The Price of Advice - Nicola Wealth

The Price of Advice


By Dylan Reece, CFP, CLU, CIM & John Nicola, CFP, CLU, CHFC

TACT 2013-08 Price of Advice (header)

Read “The Price of Advice” in PDF format.

Executive Summary

As this newsletter is a little longer than most (with the exception of Rob Edel’s regular economic dissertations in the Monthly Market Commentary), we have provided the following executive summary of its contents:

The End of Commissions?  Financial industry regulators around the world are coming to the conclusion that embedded commissions in financial products may contain inherent conflicts of interest, and that investors would be better served if financial advisors were required to have a “fiduciary duty” over their clients’ affairs.

We at NWM could not agree more.  We were one of the first advisory firms in Canada to adopt a fee-based portfolio management model and already have a legal fiduciary duty to our clients, which we believe has allowed us to become one of the fastest growing wealth managers in Canada and, more importantly, to create long-term and trusted relationships with our client families.

The Value of Advice.  Many Canadian investors may not clearly understand if they are getting “value” from their financial advisor, either due to the services not being clearly defined (or provided at all) and/or they do not know the total fees that they are paying for advice and financial products.

We believe true value is delivered through strategic financial planning advice, diversified portfolio asset allocation, and transparent and effective reporting (including the fees one pays for advice and portfolio management).  In addition, our clients have generated investment returns that are higher than that of most balanced portfolio benchmarks, and with approximately one-third less volatility (or risk).

The Price of Advice.  All else being equal, the lower the cost of an investment portfolio, the higher the returns to the investor.  Historically, the cost of financial products in Canada has been relatively high, especially retail mutual funds that contain embedded commissions.

Through our ability to pool client investment assets together (along with our own family’s financial assets of course, as we invest hand-in-hand with our clients), we are able to negotiate lower fees with third-party investment managers, and to access certain assets that are otherwise unavailable to the average investor (e.g. private equity, physical commercial real estate and mortgages, and alternative strategies).

This process allows us to build much more diversified portfolios at lower costs than traditional portfolios, and without sacrificing access to quality third-party managers whose fees may be otherwise higher than low-cost Exchange Traded Funds (ETFs).

Changes Ahead for the Financial Services Industry?

The financial services industry has been under attack from both the media and regulators with respect to its poor track record of providing investors with clear and concise reporting on fees and returns, and managing conflicts of interests relating to commissions earned on financial products (both investments and insurance).

We believe our industry needs to greatly improve in all of these areas, and that regulators will eventually enact new rules to improve these issues, as they have recently done in the United Kingdom and Australia with the banning of embedded commissions and establishing advisory fiduciary duty.

In fact, in December 2012 the Canadian Securities Administrators (CSA) issued a discussion paper that, if implemented, will dramatically change how mutual funds are sold in Canada and how advisors are paid.  The major recommendations were as follows:

  • Advisor services are to be specified and provided in exchange for trailing commissions.
  • A standard class of mutual funds for Do It Yourself (DIY) investors with no or reduced trailing commissions.
  • Trailing commission component of management fees to be unbundled and charged/disclosed as a separate asset-based fee.
  • Establish overall limits on commissions and discontinue the practice of advisor compensation being set by mutual fund manufacturers.
  • Implement higher legal standards or duties for advisors.

What this really comes down to is that the CSA is asking for full disclosure on fees and how advisors are paid.  Needless to say, there are some in the investment industry who are threatened by this and are trying to stop or water down these recommendations.

One of Nicola Wealth Management’s founding principles has been to provide clients with transparent reporting.  This includes transparency on our planning advice (written financial plans and projections), the results of client investment returns, and fees paid for our services.

In fact, in 1999 NWM was one of the first wealth management firms in Canada to move away from commissions on investment products and to adopt a fee-based compensation model, as we believed it contained the least inherent conflicts of interest and was thus beneficial for both us and our clients.  It also meant we could access and recommend a range of investments that had no embedded commissions, such as ETFs and F-Class (commission-free) funds of first-rate investment managers.

Furthermore, due to our registration as a Portfolio Manager with the provincial securities regulators, we have “fiduciary duty” over our clients’ affairs, which means under law we must put our clients’ financial interests ahead of our own.

This compares to the majority of investment advisors and insurance agents who do not have such fiduciary duty, but rather comply to a lower “duty of care” model that does not mandate the client’s best interest be placed ahead of the advisor’s (they must simply do what is “appropriate” for the client).  Our industry and the end investor would be well served by mandating that all advisors have such fiduciary duty.

The Value of Advice

So how valuable is receiving financial advice in the first place?  According to a survey conducted in 2011 by market research experts Ipsos Canada, those who worked with a financial advisor had 150% to 650% more wealth than those that did not, and these results applied to all household income brackets (i.e. advice did not just benefit the wealthy).

A significant challenge facing many investors is the inability to determine whether they are receiving “value” from their financial advisor.  This means investors are often unaware of what services their advisor can or should provide for their fee, or, more commonly, how much they are actually paying their advisor each year, since most fees and expenses are embedded within financial products and are not well disclosed.

The basic principles of how we structure and manage our clients’ financial planning needs and assets can be summarized as follows:

Strategic Advice:  Each client should have a well thought-out financial plan that is reviewed and adjusted regularly.  This ongoing planning typically includes retirement income projections, tax and compensation planning, estate and insurance strategies, cash/debt management, business succession and continuation planning, and philanthropic giving.

When well executed, a strategic financial plan will achieve key objectives sooner and will almost certainly result in reduced taxes, thereby contributing to higher net returns and increased wealth for our clients.

