Judge Lays Out Limitations of OBSI

A judge would be considered by most an expert in justice and an impartial observer of the conditions that lead to justice. It is thus worth noting the recent comments of Judge Bryan Shaughnessy of the Ontario Superior Court regarding the Ombudsman for Banking Services and Investments (OBSI). Though his comments are made only in relation to whether the OBSI would be a suitable body for resolving a class action in the case before him, I think his list applies in general to OBSI as a means for investors to get justice.

Here are the defects and limitations Judge Shaughnessy lays out:

• the OBSI invites participation by firms but cannot compel cooperation
• the OBSI can make a recommendation but it cannot compel a firm to make the payment recommended
• the only remedy for non cooperation by the firm and/or not following the recommendation is the "rather anaemic remedy" of publishing the name of the firm and details of the refusal
• the enforcement procedure is not binding on the firm; this amounts to "... a denial of access to justice" for investors
  
• the OBSI can only handle complaints for amounts up to $350,000 unless the parties agree
• claims for punitive damages are not an explicit option under OBSI; I would guess this is what the Judge is thinking about when he says later that behaviour modification "... does not appear to be the objective or mandate of the OBSI process".
  
• "The appearance of impartiality and independence of the OBSI is to some extent in play. ... [since] the ombudsman's recommendation is not binding on the Participating Firm or the Complainant. A truly impartial and independent body would have control over its process."
• the OBSI dispute process is sparsely defined
• there is no hearing process for complainants to introduce evidence or make submissions and there is little or no chance for investor participation
  
• the OBSI is not bound by rules of evidence
• the procedure by which recommendations are arrived at does not lead to a record of how the OBSI's recommendation is calculated

So there we have it, a checklist for reforming and strengthening OBSI.

Don't get me wrong. OBSI, even with its deficiencies, has been doing valuable work for investors. It does, however, need a counter to the industry offensive to shun it, no doubt spurred by too many cases where OBSI has taken the investor's side. As the saying goes, the best defense is a good offense. Let's reform OBSI and make it a body with sharp teeth and power. Go to it politicians.

Thanks to Ken Kivenko of CanadianFundWatch.com for the heads-up on this court case (the details of which seem to show some odious, abusive practices involving mutual funds, financial "advisors" and inappropriate leveraging advice). Ken's website also has a very practical (and sobering) investor guide to dealing with the OBSI. The pdf judgment from which I extracted the Judge's ideas is linked to on this page of the website of Thomson Rogers, one of the law firms in the case.

BlackRock Purchase of Claymore ETFs - Do the Smart Thing Please!

Today's announcement that BlackRock will acquire Canadian ETF provider Claymore could be a good thing for BlackRock and for ETF investors, if some smart, and not dumb changes, ensue.

Claymore charges quite high MERs - about 0.5 % too high - for its ETFs in comparison to those of BMO Financial, iShares and Vanguard. The takeover is a great opportunity for BlackRock, which already owns iShares in Canada, to lower the Claymore MERs and bring them in line. This will attract more investors and not cannibalize its iShares ETFS. In the USA, similar fundamental RAFI-based ETFs (e.g. Invesco Powershares US broad market equity fund trading under symbol PRF) have expense ratios about 0.3% lower than Claymore's, though even that is too high.

Why would BlackRock not lose by lowering fees? Claymore's ETFs are considered to be actively managed (though I do not agree with this characterization, that's the dominant public perception), more an alternative to actively managed mutual funds than to traditional passive market-cap weighted index ETFs. Let BlackRock take on the mutual fund industry with a much more compelling price proposition. After all, Claymore's ETFs already have most of the attractive features of mutual funds - auto & free DRIP and Systematic Withdrawal, Pre-authorized chequing purchases.

The dumb strategy would be to leave Claymore as is, with continued stagnation, or to raise fees, a recipe for investor flight. Claymore's ETFs are being left in the dust. For instance, the flagship Canadian equity fund Canadian Fundamental Index ETF (CRQ) has only $218 million in assets despite being started 3 years before BMO's Dow Jones Canada Titans 60 Index ETF (ZCN), which has $604 million in assets.

Mutual Funds Institute Ham-Handed Research Hurts Own Cause

Mutual funds in Canada have been under fire for their high fees and under-performance (hat tip to Canadian Capitalist). The industry body, the Investment Funds Institute of Canada has been attempting to shoot back at mutual funds' main competitor, ETFs. But its latest sloppy and slapdash salvo in the form of the July 2011 report Active and Passive Investing does more to discredit the IFIC and its cause than to help it. How so?

1) Consider the publication of the report itself. Is it secret or not?

• Not Secret - Though I received a copy from Ken Kivenko of CanadianFundWatch.com (thanks, Ken) who forwarded the email attaching it sent out under the signature of IFIC CEO Joanne De Laurentiis.
  
• Secret - The IFIC original email has the warning at the bottom "This e-mail (including attachments) is confidential and is intended solely for the addressee..." Oh really?
  
• Not Secret - Why then does the text from De Laurentiis' say "It is the objective of the Report to clarify and counter misperceptions associated with active and passive investing so that research organizations and public policy makers can be better informed...". That sure looks as though it is intended to be publicly disseminated.
  
• Secret - The IFIC website itself, however, seems not to show the report in any public area, only in a reserved members area (through this search link).
  
• Not Secret - This secret public report meant to be used per De Laurentiis "... as a reference authority in materials developed by you (e.g., articles, reports, etc.)" can actually be accessed through (marvels of the Google and the Internet!) a link at the bottom of this post on Arbetov.ca.

