Making sen$e of your savings portfolio – A case study

Recently, I received the following request from an acquaintance I will call Kristina:

“Hi Malvin,
The company I have most of my RRSP’s at recently assigned me a new adviser.  He seems pretty keen and knowledgeable but he also wants to change every fund the original adviser got (BTW: the first adviser quietly disappeared/retired about five years ago and the funds I currently have were all bought years ago).  I am slow by nature to make changes, so I appreciate your thoughts on the new ones being suggested.”

I’ve always refused to do this sort of thing for people I know – I am not a financial adviser.  But in this case, I was curious.  Having spent decades as a portfolio manager I thought it would be interesting to see what sort of recommendations an adviser would be making today, and at the same time educate my friend about investment strategy.  A little information can go a very long way in terms of simplifying a confusing scenario.

I first examined her current portfolio of mutual funds.  The strategy adopted ‘years ago’ was okay.  The consensus thinking at that time (keep in mind analytical tools weren’t as sophisticated then) was that holding similar fund types managed by different portfolio managers was a smart way to diversify style bias.  Translation?  Managers would perform better or worse at different times depending on their investment styles.  When one fund was doing poorly, the other might be doing well so net you’re somewhere in the middle.  Nowadays though, funds are far more specialized so style is less significant – or in other words one global fund manager performs pretty much the same as all the others.

My first step was to identify where the money was ‘really’ invested right now.

Kristina Table

This involved looking up each fund to determine how much of each fund was in cash (or short-term liquid securities), Canadian stocks, fixed income (bonds) etc. and creating a summary (see table).  The big commitment to Canadian stocks has been fortuitous.  Canadian stocks outperformed US stocks (converted to Canadian dollars) and many other asset classes consistently from 2004 to 2010. The weighting would have grown over time because of this.  Since 2010 the US has been the big winner.  Although a big part of Kristina’s global exposure was probably US stocks, it would take an awful lot of number crunching to pin down the precise weighting here.  Bottom line?  This mix of funds has served her well.

There are two major reasons why her adviser might want to recommend a wholesale restructuring of her portfolio.

1) The funds have grown stale (fund managers change, the fund strategy can change modestly or he believes your own objectives have changed.)

2) Business reasons (the firm your adviser works for requires activity to generate income).

I pointed out to Kristina there’s nothing wrong with change.  It doesn’t hurt to allow the new adviser to earn some money for his efforts.  In her case, he was recommending what is known as the 3% ‘low-load’ option, which means the adviser and his firm will share a fee paid by the fund company for doing the work. Should you decide to take your money elsewhere within a short period (usually 3 years) then you will pay a penalty to offset this expense.  Given that Kristina hasn’t made changes in many years – this isn’t an issue.

Her adviser reduced the number of funds from 9 to 7.  Three were three global funds, one US equity fund, two Canadian equity funds, a fixed income fund and one ‘open-mandate’ fund – meaning it could invest pretty much anywhere (essentially another foreign equity fund).

What concerned me was the adviser’s recommended weightings.  The adviser increased the commitment to US equities substantially.  Many financial  advisers are pressured to ‘go-with-the-flow’ by their compliance departments. Better to recommend funds that have done well and everyone else is buying in order to avoid potential reputational risk. But based on my many years of experience and study, I know that what has been the best place to be invested is extremely likely to become the worst place.

Also, despite the fact that he recommended multiple global funds, none of them seemed to have a meaningful weighting in Asia.  If it were my money I told Kristina, five funds would be plenty and I’d be more discerning in my global exposures.  Specifically, I presented my own suggested mix in a pie chart.  Far less in US equities and Canadian equities, but more exposure to markets currently out of favour (therefore better value); namely troubled Europe and Asia (including China).  The high money market weight I’d consider a reserve to invest in bonds when global interest rates are higher – and one day soon they will be.

Kristina today vs suggested

So how did Kristina respond?

“Wow! I love how you presented your suggestions.    What you have done is explain the broad categories in which the current vs (your) proposed funds would fall, which for a beginner like me is easy to process. My adviser also had charts with anticipated %s of returns between current vs proposed funds, as well as pie graphs.  However, it was too much info and quite overwhelming for a beginner, as I truly couldn’t appreciate all the nuances. However, with your comments I think I am getting better at understanding the details.”

And in the end she decided not to make any changes at all.  It may hurt her adviser’s feelings some, but not mine.  At least her choice was a better educated one.