PORTFOLIO MANAGEMENT: WHAT IS IT AND WHY YOU SHOULD CHOOSE IT
Portfolio management is the provision of investment portfolio management services by an appropriately registered securities advisor (sometimes referred to as an ICPM) to clients. Clients may be individuals, corporations, trusts, foundations, pension plans or any entity requiring investment management services. What sets an investment portfolio manager apart is that it performs the actual investment function. That is to say the portfolio manager actually buys and sells the financial instruments on the clients' behalf.
Today, individuals face a confusing array of choices with respect to investment alternatives. People outside of the financial industry often do not know the difference between the alternative service providers. Unfortunately, with the mobility of today's workforce and the disappearance of many defined benefit pension plans, people are forced to be more responsible for their financial wellbeing. It is incumbent on individuals to educate and prepare themselves to make these life altering decisions.
Retail investors have typically turned to retail stock brokers for their investing needs. Today, retail brokers are commonly called Investment Advisors (IA's) and are employed by Investment Dealers. Individual investors today may also be in touch with Certified Financial Planners (CFP's) that work with large or small distribution companies (typically Mutual Fund Dealers) to distribute financial products. The differences are that IA's may sell individual stocks, bonds and other financial instruments as well as mutual funds and "WRAP" products. CFP's tend to primarily offer mutual fund products but they may also be qualified to sell products such as life or critical illness insurance and they may also offer a degree of tax and estate planning services.
The IA's are regulated by the Investment Dealers Association (IDA), a self-regulatory organization (SRO) recognized by the Securities Commissions, and CFP's are generally regulated by the Mutual Fund Dealers Association (MFDA), another SRO recognized by the Securities Commissions. They are all charged with the responsibility of "Know Your Client" (KYC) and to recommend products suitable to their customers' objectives.
However, the IA/CFP is typically paid on the basis of commissions and fees based on transactions for selling financial products. Whether or not mutual funds are sold as front-end load, the dealer and IA/CFP receive upfront commissions of up to 5% or more. This commission is paid by the investor if the purchase is a front-end load transaction, and paid by the fund company if the purchase is a deferred sales charge (DSC) transaction. They also typically receive from the fund company, on an on-going basis, an annual fee of 1% of the value of the investment (referred to as a "trailer", "service" or "retention" fee). Investors who purchase on a DSC basis will be penalized if they withdraw funds early. The all-in cost (exclusive of commissions paid directly by the investor) of maintaining a mutual fund investment is referred to as the "Management Expense Ratio" or "MER" and typically ranges between 2% and 3.5%. WRAP programs (programs that offer the pooled fund services of several Portfolio Managers) offered by IA's typically have annual fees around 3%. These fees are paid to the IA/CFP by the sponsoring mutual fund company or investment dealer, not directly by the client. In fact, the IA/CFP may have incentive bonuses to sell over a given threshold of a given product.
An IA/CFP is, for regulatory purposes, a salesperson who is required to advise customers bearing in mind the information collected about customers in the KYC process and the customers' individual investment objectives.
Investment portfolio managers are regulated directly by the Securities Commissions with which they are registered. Investment portfolio managers (ICPMs) are registered, after a rigorous background check, as both Investment Counsel (to engage in the business of advising clients as to the investing in or the buying or selling of specific securities or giving continuous advice as to the investment of funds on the basis of the particular objectives of each client) and Portfolio Manager (for the purpose of managing the investment portfolio of clients through discretionary authority granted by the clients). An applicant for ICPM registration must demonstrate a high standard of qualification (typically be a "Chartered Financial Analyst" (CFA) or equivalent), demonstrate skill in financial analysis and managing investment portfolios for several years under supervision of a senior registrant, and of course, be free of any legal impediments that would impair registration. An Investment portfolio manager is charged not only with the obligations of KYC, but also because of the grant of discretionary authority has a fiduciary duty to the client. That means that the ICPM must always put the clients' interests ahead of their own.
Investment portfolio management is a fee for service business. ICPM's do not earn commissions/trailers from creating transactions or selling products. The only compensation received is the fee the client pays. Investment portfolio managers usually charge a flat percentage of assets under management, typically between 1% and 2%. Some managers may offer a lower base fee and charge a performance fee for exceeding a predetermined hurdle rate. An ICPM cannot put themselves in a conflict of interest position with the client over the sale of a financial product. Furthermore, portfolio management fees are deductible for tax purposes in non-registered accounts. Contracts with an ICPM can be cancelled without penalty with thirty to sixty days notice.
The investment portfolio manager customizes a portfolio with respect to each client's objectives and constraints. These objectives and constraints are determined during the KYC process and spelled out in an Investment Policy Statement (IPS). The IPS provides the framework in which the investment portfolio manager executes an investment strategy to meet the client's objectives. Those objectives are measured by a benchmark which can be relative to a combination of market indices or an absolute numerical return. Though this mechanism, the client is able to track the progress and performance of the manager over time.
In cases where a group of clients have very similar IPS's, the client may elect to participate in an investment portfolio manager's pooled funds, often for a fee as low as 1% (See WRAP discussion earlier).
So, why would a client choose to go with an IA/CFP?
Education is often the answer, but more than that, ICPM's typically require much larger pools of investable assets before they will take on a client. Minimum account sizes very usually between $500,000.00 and $2,000,000.00 but in some cases can be as high as $5,000,000.00. Sometimes ICPM's with pooled funds will take accounts as small as $150,000.00 to $250,000.00.
Many people move to an ICPM because they find that mutual funds generally do not provide products that meet their particular needs and objectives. They are looking for more than "off-the-shelf" products typically designed only for registered investments. Many are tired of being sold last year's winner to find they own this year's dog.
If you are in this situation, I invite you to talk with Sprung & Co. We believe that every client is unique and deserves individual attention.
GLOSSARY
CFA: Chartered Financial Analyst
CFP: Certified Financial Planner
IA: Investment Advisor
ICPM: Investment Counsel / Portfolio Manager
IDA: Investment Dealers Association
IPS: Investment Policy Statement
KYC: Know Your Client
MFDA: Mutual Fund Dealers Association
MER: Management Expense Ratio
OSC: Ontario Securities Commission
WRAP: An IA's Offering of ICPM pooled funds