On the whole the image one is left with is that IFIC is trying to feed ammunition to its membership of fund distributors and sellers to have numbers to quote to clients but that it does not want to release the report to wider public scrutiny, including skeptical bloggers!

2) The suspicion of devious intent gets stronger once one looks at the flawed report itself. Its basic approach is to show that passive investing can be expensive, done by trying to show that ETF costs are higher than many people think. However,

• ETF does not equal passive investing (and the flipside is that Mutual fund does not equal active investing). The report throughout treats all ETFs as if they are the same as passive index investments. That might have been a fair generalization ten years ago but today ETFs have become very diverse. Many high cost, poor-quality, narrowly focussed ETFs have come on the scene, some even with explicit active strategies.
  
• Mixing all ETFs together and calculating average costs raises the apparent cost of a passive index (i.e. a broadly based market-cap) strategy. Transaction costs, bid/ask spread and tracking error, which the report says add up to 1.2% ETF under-performance relative to index, is at most 0.1% for a fund like Vanguard's Total (US) Stock Market ETF (VTI) or the grand-daddy biggest-of-them-all SPDR S&P 500 (SPY). The true lesson is not that passive indexing is expensive, it is that today investors need to be just as careful picking ETFs as mutual funds. ETFs that are too small, too narrow and only sample stocks instead of replicating an index are prone to index under-performance from large tracking error.
• The 1% that IFIC says goes to providing advice to mutual fund investors, which ETF investors do not get, and therefore causes ETF under-performance by that amount, rests on the dubious conclusion that investors get 1% worth of advice. The previous IFIC report The Value of Advice (which also seems to be hidden away in IFIC's website) it cites as evidence received a thrashing on its release in 2010 - e.g. see Canadian Capitalist's Readers Rip IFIC Report to Shreds.
  
• Risk, as expressed in volatility, is not or should not be an end in itself, so for IFIC to state that actively managed funds offer investors the risk exposure they wish is beside the point. As books like Richard Ferri's The Power of Passive Investing, David Swensen's Unconventional Success and many others have repeatedly documented in great detail, actively managed mutual funds have performed poorly on a risk vs return adjusted basis. It doesn't help to take on risk if you lose in doing so.
  
• As I said in my review of Ferri's book, the issue is not active investing vs passive investing in principle or in general, it is with the funds actually available to small individual investors and how they perform in reality. That's why I am currently testing the RAFI fundamental strategy, which I think is better in principle and has been shown to be so using (non-investable) index data, against cap-weight using actual ETFs available to investors. A key question is whether the higher fees on the RAFI funds overcome their theoretical advantage and give off lower net returns.
  

There is nothing wrong with mutual funds per se. I don't think that as a technical legal structure they are any better or worse than ETFs. The problem is simply that the current mass of available mutual funds suffer from too high fees that negate their value. They don't add enough value to earn their fees. This lackadaisical offering from IFIC doesn't inspire much respect or do much to help their cause.

Who Controls Financial Markets in Canada? Individual vs Institutional Investors

Have you ever been annoyed at those breathless news reports on market moves? You know what they are - "investors today have been spooked/cheered by the quarterly inflation figures / credit crisis in Greece / nuclear incident / trade figures / royal wedding / hurricane / terrorist killing" etc (in fact, often it seems that the person writing the text merely attaches the market result, whatever it is, to the current headline news item of the day, good or bad. For those who believe that markets are random, the random association of events to ups and downs makes a certain sense I suppose.)

Anyhow, on reading these news reports, I find myself muttering that it wasn't me, I didn't do it! I have a portfolio apportioned amongst fixed percentages of various passive ETFs and I only trade when rebalancing, taking money out, or buying more. Even when I do trade, my amounts are so puny and I almost always place orders at market price, it cannot make a jot of difference to move markets up or down.

So who does have enough heft in the market to influence things, individual or institutional investors? Are there a few super-rich individual investors with enough money to manipulate things, or is it the mass of ordinary Canadians? Are the mainstream mutual funds the heavyweights or is it the pension funds? It seems to be really difficult to find out through simple Googling but here is what I found out, with admitted uncertainty through some of the guesstimation I've had to do. This is all 2009 data, which seems to be the most common recent data available. The grand total of financial assets in 2009 was $1713.3 billion. Here is the breakdown of who more or less controls or decides how to invest the money (as opposed to who it may belong to or for whose benefit it is being invested).

1) Pension Funds - $898.1 billion 52% share
This is only the top 102 funds - the 100 biggest from the Benefits Canada 2010 report plus the two biggest funds of all in Canada, the Caisse de dépôt et placement du Québec ($131.6 billion in net assets) and the Canada Pension Plan Investment Board ($105.5 billion). Interesting fact - these two plus the top 10 of the Benefits Canada list are all government or public servant plans and together they control about 1/3 of total financial assets in Canada. Reminds one of an old joke ... "what is the difference between capitalism and communism? ... capitalism is the exploitation of man by man while communism is the reverse".

2) Mutual Funds - $595.2 billion, 35% share
(source IFIC reports)

3) The Mega-Rich $140 billion and the Quite Rich guesstimate. $40 billion, combined 11% share
The Mega-Rich cutoff in 2009 was $1 billion for the 55 richest Canadians (see Wikipedia List of Canadians by net worth). For the Quite Rich I had to guess that the next 100, down to about $200 million in assets, might hold around $40 billion in total at an average $400 million each.