Diversified Asset Allocation:  Many recommended asset allocation models are split between equities and bonds with diversification only occurring geographically (e.g. Canadian, U.S., international).  We have always believed that a broader range of asset classes including real estate, private equity, alternative strategies and other forms of fixed income assets such as mortgages, preferred shares and high yield bonds, are needed to create a truly diversified portfolio.

Transparent & Effective Reporting: Clients should be provided with clear and integrated reporting that indicates the following:

  1. Their current financial position (assets, debts, income, etc.).
  2. The return on their portfolio, including long and short-term results and the ability to drill down and get performance information on each asset class within the portfolio.
  3. The cash income being generated each quarter and year from rents, dividends, interest, and capital gains.
  4. Portfolio management fees paid (tax deductible in non-registered accounts).
  5. Comprehensive fiscal reporting for personal, trust, and corporate year-end tax return filing.

Over our near 20-year history, we have invested heavily in technology and our reporting systems to provide clients with what we hope is timely, transparent, and meaningful information that enables them to determine the ongoing value they receive from their relationship with NWM.

As a results-oriented wealth manager, we also need to track how our clients’ portfolios are faring relative to appropriate benchmarks and our competitors.  While high-quality client service and strategic planning are important to long-term success, we need to ensure our clients are realizing an adequate real rate of return on their financial assets that will allow them to achieve their unique financial objectives.  In addition to generating reasonable returns, capital preservation during times of financial stress is also a key objective.

We believe our broadly diversified asset allocation approach and focus on cash flow improves the net results our clients achieve.  Below is a table that shows the actual weighted average return for all NWM clients, after fees, for the previous one, three, and five-year periods, as well as since January 2000 (all returns to June 30, 2013).

It compares those results to both traditional balanced mutual funds and the indices (returns of the indices are reduced by 1% per year to reflect the actual MER one would pay to hold Exchange Traded Funds and the approximate trading commissions incurred to acquire and rebalance the portfolio on an ongoing basis).

TACT 2013-08 Price of Advice - NWM v Market

As demonstrated by the figures above, we continue to provide our clients with longer-term net returns that are in excess of reasonable benchmarks, and with approximately one-third less volatility (or risk, defined as standard deviation) since January 2000.

Below is a chart that shows year-by-year returns for our clients versus the average balanced portfolio available in Canada (60% Cdn Neutral Balanced Peer Index and 40% Global Neutral Balanced Peer Index [Morningstar]).  It shows that one can achieve better returns and reduce volatility at the same time.

TACT 2013-08 Price of Advice - NWM v Balanced Peer

In order for us to build the asset allocation model we want for our clients, we need to be able to access assets in one or more of the following ways:

  1. Acquire the assets on behalf of the clients directly in either segregated accounts or in NWM Pooled Funds.
  2. Acquire pools or funds managed by third parties at the best price possible for our clients.  (This is usually done by purchasing F-Class funds which have no commission embedded in their structure.)
  3. Buy Exchange Traded Funds (ETFs) for each asset class we want to have in our clients’ portfolio.  These ETFs tend to have lower costs than the F-Class funds of third party managers, but there are trading costs to acquire them through custodians.  In addition, not all asset classes are available through ETFs (e.g. private equity, hedge funds, and Canadian commercial mortgages).
  4. Engage third party managers on a special institutional basis, where the pricing is considerably less than the F-Class fund offered by the same managers, and hold these low-cost investments in our own pooled funds.  Usually the minimum investment for these institutional investments is between $5-million and $10-million.  We can save our clients between 20 and 30 basis points per year versus just using the F-Class shares.

Overall, we have the bulk of clients’ assets in the NWM Pooled Funds using a mix of options one and four above.  While fees may be lower if we simply buy investments directly for clients rather than by using third party managers, there are many examples where the third party manager provides value far in excess of their fees.

Our position is to do both, keeping our clients’ overall costs down, but not at the expense of accessing exceptional managers at a reasonable price.  In other words, we are seeking the best possible, risk-adjusted returns net of fees and expenses.

The Price of Advice

The table below outlines a summary of what our clients pay for costs related to ongoing investment management and financial planning based on our investment model discussed above.  The components of the costs stem from the following:

  • Ongoing planning work for clients (retirement, tax, estate, philanthropic, etc.).
  • Reporting on their investment results and tax filing requirements.
  • Investment management, including research for specific assets, due diligence, and review of third party managers.
  • Fees charged by third party managers.
  • Custodial, accounting, legal, and general administration.

TACT 2013-08 Price of Advice - Summary Total Fees

In summary, the weighted average fee that our clients pay for our advisory and portfolio management services is 1.65% per year.  The actual fee that each individual client pays will vary based on the size and allocation of their portfolio that we are managing on their behalf.  Note that the NWM advisory fee is also tax deductible for non-registered accounts, and thus the after-tax net fee is considerably lower.

So how do these fees compare to other balanced investment alternatives? 

The table below compares the total fee paid by the average NWM client to that of an investor who invests solely in low-cost ETFs (but through a financial advisor who charges a 1% annual management fee) and another who invests in commonly used commission-based balanced mutual funds (also purchased through an advisor, but whose compensation is built into the Management Expense Ratio of the fund).

TACT 2013-08 Price of Advice - NWM vs. ETF or Balanced Funds

Overall, we are able to position our average client into the appropriate portfolio at a cost of approximately 1.65% per year, which includes all costs related to ongoing financial planning, reporting, investment management and pooled fund administrative/custodial expenses.  We believe this to be a very fair and competitive outcome, and is part of what has allowed us to generate above average returns for clients over an extended period of time.

As a reminder, the partners, employees and shareholders of NWM invest their own families’ assets alongside our clients, so our common objective of seeking the best risk-adjusted investment results at the lowest reasonable cost could not be better aligned.

There’s a saying in the kitchen: “never trust a skinny chef, as obviously they don’t eat their own cooking.”

At NWM, we happily consume our own advice.