A recent proposal tabled by the Ontario Securities Commission (OSC) that was designed to hold investment advisers who work for bank-owned investment dealers, mutual fund and insurance companies to a higher standard of client care was recently rejected by the Canada’s provincial securities regulators.
The quashed “best-interest standard”—an overarching rule stating that investment advisers must put their clients’ interests first—did succeed in bringing to light many conflicts of interest clients face when dealing with financial advisers.
Importantly, independent portfolio managers like Bridgeport Asset Management sit outside this debate because they already owe a “fiduciary duty” to their clients: they are legally required to act in their clients’ best interest and make decisions that are independent and free of bias at all times.
We find it surprising that the securities commissions did not require financial advisors employed by large Canadian financial institutions to adhere to this fiduciary standard, given that most clients are surprised to learn that this standard is not already in place as it is for other professionals such as doctors and lawyers.
Advisors vs. Portfolio Managers: A Lower Standard of Care
The changes proposed by the OSC were intended to raise the bar for several standards of care that investment advisers are not currently required to uphold.
• An obligation for advisers to put clients’ interest first when deciding on an investment’s suitability, including a requirement to take into account any costs associated with a given investment and whether the investment make sense for a client within the context of their overall account holdings.
• Minimum intervals for updates of “know your client” information (such as financial circumstance, investment goals and knowledge, risk tolerance and time horizon).
• A requirement to take reasonable steps to understand the essential elements of an investment that the adviser makes available to clients, including how the investment compares to others available in the market.
Portfolio Managers Are a Different Breed
Portfolio managers administer their clients’ investments directly, buying and selling on the client’s behalf on a discretionary basis, which makes the relationship a fiduciary one and gives rise to the legal requirement that client interests must always come first.
A portfolio manager will develop an investment policy statement (IPS), something an adviser is not currently required to do.
An IPS goes beyond basic “know your client” requirements and forms a holistic plan for investments, including clear parameters such as limits a client wishes to place on the manager (for example, avoiding certain stocks or sectors), a timeline for when, say, they plan to retire and any other financial requirements or constraints.
Think of an IPS as a living document that adjusts to the client’s needs as time goes on.
Because a portfolio manager places trades without having to first call the client, they can act as soon as they see an opportunity and make the trade in many client accounts at the same time (if it fits with each client’s IPS, of course).
An adviser, meanwhile, has to call each client before acting. That can take weeks, and by then an attractive opportunity may have passed. If the adviser has many clients, they’ll have to decide whom to call first (with the obvious temptation being to start with the biggest ones).
Further, as portfolio managers are fiduciaries, they must meet the highest educational standard in the investment business. A portfolio manager will likely have a university degree or MBA and possibly a Chartered Financial Analyst (CFA) designation.
Becoming a CFA charterholder has become a basic requirement in professional investing, demanding 1,000 hours of study and four years of work experience; fewer than 1 in 5 people who set out to attain it actually do. (Four of Bridgeport’s team members are CFA charterholders.)
Conflicts of Interest: Performance Killers
Many advisers are paid a commission on every investment they buy or sell, which builds in a potential conflict of interest, namely the temptation to suggest more trades than necessary.
Advisers may also receive trailing commissions from mutual funds: ongoing payouts they’ll receive as long as the client owns the fund. The problem here is obvious: an adviser may be biased toward recommending or holding a particular fund based on the size of the trailing fee.
Portfolio managers like Bridgeport do not generally take commissions, but receive a management fee based on a percentage of assets under management. This approach acts as a safeguard against excessive trading, because it encourages the portfolio manager to grow the value of their client portfolios and only make transactions if they feel they’ll generate a good return relative to each client’s risk profile.
Ask About Compensation
Be sure to have a frank discussion with any current or potential manager on how they’re compensated. It’s important that all compensation arrangements, especially if they go beyond percentage-of-asset charges, are clear and properly understood. Scrutinize advisers who stand to gain from excessive trading or who have little involvement in researching the investments they recommend. If your adviser does not owe you a fiduciary responsibility, it’s likely they are only acting as an intermediary between you and the institution they represent.