4) The Hoi Polloi (that's you and me the retail investor) - $40 billion, 2% share
I'm being optimistic here I think, assigning an average $1200 in directly held investments of stocks, bonds and ETFs (i.e. not owned within pensions or mutual funds) or so to each of the remaining 33 million Canadians. For comparison, consider that the total market value of Canadian ETFs in 2009 was $33.7 billion according to TMX Money.

Let's put a personal face on it. Today when the TSX go down or up we can point the finger at Michael Sabia (Caisse CEO), David Denison (CPPIB) or maybe Jim Leech (OTPP). One thing for sure, it wasn't me.

PS came across figures for the USA ... John Bogle said in the Wall Street Journal in Jan. 2010 that insititutional investors control 70% of US shares, with mutual funds 26%, private pension plans 11% and government pension plans 9%.

Groucho Marx Helps Explain Mutual Fund Under-Performance

Bet you never thought that Groucho Marx ever said anything bearing on mutual funds. Never did I till I pondered this quote (on Wikipedia): "Please accept my resignation. I don’t care to belong to any club that will have me as a member."

Why do mutual funds want us as members? The answer sadly for most mutual funds, is to collect management fees and not to provide the supposed membership benefit of a fair investment return. Consider the simple arithmetic. Funds charge a fee based on assets, such as 2% per year. Thus, for example, if a fund has $100 million in assets, the managers collect a $2 million fee annually. Boosting assets raises fee pay for the managers. There are two ways to boost assets - 1) investment return, 2) sales of fund units to the public. The question then is, which is easier?

For option 1 generating investment return, as long as the fund invests in something it will gain a certain return somewhere around the market, but beating the market is very difficult, some say impossible on average. Going from 6% market return, approximated by simply investing in a broad range of holdings within the particular asset class, to 7% (outperformance by 1%), requires a lot of effort and/or skill, or luck (if you believe in efficient markets). In fact, actively managed mutual funds have been shown in many many studies not to be able to outperform by much (e..g read Richard Ferri's new book The Power of Passive Investing which slices and dices US actively-managed mutual fund performance against passive index investing every possible way, citing those numerous studies) even before fees. The one-third of funds that were actually successful in outdoing a US S&P 500 index fund from 1985 to 2009 (graph p.38 of the book) only averaged about 1% per year extra return and the very best only attained under 5% per year extra return. Two-thirds of the active funds lagged the index fund - by an average 1.69%. That's before sales commissions and income taxes, which would knock a bunch more down into the lagging side. The net effect on fees of 1% outperformance / $1 million excess return (which raises assets by 0.01 x $100M) is 2% of that extra $1 million or only $200k.

Option 2 is to raise assets by marketing and sales. Through advertising tailored to highlight its winning funds, companies can stimulate fund inflow. Winning funds are defined advatageously - they are compared only to other funds, not market indices, which means half can be above average as opposed to only the third when compared to indices. When a fund's performance almost inevitably falls behind it gets terminated or merged into another more successful fund to incite investors to stick with it and not withdraw their money. New funds are constantly being created or incubated to find some that outperform so they can be featured to attract new money.

How much extra effort is required to gain more than $1 million in new assets - and thus be ahead in garnering fees - by advertising and marketing and what is the comparative chance of success? For one thing, the public is constantly being motivated to contribute, being told to save for retirement, especially at this TFSA/RRSP time of year, when the investment decision becomes only a question of which investment to buy. Those dollars are probably easier for the fund company to grab. Furthermore, the process is much more under the control of the fund company than fickle markets are, so it's likely a lot easier to generate more fees with option 2. In sum it appears that mutual fund companies are much more marketing organizations than asset management / portfolio management companies.

Maybe the search for successful active management amongst mutual funds is looking in the wrong place. Ferri himself remarks that "Most of the great managers aren't for hire by the general public. The truly talented managers like to fly under the radar as long as possible to keep their assets manageable." He also quotes famed Yale University endowment manager David Swensen, who said "Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high quality active management decisions." A book I reviewed recently, Pension Revolution by Keith Ambachtsheer, followed the same thinking when discussing pension funds. He found that good governance, which includes properly motivated fiduciary-bound managers, made a big difference to performance. Well-governed pension funds achieved 1% per annum excess risk-adjusted return (he thinks 3% is possible for the best governed), though even the average pension fund achieved 0.2% excess return after fees and expenses. The problem with mutual funds, as Ambachtsheer puts it, is the managers' conflict between producing good returns for clients and profits for themselves. If individual investors are the "dumb money" patsies of the investment world that the "smart money" active investor eats for lunch, then mutual funds are the "conflicted money" that they eat for dinner.

Maybe Groucho had the right idea with respect to actively-managed mutual funds.

Mutual Fund MERs - Can You Get Even?

We all know the old saying "don't get mad, get even". There has been a lot of justified complaining about high mutual fund expenses in Canada. It so happens that a number of the companies that charge those high fees - all the big banks and insurance companies amongst them - are public companies whose shares we can buy. Presumably those high fees go into the coffers of those companies. So should we investors simply invest in those mutual fund sellers to get our own back and make decent returns?

The answer appears to be yes for some and no for others.

Yes - Royal Bank of Canada (RY) vs RBC Canadian Dividend (RBF266), a flagship mega fund with $10.4 billion in assets
The TMX.com chart shows that over the past ten years the price of RY has risen a lot more than RBF266 (even excluding dividends, which are sure to have been higher for RY than RBF266). It is also interesting, and perhaps significant since RBF266's MER at 1.7% is appreciably less than the typical 2+% equity mutual fund MER, that RBF266 outpaced the TSX Composite by a good margin. The Morningstar.ca entry for RBF266, which includes all dividends/distributions in Total Return figures, confirms that fact - 10-year performance was 8.16% annualized vs only 1.64% for the TSX. An RBC Investor Deck shows total returns for RY to Dec.1st, 2010 at 13.0%.


