks have lineups of passively managed ETFs.

Starting another firm, offering ponies doing the same trick, would be a suicide mission. Still, Seif was undeterred. He didn't just want to wade back into the market. He wanted to make a splash with an innovative new lineup of ETFs Canadians had never seen before, and earlier this year he launched his newest "game-changer": Purpose Investments.

"We grew Claymore from zero to $8 billion in seven years, which was the fastest growing firm in Canadian history, so it was a lot of fun and success and a wonderful thing for the Canadian marketplace," says Seif, CEO of Purpose Investments.

His new firm, however, is a different beast, representing an evolution in passive investing.

While Purpose's main products are low-cost ETFs -- and adviser-sold mutual funds too -- they offer a new twist on passive investment.

Already, Plain Jane index investing has a lot going for it simply because these type of funds aim to emulate the performance of an index like the Dow Jones industrial index.

"The reason why it wins versus active money managers is because it's low-cost and unemotional," he says.

Companies held in an index fund are weighted on their market capitalization -- the total monetary value of their shares -- whereas an actively managed fund weights holdings based on the analysis of a manager who tries to weed out the bad.

Investors pay that manager between one and four per cent a year of their assets in fees for that expertise, with the expectation this special blend of investments will beat the index.

It sounds good in theory, but in reality, active management often doesn't turn out as well as advertised.

"Net of fees, most active money managers charge too much for their ability to outperform markets, and whatever outperformance they do provide often gets eaten up by their fees," Seif says.

As a result many investors are now choosing to simply buy the index instead. They're investing in passively managed index funds that charge fees -- often expressed as the MER (management expense ratio) -- that are substantially less, in some cases less than a tenth of an actively managed mutual fund.

Purpose, however, wants to change the way we 'passively' invest.

Its lineup of funds aims to avoid some of the pitfalls of passive investing, such as the overweighting of in-vogue stocks listed on an index. One of the biggest strikes against index investing is you end up owning large stakes in overvalued companies that might be poised for a collapse. For example, in the past Nortel and BlackBerry have both made up large stakes of the TSX 60--a listing of Canada's largest companies -- only to plummet from a $100-plus stock values to low single digits. If you own the index that kind of downside is inevitable.

Conversely, Purpose uses "quantitative fundamental analysis" to screen out investments from its funds that might be overvalued, aiming to include only the strongest, Seif says.

Purpose's Core Dividend Fund, for example, includes only the 40 best publicly traded North American companies based on earnings, cash flow and other fundamental metrics.

While this strategy appears to be active management, Seif begs to differ.

"This process involves thoughtfulness, and active thinking in the way that we've structured and set the principles of how to invest, but the funds are still passively managed," he says. "You use a set of principles and disciplines guiding how you invest, but you don't do it in a qualitative or arbitrary way, meaning people aren't picking stocks, selecting one company over another."

With the Core Dividend Fund, this framework determines the companies to be included in the portfolio, and the investment mix is reassessed and changed quarterly based on this structure.

The result, Seif says, is an ETF that is more likely to outperform its benchmark than an actively managed North American dividend fund because it charges a management fee of 0.55 per cent annually instead of two per cent or more.

Another unique feature offered by Purpose Investments is most of its ETFs can be held in a corporate class structure, allowing investors to switch between Purpose ETFs without triggering a deemed disposition like a taxable capital gain.

"It's a benefit that no one else does in the (ETF) marketplace."

Seif says all of Purpose's funds -- from its Real Return Bond Fund to its Monthly Income Fund -- include innovative features that set it apart from the rest of the ETF market.

Among the most cutting edge might be Purpose's newest -- the High Interest Savings ETF. It's geared for investors who are dissatisfied with available options to park their cash for the short term.

Money market mutual funds have been the main option for most Canadian investors but Seif says this fund class is far from ideal.

"The net return on money market funds is anywhere from 0.2 to 0.4 per cent a year," he says, adding the average MER on a money market fund is about 0.8 per cent. "It's disgusting, so if anyone is in a money market fund, they should be out of it."

People who already have their money in high interest savings accounts charging between 1.25 and 1.4 per cent can stay put, he says. But others earning less on their cash should consider the Purpose ETF.

"We invest in three savings deposit accounts at three different banks: National Bank, Manulife and RBC, and pay out a net yield of, let's say, 1.35 per cent."

The High Interest Savings ETF -- the first of its kind in the world -- is geared for DIY investors wanting to hold cash in a brokerage account while earning a modest return.

And it's just one of many novel ideas Seif has been cooking up at Purpose.

So far investors have liked what they've seen. Although Purpose is only a few months old, it already has $200 million under management. That's just a grain of sand in the beach called the Canadian mutual fund investment market, worth more than $1 trillion.

But Seif sees plenty of market share up for grabs because this behemoth industry has largely been letting Canadians down by charging high fees for lacklustre performance.

"There is a lot of change that needs to happen and what we're trying to do with Purpose is to make investing a lot better for Canadians," he says.

If Purpose's funds do turn out to be as good as advertised, long live the revolution.

Republished from the Winnipeg Free Press print edition November 9, 2013 B12

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