CRM2 isn’t the full picture

CRM2 isn’t the full picture

CRM2 isn’t the full picture Sweeping changes in the financial services industry are in full swing, and Canadian investors will benefit. CRM2 is intended to provide greater transparency around what investors are – or should be – most concerned about: performance and fees.

Effective for 2017, advisors must deliver two new annual reports to clients, informing them about their personal money-weighted rate of return (which will be influenced by the timing of any deposits or withdrawals from the portfolio) and the charges/fees incurred to work with their advisor.

These changes are a step in the right direction for our industry, but they still do not level the playing field for advisors of different compensation models.

Understandably, a regulatory body’s first priority should be to support clients and their experiences with professionals in our industry. Improvements to fee and performance transparency have been a long time coming. As helpful as the new reports will be, the less astute investor will not see the entire picture. Stand-alone numbers on a statement do not paint a detailed picture of the overall relationship or the value the advisor brings to the table.

Unfortunately, in the eyes of most clients, an advisor’s value is derived by his or her ability to provide absolute returns. A money-weighted rate-of-return calculation can negatively affect an advisor’s investment strategy through no fault of their own. For example, an investment may have provided a 5% calendar-year return, but that doesn’t mean that the investor’s account had a personal rate of return of 5%. If the investor withdrew funds from the investment midway through the calendar year at a time when the investment itself was down 1% year-to-date, then the investor’s personal rate of return would be less than 5%. Because losses are not realized until a sale takes place, if an investor sells units/shares at an inopportune time and realize losses, that affects the investment’s rate of return.

An investor should know what he or she is paying in fees. But even more important, an investor should know what services he or she is being provided for the fees agreed upon.

The shortcoming of CRM2 is that it doesn’t address the two components of an advisor’s fee. The fee for the service component (i.e. financial planning, portfolio rebalancing, plan maintenance/review, etc.) is distinct from the fee for investment selection (i.e. selecting and maintaining the investment solution). Under CRM2, only the service component must be disclosed as a dollar amount, which may not
provide the entire cost picture.

For example, a fee-based advisor may charge 1% for the service component, but may use mutual funds for the investment selection of the portfolio. On a $1 million portfolio, the fee is $10,000, but a management fee is also charged by the mutual fund company within the management expense ratio [MER]. The management fee within the MER is also expressed as a percentage, similar to the service component, but is not required to be disclosed in dollars and cents.

Thus, investors will continue to be unaware of the total fees charged. Advisors compensated on a fee-based model may be inaccurately evaluated, given this omission.

CRM2 could be improved by implementing changes that don’t put the focus of advisor evaluation on factors out of their control. For example, if personal rates of return are disclosed, then a benchmark for comparison purposes (i.e. commercial index, peer group index) should also be included. Doing so would suggest that any underperformance of the portfolio from the benchmark could be due to the timing of deposits and withdrawals and not the advisor’s lack of skill or expertise.

Alternately, the personal rate of return could be calculated using methodology that does not consider the timing of deposits or withdrawals. CRM2 should also require that all fees (i.e. mutual fund companies’ management fees) are disclosed so that investors are fully aware of the fees they are ‘paying’ for the advice.

Improving transparency not only benefits clients directly, making them more aware and able to make informed decisions; it also requires advisors to up their game to justify their fees and explain their value. Raising the level of advisors as a whole will benefit the end-user.



The opinions expressed here are those of the author.

Carlo Cansino is a senior financial planner for The McClelland Financial Group of Assante Capital Management.