Your Interview

Although the advisor/broker has a fudiciary responsibility to their client, the compensation structure of the advisor/broker is at odds with this duty of care..meaning that brokers/advisors are really sales people and their jobs depend on generating a continuing stream of commissions/trailers.

How can we move to ensure the broker/advisor is able to fulfill their obligations to their clients while not succumbing to the SELL SELL SELL OR ELSE that is forced upon them by their employers?

Eric Kirzner: Robin, yours is an important question and one that has been central to the advisor/client relationship ever since the genesis of organized markets. Let me start by saying that the relationship between client and advisor/broker is not always a fiduciary one.

It depends on the degree of reliance and trust that the client places with the broker. For example, a sophisticated investor with considerable investment experience who participates in making decisions is probably not in a fiduciary relationship with her broker.

That being said, compensation in the investment advisory field, as you know, is generally based on commissions and sales activity.

Some advisors offer fee for service structures where compensation is based on (i) a percentage of the client’s assets under administration or (ii) an hourly rate. These approaches might reduce the incentive of brokers to oversell but may not necessarily result in lower fees.

Ultimately, management of the potential conflict of interest between the client’s best interest and generation of sales commissions is a function of the integrity of the advisor and the diligence of the client.

Rigorous training for financial advisors both in (i) proper account management by focussing on getting a suitable asset allocation to match the client’s investment objectives, risk tolerances and time horizon and (ii) in ethical behavior will help.

Informed investors who know how to spot professional well-trained advisors (see my answer to Mr. Forbes below) will also go a long way to reducing abuses.

I don't think it's unreasonable to feel a bit wary of the financial industry at the moment. Are there any tell-tale signs that you are dealing with someone who is a professional and knows how to invest your money safely?

Eric Kirzner: Here is what I look for:

1. Does the potential financial advisor spend considerable time and effort obtaining full “know your client” information? Does she ask probing questions of you to ensure that she is recording suitable objectives, risk tolerance levels, financial and other circumstances, investment horizons, level of investment knowledge and experience?

Does she point out and get you to clarify any inconsistencies (such as aggressive investment objectives with low risk tolerances and little investment experience)? Is this critical stage of information gathering done in a thorough and competent manner?

2. Is the advisor’s focus primarily on the structure of your portfolio (getting the right mix of safety, income and growth to match your objectives and risk tolerances --a process known as asset allocation).

If so- this is a good start. If instead, the focus seems to be on individual stock or other investment selection I would be wary. Nothing is more important than getting the right asset mix for you.

3. You should quiz any prospective adviser to ensure that you’re right for one another. Make sure to ask the adviser about how large a portfolio her typical client possesses. You don’t have to be the largest fish in the advisor’s pond but you don’t want to be the smallest client either. You want to be treated with respect and get appropriate attention.

4. If you are prepared to take the tougher route ask the advisor what their value added is expected to be. Remember that advisors are not analysts – they generally rely on their own research department.

You, as an investor, if you are prepared to do a little homework can easily build a diversified portfolio using low-cost mutual funds or exchange-traded funds. It’s not brain surgery. Politely ask the advisor what she will be contributing to this process and how she expects to add value over a simple index based buy and hold strategy.

5. Ask about portfolio turnover. Once the portfolio is in place what do they foresee in terms of trading and changes?

(I want to hear that the advisor’s plan is to recommend rebalancing the portfolio if the weights change- i.e. sell stocks and buy bonds if stocks have a good run relative to bonds or to change the composition if your objectives, tastes and /or circumstances change.)

6. And finally you need to make sure that you are dealing with a quality person. A site visit is important. References from qualified people who know the investment business are essential. Don’t rely on recommendations from well-meaning but amateur friends and relatives.

Do you feel that bank preferred shares are a safe alternative to gic's and bonds?

Eric Kirzner: I like bank preferreds now (although not as much as I did a few months ago when yields were higher) but I cannot compare them to GICs.

GICs, if the issuer and issue are eligible (check the terms carefully before you invest) are subject to CDIC deposit insurance ($100,000 per account per issuer) and thus fall into the safety category.

Check the CDIC website at www.cdic.ca to get a precise definition of the extent of the coverage and what is covered. Do your homework- don’t rely on others.

Bonds on the other hand are not subject to deposit insurance but as bond holder you are a creditor in the event of a default. Preferred shares as equity securities rank below the claims of creditors. Preferred share dividends are taxed differently than GIC and bond interest income.

The features on preferred shares can be quite complex (maturity, redemption, whether dividends are cumulative or non cumulative) and need to be well understood by the investor.

Some could be highly sensitive to rising interest rates --although medium and long term bonds would be as well. For that matter a 3 or 5 year GIC also has interest rate risk – you just don’t see it because the price is fixed.