IGM Financial (IGM) vs Investors Group Dividend A or C (IGI008), another mega fund with $13.5 billion in assets. Here's another chart from TMX.com. Over the past ten years IGM seems to have easily outstripped INI008, which has not even done as well as the TSX Composite (the blue line). Perhaps the 2.78% MER of INI008 has something to do with that?


No, or perhaps more precisely, it's hard to tell which will lose you more money - Matrix Asset Management (MTA) vs GrowthWorks Canadian (WVN612)
It seems to be a choice between the long, slow, steady slide into oblivion of WVN612 (see this Morningstar.ca chart - even the highly volatile TSX Small Cap Index has eventually recovered and is up) vs the yet-to-be revealed hazards of MTA.


The chart above doesn't tell the whole story of WVN612's sorry life. Prior to 2005, it was the Capital Alliance Venture fund, which led an equally horrible life (Returns for CAVI to November 29, 2005 were: 1 yr: -7.7%; 3 yr: -9.8%; 5 yr: -13.8%; since inception: -1.3% per bottom of page 4). It's funny that CAVI founder and longtime president Denzil Doyle was inducted into the Order of Canada in the same year - 2005 - that the failing fund was sold to GrowthWorks. Disclosure: I invested money in CAVI way back in the 1990s and am a disgruntled loser!

Now MTA manages WVN612 along with a whole collection of similar Labour Sponsored Investment Funds (see Globe and Mail's How Risky is an (sic) LSIF?). Though the funds lose money, the management company doesn't need to, since it draws juicy fees e.g. WVN612's MER is currently 4.96% per annum. That should mean juicy profits for MTA, right? Um, no, MTA has eeked out losses or small profits since its reincarnation on the TSX in January last year after spending years as Seamark. (see the Google Finance chart below of how successful Seamark was for investors)

MTA's stock price is down 9.3% from its initial price, though hey, it is ahead of WVN612 which has lost 14.7% in that time.

What is going on at MTA then? It is hard to tell without spending a lot of time in the financial statements. However, I would be worried that the individuals who manage MTA, the executives, having milked the LSIFs (which is why those failures have been kept alive), will garner most of the benefit from the public company, all perfectly legally no doubt. Various worrying signs are visible - transactions with related parties, extra non-GAAP figures like recurring income before taxes in the income statement to more favourably portray company results. Pass me my ten-foot pole please!

The world is never simple.

Star Investment Analysts Lose Their Brilliance When Changing Jobs

The publisher's blurb for the new book Chasing Stars: The Myth of Talent and the Portability of Performance by Harvard prof Boris Groysberg says:
"Groysberg comes to a striking conclusion: star analysts who change firms suffer an immediate and lasting decline in performance." Why does this happen? "Their earlier excellence appears to have depended heavily on their former firms' general and proprietary resources, organizational cultures, networks, and colleagues." I wonder if that also applies to mutual fund and portfolio managers. It could form a handy way to filter out future losers.

Kudos to Simoleon Sense where I found the link.

Socially Responsible Funds: Forcing Investors to Buy Blind

Recently, one of my kids suggested I look into Socially Responsible Investing. She doesn't want to invest in companies like Copper Mesa, which is apparently doing bad things in Guatemala to the environment and the local population near their mine.

A popular way to invest in companies that toe the SRI line is to buy one of the many mutual funds (e.g. Social Investment Organization's 2010 Guide to SRI Mutual Funds) which promise to adhere to such principles. Do you think you could actually find out whether Copper Mesa is amongst the holdings of any particular fund? Unfortunately, no. Funds seem to only publish their top ten or twenty-five holdings. An exception is the only ETF in the field in Canada, the iShares Jantzi Social Index Fund (symbol: XEN), which has a constantly updated complete list of its holdings. They are not especially noble in that since all ETFs are similarly transparent. At least one can see there is no Copper Mesa within.

Beyond the generality of statements like the following, a fund prospectus isn't a lot more explicit or detailed about its own method of stock selection.

"Positive and negative screening, such as tobacco, alcohol, environmental performance, human rights violations, community involvement and employee relations. Screening involves the application of pre-determined social or environmental values to investment selection. The aim is to screen out particular companies or sectors based on values choices, or to positively select companies considered “best of sector.”

Does Jantzi Sustainalytics, the well-established leader in SRI indexing, do any better in revealing what companies its indexes contain or the exact inclusion/exclusion criteria? Not that I could find.

To my mind, simply sticking the SRI label on a fund and asking individual investors to believe in the product is not sufficient. Most SRI investors I would guess feel strongly about specific issues or companies they wish to promote or avoid, so they need to be able to figure out if the fund is ok that way. Unlike politicians who are never to blame for anything, companies are never perfect. Indeed, as fact sheet #2 on Social Investment Organization admits, "Social investors know there are no perfect companies." SRI investors must pick their spots and be able to act on their preferences.

Copper Mesa is probably in no fund's holdings, SRI or not, given its dodgy corporate machinations and financial condition (see this post on StockHouse and the TSX delisting announcement). After all, it is investing (I doubt any SRI fund screens out companies for making too much profit, an inference I make based on the prominent presence of Canadian banks amongst top Canadian SRI fund equity holdings).

