CRM2 – Mutual Funds vs Portfolio Management

CRM2 – Mutual Funds vs Portfolio Management – Beginning in July of this year all Canadian investors now have to be advised of the costs (immediate or deferred) associated with the sale or purchase of all securities, including mutual funds, investment funds and ETFs.

This requirement is part of the new rules prescribed by the Canadian Securities Administrators (CSA). The rules are often referred to as CRM2, which stands for Client Relationship Model, Phase 2. What CRM2 means for mutual funds is that investors must now receive timely, easy-to-understand, detailed information about all of the costs and the performance of their funds. The following costs must be disclosed:

  • The charges investors will pay for the purchase, or a reasonable estimate if the actual amount is not known at the time of disclosure;
  • Details of any deferred charges that the client might be required to pay, including the fee schedule that will apply;
  • Any ongoing commissions that will be received by their advisor.

CRM2 is being phased in over three years. By July 2016, investors will receive statements showing, in dollar amounts, the costs associated with each of their products. A separate statement will tell investors how well their investments have performed in dollar terms and percentage terms over several time periods.

CRM2 Mutual Funds Portfolio Management

CRM2 – Mutual Funds vs Portfolio Management

In spite of a decade of lacklustre performance and high fees, many Canadians continue to hold their investment assets in mutual funds. Even the emergence of exchange traded funds (ETF’s) has failed to put much of a dent in the mutual fund industry. As of November 2013, mutual fund assets in Canada were $986 billion; Canadian investors held only $62 billion in ETF’s.

One of the reasons for the ‘stickiness’ of mutual funds may be that investors are not fully aware of how much they are paying in fees and how much their advisors are receiving in ongoing commissions for selling funds to them. CRM2 means that, in effect, investors will now receive an invoice detailing exactly what they are paying.

One of the key differences between advisors (brokers and financial planners who sell mutual funds) and portfolio managers is that portfolio managers have always disclosed all costs to their clients by directly invoicing them for their services. We also report investment performance—something advisors won’t have to do until 2016.

Before describing how portfolio managers work with their clients, let’s take a quick look at how mutual funds function. A mutual fund is an investment vehicle that is made up of funds collected from many investors. The manager invests those funds in securities such as stocks, bonds, money market instruments and other similar assets. Individual investors own units in the funds in proportion to the amount they have invested.

While the first mutual funds were founded in the 1930’s, they grew in popularity beginning in the 1960’s. In an era of high trading commissions, their main benefits were that they gave small investors access to professional management and diversification at lower cost. With the advent of discount brokerage in the 1980’s and ETF’s in the past 10 years, mutual funds are no longer a low cost option With many large Canadian mutual funds still charging fees in the 2% to 3% range, they are now an expensive way to invest.

Why have many mutual funds performed poorly? High fees are certainly one reason. Another is that mutual funds tend to be over-diversified. Larger funds have so many assets (i.e. so much cash to invest) that they have to hold hundreds of stocks. This can make it difficult for funds to outperform market indices.

Despite this difficulty, brokers and mutual fund managers feel that clients expect them to out-perform the market. To do that they are forced to take on more risk. However, if a fund out-performs in a rising market, it will likely under-perform in a declining market. That is exactly what many Canadian investors experienced in 2008: while the TSX Composite Index declined by just over 30%, many supposedly ‘conservative’ large-cap equity funds declined by 40% or more.

Given the poor performance of many large Canadian mutual funds, why do so many investors continue hold them? The reality is that mutual funds, like life insurance, are sold not bought. Brokers like to sell mutual funds to their client because they are paid commissions at the time of the initial sale and ongoing trailer fees that in the past were largely invisible to their clients.

It is also worth noting that there is growing evidence suggesting that the sort of people most likely to go into the lucrative financial service sales roles are precisely those least suited to judging risk. Read more here>>

CRM2 – Mutual Funds vs Portfolio Management – What’s the difference between a portfolio manager and a broker?

It is a source of pride for us that we are discretionary investment managers, not brokers. We are independent of any bank or broker and our only source of revenue comes directly from our clients. We do not receive any kind of commissions or trailer fees. Sprung Investment Management is committed to meeting a fiduciary duty. A fiduciary duty or best interest standard (already the norm for accountants, lawyers and some other professionals) is a legal requirement that an adviser must put the client’s interests first. That includes avoiding all conflicts of interest and making the best recommendations for the client even if it means lower compensation.

Canadian securities regulators are reviewing the potential benefits of introducing a fiduciary standard for brokers. Their industry body, the Investment Industry Association of Canada (IIAC) is fighting against this proposal. Learn more here>>

At Sprung, our investment management approach is based on the value investing principles developed by Ben Graham. Graham explained that “the essence of investment management is the management of risks, not the management of returns.” Learn more here>> The management of risk begins when a new client joins us. Clients meet directly with Michael Sprung and other members of our team. We take the time to get to know our clients in order to understand their investment objectives and risk tolerance.

Based on that understanding, we begin to build a portfolio that includes high quality dividend-paying stocks and Canadian government bonds. Whereas mutual funds often hold hundreds of stocks, our client portfolios typically hold 20 to 25. We believe this is a sweet spot for diversification. If you hold more, gains in any single stock will hardly affect the total value of your portfolio. If you hold fewer, losses in any stock can have an adverse effect on your portfolio.

In summary, the benefits of portfolio management include:

  • A personal relationship with the person who is actually making investment decisions on your behalf;
  • Holding a well-diversified portfolio that properly reflects your risk tolerance and investment objectives;
  • Avoiding the conflicts of interest inherent in the broker/fund manager model;
  • Transparency—no hidden fees or commissions;
  • Lower cost.

Download Our Free Special Report – How to Hunt For Value Stocks. Michael Sprung will explain our approach to identifying value stocks and share with you 5 stocks set for long-term gains.

Is Your Stock Broker Acting in Your Best Interest? Read more here>>

Exchange Traded Funds Expose Investors to Unexpected Risks. Read more here>>

Investment Management – Risk vs. Return. Read more here>>

We believe that investment management is about managing risk, not chasing speculative returns. Like to learn more? Please contact us here>>

The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.