If you understand what you are buying and are buying in a non-registered account I can see a place for a small allocation to bank preferreds in a portfolio.

I am dealing with a CCP who owns an Edward Jones Franchise. Before that, she was the
Manager for Investments for my Branch of the CIBC. Do I have to be concerned? Is Edward Jones a reputable outfit?
Thank you,
Barb Jaeger
Chilliwack, BC

Dr. Kirzner; Given the recent global financial crisis and the climate of uncertainty, do you still believe that holding high quality equities for the long term within a diversified portfolio is the best investment strategy? Do you recommend being overweight in any particular sectors at this time?

Eric Kirzner: Well I haven’t changed my views on asset allocation. I still believe that for many investors a high quality portfolio of equities has its place as part of a suitable mix with safety and income-oriented investments.

Many investors of course suffered severe losses from summer 2008 through March 2009 if they had high allocations to equities during that period. Hardly anything or anyone avoided losses of 30, 40% or more. You need to make sure that you have the right allocation—it’s the portfolio that matters!

Are bank investment houses or divisions. Safer then privately run houses or offices???

Eric Kirzner: I assume you are talking about safety of your capital not the investment risks, There is no question that the banks are the best capitalized of the Canadian financial institutions.

That being said, the real issues are (i) whether the firm you are dealing with is a member of the Canadian Investor Protection Fund (CIFP) and (ii) the size of your account.

The CIFP provides protection of up to $1,000,000 in the event of the bankruptcy of a CIFP member. Investors can have up to two accounts with a Member - a general or non-registered one and a registered account.

So this would mean for investors with RRSPs coverage of up to $1,000,000 for each of two accounts. The coverage is on the shortfall and is calculated on a pooled basis.

So, under certain circumstances you can have much more than $1,000,000 in an account and still recover your full loss. See the CIPF website (www.cipf.ca) for a useful illustrative example, for a discussion of the distinction between general and retirement accounts and other information about CIPF.

Let me make somewhat crystal clear. This coverage does not apply to market losses, bankruptcy of issuers or any of the investment risks you undertake when you buy an investment. It only applies to bankruptcy of a CIPF Member. These haven’t happened often.

According to the CIFP website there have been 17 such CIPF Members bankruptcies since the inception of CIFP in 1969 and no investor has ultimately lost money as a result of such a bankruptcy.

Does holding assets through a discount brokerage operated by a federally-regulated bank (e.g. BMO Investorline) guarantee that one is not vulnerable to frauds like the one which Earl Jones is alleged to have perpetrated? Is there a government-backed guarantee like there is for for savings deposits by the Canada Deposit Insurance Corp?

Eric Kirzner: Noel, see my answer to David W. I think this addresses your questions. Just for clarity the CIPF is not a government agency – it was created by the investment industry.

What are the potential consequences to investors if online brokerages, such as Qtrade, Etrade, etc, go belly-up?

I've had several advisors over the past 20 years. Each one seems to bring me great returns during the first two or three years of our "relationship" and then the returns quickly vanish as they "advise" me to move to other "investment opportunities", which have never worked out very well. As it's happened several times, I'm wondering if it's just wise to change advisers every 3 or 4 years to ensure that they're always trying their hardest to obtain the best return for the "new" client. Your thoughts?

Do you think stock market "investing" is legimate? I participated in the stock rally of america's bankrupt banks and made a killing, it seems to me the stock market functions like a legitimized ponzi scheme (i.e. shares of a stock act as an abstract intermediary in the ponzi structure of the stock market, thereby obfuscating the operation of the fact that you'd never do it face to face).

The returns from a stock rarely comes from profits and more from one investor taking the place of at a higher price.

When one is investing in securities, someone is going to have to lose so that someone else will gain. Are there other less ethically questionable investments and wich ones would you choose outside of securities?

I have investments with both BOM and RB, thinking that I should not put my eggs all in one basket. I have not added any additional funds to either and as a result other than the quarterly statements, have not been contacted by either institution. Should I be looking for more contact with them or should I perhasp be looking for somewhere else to invest?

Is there any evidence that active management really adds any value to a portfolio? Isn't it better to just hold an ETF which models the universe of stocks and sit tight?

Many Financial Advisors work in association with reputable investment companies such as Dominion Securities and Investors Group.

Does this association protect the investor any more than advisors working on their own?

What actually are the advantages of engaging an adviser and what are the risks of going it alone of which I may not be aware?

I have no training in investing except my unsatisfactory experience with the two financial institutions I left when I decided to go it alone.

At present I am content with the moderate growth of my ETFs.

My fees are 15-16 % of what they were with an adviser. Frequently ETF companies, who are not trying to sell their own counsel, advise me to consult with my financial adviser. Having an adviser seems to be the default position, hence my question.