However, bigger, successful companies like Barrick Gold may be more problematic. It has attracted criticism at MiningWatch Canada. Since Barrick is a large company we are fortunately able to find Barrick among the top 25 holdings of the Acuity Social Values Canadian Equity Fund (see latest March 2010 Quarterly Portfolio Disclosure). Investors should be able to see all the holdings to decide for themselves whether the fund is acceptable or not with Barrick in it.

The SRI sector, especially given its avowed aim, needs to apply its own principles to itself and adhere to a higher standard of transparency and disclosure.

The Myth that ETFs are Always and Necessarily Better than Mutual Funds

It's all about costs and investment strategy. Whether a fund is an ETF or a mutual fund doesn't matter all that much. If the costs to buy into, to manage and to run the fund are low and it passively invests in a broad market index, the results for the retail individual investor will be good. The fact that mutual fund fees in Canada have been high and net investor returns have been low as a consequence does not mean it has to be so. In fact, ETFs are catching up to mutual funds in both good and bad ways. The recent proliferation of new ETFs with active trading strategies, narrow asset groupings and leveraging, foretell that investor returns will be poor.

That it is possible for mutual funds to equal the original virtues of ETFs is evident at the US fund company Vanguard, which offers both ETFs and mutual funds.

Here is a sample of funds with identical holdings and thus returns, apart from fees. In fact, the ETFs of Vanguard are merely a share class of the same asset base.

• US Total Stock Market ETF (symbol: VTI) - MER 0.09%
• US Total Stock Market Index Fund (VTSMX) - MER 0.18% no purchase or redemption fee

• US total Bond Market ETF (BND) - MER 0.14%
• US Total Bond Market Index Fund (VBMFX) - MER 0.22% no purchase or redemption fee

• Emerging Markets ETF (VWO) - MER 0.27%
• Emerging Markets Fund (VEIEX) - MER 0.39% plus purchase fee 0.50% and redemption fee 0.25%

The mutual fund on-going MER fees are a bit higher but for someone trying to make regular small purchases through an automatic savings and investment plan, avoiding the payment of trading commissions on ETFs, even when they are $1o per trade from a discount broker (a $10 cost on a $1000 purchase is a 1% "fee") makes the two alternatives very similar. Add in the convenience of automatic dividend reinvesting (DRIP) and tax record keeping that mutual funds offer, and ETFs lose their advantage. Vanguard even has a handy ETF vs mutual fund calculator to compare which version you would be better off to buy, considering fees, holding period, frequency and amount of purchases and commission costs.

The big problem for Canadians, of course, is that Canadians are not allowed to buy US mutual funds.

To its credit, one Canadian ETF provider - Claymore Canada - has adopted useful mutual fund features by offering pre-authorized chequing contributions (PACC) for buying its ETFs, along with a DRIP and a systematic withdrawal plan (SWP), all at no transaction cost. And all of BMO'sETF family new offer DRIP as an option, though not the PACC and SWP (yet?).

If only some mutual fund visionary in Canada would catch up to good aspects of ETFs ....

Book Review: Winning the Loser's Game by Charles D. Ellis

Call this book A Random Talk About Wall Street. That is both a compliment and a criticism.

It is a compliment because comparing this book to Burton Malkiel's famous A Random Walk Down Wall Street puts it in a special category. Indeed much of the message is the same in the two books - valuable and sage advice on how to survive and prosper as an individual investor in a financial world filled with many predators and some good guys. Ellis pushes many familiar themes: diversify, buy index funds, trade seldom, take a portfolio view, re-balance to maintain asset allocation, adopt a long-term perspective and ignore short-term market fluctuations, consider inflation and real return bonds, market timing futility, avoid excessive mutual fund fees, take account of how various risks work.

The "Random" comparison is also a criticism in that I found the book meanders quite a bit. A chapter topic is begun, and part way through, the text diverges onto a peripheral topic. Ellis' method of exposition feels like a fireside chat from wise old uncle Charley as one idea spurs another. Maybe some readers like that style but I found myself muttering "stick to the topic, will you?" The epitome of this is Chapter 20 Endgame, at once the best chapter in the book and the worst. Endgame talks about leaving the world a better place after you are done, through using your money wisely so that it is a positive force and not a negative force, as it can end up being. There is much text that I found to be inspiring e.g. "Investors who have enjoyed substantial financial success should give careful consideration - no matter what their hopes or intentions - to whether the amount of wealth they can transfer to their children might do real harm by distorting their offspring's values and priorities or by taking away their descendants' joy of making their own way in life." Every parent must think of their money actions with kids from a very early age even if they are not rich e.g. giving a child an allowance to spend or save and considering how to guide the child into using it wisely. Ellis quotes another author who suggests people should give younger family members as much responsibility as they can manage as soon as possible. So true, I experienced that myself and wish I had done it more with my own kids. Suddenly Ellis switches gears. On the next page, there begins a series of numbered paragraphs on IRS limits for IRA accounts, tax-free gift limits, compounding rates, personal residence tax exemptions, trust concepts and the like. After four pages of too-general-to-be-useful such info on tax nitty-gritty, he goes back to the original theme and philosophical level of discussion. He could simply have said at the end of the chapter, "once you have decided what you want do, go talk to a good accountant to make it happen."

The informal presentation does have its benefits - short, easily read and digestible chapters. There are lots of good quotes and anecdotes to illustrate his points. I got lots of ideas for blog posts! e.g. on why this statement is wise in the sense he means it, and silly in another sense - "Never risk more than you know you can afford to lose."

Overall, this book does deliver on its sub-title promise to provide "timeless strategies for successful investing". It is definitely worth reading.

My rating: 4 out of 5 stars

Thank you to publisher McGraw Hill for providing me with a review copy.

Thoughts for the Active Management Mutual Fund Industry

Ottawa Business Journal wrote about the new Investment Partners Fund which has a completely different fee structure from the usual 2% or so annual MER charged by the average Canadian equity mutual fund. The fund managers will only charge a fee if returns exceed 5% in a year. If the fund loses money or makes weak returns, no fee! Over 5% return, they will charge 0.25% for every 1% (or part) return. If the fund was to get a 9% return, which would be quite an achievement, that would be a 1% fee for the year, pretty darn reasonable.

Only thing the article doesn't mention is whether the fund may or will use leveraging (borrow extra money) to try juicing returns, which of course the managers have extra incentive to do. I'd certainly want to see a restriction on borrowing in the fund policy. Otherwise the risk of loss goes way up. Make it a pure stock picking challenge.

Unfortunately the fund is only open to accredited investors, i.e. rich people or professional investors.

But it does offer an idea to our over-charging fund industry.

Bad Stuff: Harmonized Sales Tax and Sprott Clampdown on Questrade Trailer Fee Rebates

There has been a nose-to-nose yelling match going on between the mutual fund industry and the Ontario government about the extra costs that will result from the Harmonized Sales Tax. But that's not all the HST will affect.

Financial author of No Hype–The Straight Goods on Investing Your Money and speaker Gail Bebee sent along a good commentary, excerpted below, about several other consequences that will hurt individual investors. Grrr!

"There are many investing-related services that are currently subject to the Goods and Services Tax (GST), but not provincial sales tax (PST). These services will probably be subject to the HST, a combined PST/GST tax that effectively increases their cost by 7% in BC and 8% in Ontario. Here is a partial list of services that will likely be impacted:

1. RRSP, RESP or RRIF administration

2. Setting up and holding your mortgage in your self-directed RRSP

3. Transferring securities to another institution

4. Mutual fund and portfolio management

5. Financial, tax and estate planning

6. Changing the beneficiary in an RRSP, RESP or RRIF

7. Searching records and providing copies of account statements.

Concludes Bebee, “Investors should lobby their investment dealers for price reductions to compensate for the pending HST increase. Businesses can afford to drop prices because the new tax regime will significantly reduce business costs.”

For more information or to arrange an interview, please contact:

Gail Bebee

Canada’s Independent Voice on Personal Finance

Tel: 416-733-0221 gbebee@gailbebee.com"

***********************************************
Another frustrating development comes from Sprott Mutual Funds for clients of Questrade. Questrade PR person Lynn Suderman sent along the following blurb with which I can only concur. (Note, I do have an account with Questrade but don't own any Sprott funds)

"As you may recall, Questrade launched a Mutual Fund Maximizer service (with trailer fee rebates) in January. As of yesterday, September 16^th, Sprott Asset Management decided to block the purchase of any Sprott fund by Questrade clients and will no longer be paying the trailer fee rebate. Why? We’re not entirely sure – their reasons are vague. No other mutual fund company is blocking sales of funds or trailer fee rebates.

Attached is a bit of background on the issue. Questrade will be pursuing all available avenues to reinstate Sprott funds and Sprott trailer rebates to our clients. In the meanwhile, I thought you may be interested in this turn of events. Note that Jonathan Chevreau wrote about it in his blog today:

http://network.nationalpost.com/np/blogs/wealthyboomer/archive/2009/09/17/sprott-blocks-trailer-fee-rebates-to-questrade-clients.aspx

I’m hoping to encourage people to lodge complaints with Sprott, the Competition Bureau, OSC, etc – see if we can get this overturned!

This is part of the email sent to our clients who own Sprott:

If you would like to show your support for Questrade and our trailer fee rebate program, we invite you to contact Sprott and the regulatory bodies that oversee our industry. Their contact information is below. Please remember to copy (cc) your letter and emails to marketing@questrade.com.

Sprott	invest@sprott.com	http://www.sprott.com	Toll Free: 1.888.362.7172
The Competition Bureau of Canada:	To fill out a complaint: http://competitionbureau.gc.ca/eic/site/cb-bc.nsf/frm-eng/PJSH-6X9KQY	http://www.competitionbureau.gc.ca	Toll free: 1.800.348.5358
The Ontario Securities Commission	inquiries@osc.gov.on.ca.	To fill out a complaint: https://www.osc.gov.on.ca/Contact/ct_cat-form.jsp	Toll free: 1.877.785.1555

China ETFs and Mutual Funds - Any Difference?

The Contenders: the two largest by assets of each type

ETFs

• iShares FTSE/Xinhua China 25 Index Fund - NYSE: FXI
• SPDR S&P China - NYSE: GXC
• other China-only ETFs listed at Stock Encyclopedia's China ETF list
  

Mutual Funds

• AGF China Focus Class
• HSBC Chinese Equity Fund
• a bunch of others in GlobeFund's Greater China selection
  

1st answer: No, there is no difference
Though the ETFs are explicitly passive index followers and the mutual funds are presumably active managers trying to pick winners, their holdings all look remarkably the same. Take a look at the top ten holdings table below, where I highlighted with different colours the common companies in each fund. It is a very colourful chart!! There is only ONE company at most in each fund that is not found in at least one other. Six companies are in all four funds. Even the place of individual companies in each top ten looks quite similar. The funds are all heavily concentrated in their top ten, with the total assets devoted to the top ten ranging from 50 to 60%. Finally, even the mutual funds are more or less fully invested, with the maximum cash holding being HSBC's 4.5% - if active fund managers were to be able to time a market peak and pull back, would it not have been a good time a few weeks ago (the time of this data) when valuations seemed to be ambitiously high? Today's Globe article Shanghai exchange: Tea leaves might be helpful talks about a possible growing chinese bubble, which is after recent days' big declines.

The net result is that FXI and GXC track each other's market performance very closely (easily verified by a Yahoo stock chart). I bet HSBC's and AGF's would too, except for ...

2nd answer, Yes, there is a difference
Perhaps this is no surprise for observers of ETFs against mutual funds, but the ETF MERs are vastly lower:

• FXI - 0.74%
• GXC - 0.59%
• HSBC - 2.56%
• AGF - 2.94%

With the holdings being pretty well the same, the extra MERs will surely drag down the net performance for the mutual fund investor by about that 2% difference. Maybe a series of small trades could eat away that ETF advantage through trading costs but someone planning to buy infrequently and then hold with medium size amounts (e.g. $10 trade commission on an ETF on $1000 purchase is a 1% cost) would be much worse off in the mutual funds.

On the other hand, I have read that professional fund managers with resources to do proper research in less developed and therefore less efficient markets, such as China surely still is, can outperform and produce returns superior to an index (see this 2007 YouTube video of Random Walk Down Wall Street author Burton Malkiel - the market efficiency discussion starts at around 33 minutes).

Maybe the China mutual fund managers need to re-think their value proposition and either adopt outright passive indexing and drop their fees considerably, or start doing their job of company analysis and start earning their fees?

Gail Bebee asks: Has the death knell sounded for mutual funds?

Author Gail Bebee sent me the following message with the above dramatic title:

"New exchange-traded funds from a Big Five Canadian bank will compete with mutual funds

Toronto, June 17 – The Bank of Montreal (BMO) is getting into the exchange-traded funds (ETFs) business with an offering of seven funds which largely mimic existing products from ETF industry leader, iShares. Says independent investor and personal finance author Gail P. Bebee “ETFs, the low cost alternative to Canada’s high fee mutual funds, are making major inroads into the mutual fund business and BMO wants to profit from this trend. The good news is that a major bank is offering ETFs to clients, so more Canadians will learn about the benefits of investing using ETFs instead of mutual funds. Hopefully, BMO’s decision will motivate other Canadian banks to launch their own ETFs. Canadian consumers will be the winners.”

According to Bebee, ETFs offer several advantages over mutual funds:

1. Better returns than most equivalent funds

2. Lower management fees

3. Greater tax efficiency

4. Ability to buy and sell throughout the trading day.

For more information or to arrange an interview, please contact:

Gail Bebee

Personal finance speaker and author of No Hype - The Straight Goods on Investing Your Money

All the investing basics for Canadians from a savvy financial industry outsider

Tel: 416-733-0221

gbebee@nohypeinvesting.com

www.nohypeinvesting.com"

To which I would comment, I hope not a death knell since there is nothing inherently wrong with the concept and structure of mutual funds. It's just that the current fees are so darn high, they do not provide good value to investors. However, the ability of mutual funds to take small amounts of new money efficiently and to automatically reinvest distributions and keep track of tax info such as Adjusted Cost Base are worthwhile attributes. Some fund company in Canada needs to go the route of Vanguard in the USA by providing ultra-low cost index funds.

The flight from mutual funds that Bebee refers to may just be a good thing. It reminds me of the situation many years ago when Canada's wine industry (which was more aptly described as the whine industry) contentedly produced horrible stuff in high volume until free trade opened up competition and the industry successfully shifted to high-value, high-quality niche wines. I hope the surge of ETFs is a wake-up call to mutual fund providers.

Great News from Claymore for ETF Investors

It is wonderful to read in an article by Rob Carrick in the Globe and Mail that Claymore Canada will be offering investors in its ETFs the possibility to do three things previously missing and which in my opinion add significant value:

1. Pre-Authorized Cash Contribution (PACC) plan to make regular monthly, quarterly or annual purchases of new shares
   
2. Dividend Reinvestment (DRIP) from existing holdings into new shares
3. Systematic Withdrawal Plan (SWP) to make regular withdrawals/sales of existing shares to generate cash

This considerably levels the playing field with mutual funds for small investors since all this will be done without charge - Free! The smaller the amount you have to invest the bigger the relative benefit since flat rate commissions at discount brokers would eat up more of small amounts to the point that it really did not make sense for trades of ETFs under $1000. The other big advantage is that one can put more of the mechanical part of investmenting on auto-pilot.

The article says Barclays, creator of the more popular market dominating iShares, is considering doing something similar. Yes, Please! That would really help force the mutual fund industry to lower its fees.

Questrade and Qtrade also lose a competitive differentiator. Their DRIP service would become un-necessary if iShares follows suit.

Mutual Fund Underperformance - A Sadly Consistent Story

Standard and Poor's has just released the latest quarterly SPIVA report that tracks the performance (see the list of all reports here), or I should say, the under-performance of Canada's mutual funds.

The results are perhaps not surprising to those familiar with mutual funds but they are shocking nevertheless. Consider the chart below, constructed from SPIVA reports from 2005 to the most recent. Note the following:

1. A tiny proportion, hovering around 10%, of actively managed Canadian equity mutual funds manage to outperform the relevant index the TSX composite over a rolling three-year period (I picked three years since that is around the average holding period for mutual fund investors - if I had picked five years, the results would be even worse)
2. The amount of under-performance is enormous, about 4% per year - see the red line on the graph.
3. These poor results are consistent through all of 2005 to 2008 including times of strong upward movement and more recent big declines (though we have yet to see October's results)
   

ETFs vs Mutual Funds: the Big Switch or Different Investment Philosophies?

Wealthy Boomer Jonathan Chevreau told us that in September and October mutual fund investors in Canada withdrew huge amounts from their mutual funds while ETFs were simultaneously experiencing large net purchases, notably of iShares broad-based S&P TSX60 Canadian Market Index (symbol XIU).

The iShares Canada press release touting these results also mentions the same thing happening in the USA: "As of July, the United States saw ETF inflows at US$41 billion as compared to US mutual fund outflows of US$47
billion.", citing its source as Investment Company Institute, August 2008.

It is interesting to speculate whether this is actual switching from mutual funds to ETFs in a kind of deathbed conversion or if it is simply symptomatic of two groups of investors with different mindsets and reactions to the market woes, i.e. the mutual fund sellers think the market decline is the end of the world while the ETF buyers see it as a buying opportunity for the long term. I vote for the latter interpretation.

An Investing Lesson from Greek Mythology

There is one ancient Greeks myth that we investors would do well to heed even today thousands of years later. Like Odysseus, we must resist the seductive songs of the investment Sirens luring us to financial destruction.

A case in point is mutual funds. Many times has the disappointing truth been told that most mutual funds' investment returns are worse than their reference index. Worse, far worse in fact, than this are the investment returns of the actual investors in mutual funds. Vanguard fund founder John Bogle recently wrote in his Bogle's Corner May/June issue (thanks to the Bylo where I found this link) of evidence of shocking under-performance of investors in a group of 200 US mutual funds.

"... the 200 funds with the largest cash inflows during the five-year period 1996–2000—essentially the duration of the late, great bull market—reported an average return of 8.9 percent for the 10 years from 1996 to 2005. But the dollar-weighted return of those 200 funds— the return actually earned by their shareholders—was just 2.4 percent, only 25 percent of the annual returns reported by the funds themselves."
After inflation and taxes, that wouldn't be much!

To continue the analogy, the Siren song was the advertising of the mutual fund companies touting their recent past investment performance. Sadly, the cash inflows are evidence that the investing public listened. (Others call this chasing returns but I like the Greek analogy.)

The way to resist is to do as Odysseus instructed his sailors - build a plan, stick some wax in the ear and don't deviate when the temptation is strongest.

UK and Australian Active Fund Manager Performance

The poor investment performance of actively managed mutual funds in Canada and the US is becoming a reasonably well-known fact, with mainstream media increasingly picking up the message. Less well-known is that the same phenomenon exists in the UK. A 2000 study in 2000 by Garrett Quigley and Ray Sinquefield "Performance of UK equity unit trusts" shows the same disappointing results as in North America.

Some choice quotes:
"UK money managers are unable to outperform markets in any meaningful sense, that is, once we take into account their exposure to market, value and size risk."

"Does performance persist? Yes, but only poor performance. As others find for US mutual funds, so we find in the UK. Losers repeat, winners do not."

There is no exception to this trend in Australia either as this Abstract of a journal article by David R. Gallagher and Elvis Jarnecic titled " International equity funds, performance, and investor flows: Australian evidence" confirms: "... active management does not provide investors with superior returns to passive indices."

Bloggers tell institutional investors to stay calm and stick with plan as market weakens

In light of the recent article on the CBC website, titled "Advisers tell investors to stay calm and stick with plan as market weakens", a reply from the blogosphere is called for.

The CBC says:
"After a nearly five-year run, investment advisers say it's time to stay calm, review your investment plan and look to defensive plays such as utilities, health care and consumer stocks to wait out the slowdown."

... Bloggers say it's time time to stay calm, stick with your investment plan, look for stock bargains among long-term high-quality companies and wait out the slowdown.
"Me? I’m sticking to my plan and giving this all some time to settle out." Canadian Dream: Free at 45
"During Monday’s panic, I actually went out and bought more banks." CanajunFinances
"Often the best thing to do is nothing, especially when our emotions are getting the better of us." Michael James on Money
"At times like these, amidst breathless front-page coverage of every gyration in the stock market, you can dust off your copy of The Intelligent Investor and find solace in the counsel of Benjamin Graham." and goes on to quote words saying to stay calm. Canadian Capitalist

Let us also note the results of a small informal poll conducted on this very website regarding the severe market slide of January 15-17. In answer to the question about what they did in response, 39% of readers said they bought stocks they considered a bargain, 71% said they did nothing and were going to wait things out, 0% said they sold to pay for Christmas expenses or for other expenses and 0% (yes, that's a big fat ZERO) said they sold equities! Yes, sir, the average person on the street sure was panic selling!

In contrast, the CBC article quotes mutual fund managers saying, "I think you have to continually look at your portfolio and make sure you're focused on quality and to the extent that you have more speculative or lower quality investments, you may have to have make a decision to exit some of those securities," Pym said." ... and ... "Watson said defensive stocks like utilities, health care and the consumer sector will be areas investors will want to look to." Ah yes, sector rotation, tactical asset allocation, market timing, those discredited and disproved strategies. Now we know who was doing all that panic selling in the last little while.