There is a major difference between a full-service financial advisor and an ICPM. The advisor must approach the client for instructions with respect to all transactions. The ICPM need only report periodically, as instructions have been given in the form of the initial contract.

The actual role of the ICPM

The client is therefore responsible for what the ICPM does only in the sense that the client chose the mandate (relying on advice from the ICPM). So long as the ICPM follows the mandate, there is little to discuss with the client as decisions are made. The ICPM must report to the client. The client should monitor what the ICPM is doing, either through written reports or through personal communication. If the client is unhappy with progress, or if the ICPM identifies changes to the market that have an impact on the mandated strategy, then the parties must meet to discuss the changes. This is especially true for significant events that change the landscape for the client. In another article, the subject of “material change” will be discussed.

Each client is different

Because clients do not have the skills that professionals have, clients retain the professionals to perform those functions.   Often clients do not understand what is involved with the investment process.

In all these circumstances, the ICPM must cater to the ability of the client to understand the issues involved with any decision. A client with weaker skills must receive more education. The ICPM should not assume that the client fully understands the concepts of risk and time horizon. More importantly, the ICPM should not assume that the client understands the risks of a particular strategy as they affect that client.

An uninformed client is not responsible for losses arising from a risky strategy.  “Informed consent” applies to investment relationships as much as to doctor-patient.  Only an informed client can be truly said to be “in charge”.

If you have suffered losses at the hands of a discretionary advisor, contact us to see if you have the right to receive compensation.  For a free consultation to discuss your rights, complete and submit this online form.

The investopedia.com dictionary defines time horizon as “the length of time over which an investment is made or held before it is liquidated.”  According to James Bagnall of the Globe and Mail, a better definition is the length of time between when the client wants to grow funds and the time the client has to live off the income from those funds.  In other words, investors need to realize that this time horizon is really the span of time they are taking on risk to grow their funds.  A new time horizon starts when they know will need income from the past growth.

The Conflict of Interest

How much growth is “growth”? If you own a portfolio that increases by 5% each year, do you care whether you actually receive 5% in cash from interest payments, or whether the value of the securities increases by 5%? You would care if the tax consequences were different, as they can be.  However, if your holdings are within a registered plan, such as a Canadian RSP or an American IRA, you would not care, because there are no tax consequences either way.

Regardless, what you need to know – and what your financial advisor has a professional obligation to explain to you – is that your risk of loss increases with your hoped-for percentage gain.  If not explained to you, how can you fully understand the trade-off between the real risk and the potential reward?  Failure on the part of financial advisors to make the explanation comes from a conflict of interest – your interest in having appropriate investments that work for you, and the advisors’ interest in continuing to manage high-risk investments that work for them!  A professional advisor will put the interest of the client first, and make suitable recommendations after full explanation of risk.

The Myth of Inflation

In reality, the shorter an investment time horizon you have (i.e. before you have to access your money), the less risk you can afford to take.  If you need $50,000 a year to live on, and receive $10,000 a year from pensions and other sources, you will need $40,000 a year from investments. Your financial advisor may warn you that the $50,000 requirement will increase with inflation. What your financial advisor may not add is that retired people often do not suffer the consequences of inflation the way working people do, because many of their expenses are no longer tied to the cost of living.

For example, many retired people have paid off the mortgages on their homes and have already invested money in upgrading and maintaining them.  Therefore, they do not have to worry about any increase in housing costs, except to the extent that real estate taxes and house operation costs increase.   House values may well increase faster than those costs.

Also, as retired people age, the cost of social and recreational activities may decline.  They may continue to travel, but going to stay in one place in the sunny southern United States or the Caribbean will be far less expensive than the trips across Europe or elsewhere they took when they were younger.  Pension incomes may increase with inflation, and government subsidies may kick in. Granted, increasing health care needs may be a factor, but many people continue to have health insurance benefits that carry over into their retirement.  Government subsidies for health care increase with age.

The Risk Factor of Age

The older investors are, the less time they have to make up losses. They also have fewer resources to draw on should a loss reduce their account.  They may suffer severe family stress, as their investments decline and they see their goals slipping out of reach.  It is their financial advisor’s obligation to protect them by knowing their situation and needs, by setting appropriate financial goals, and by keeping their investments secure.

To put it clearly, investors who have substantial stock market exposure should consider making changes in the risk factor of investments as they approach and then pass the age of retirement.  Their advisors have a professional obligation to advise them to take less risk.

If your financial advisor has not fulfilled this obligation, you have the right to complain to your provincial securities regulator and to retain legal counsel.  For a free consultation, please complete and submit our online form.

The Beta Factor

To an investment industry professional, if something rises quickly, it can be expected to descend just as quickly. The industry term “beta” compares the value changes of the security to the market generally. A low beta means that the security value will change less than the market changes, and is therefore of lower risk. However, the stock market itself can be very volatile, i.e. risky. We have seen increases of 100% and decreases of 50% (which amount to the same number of dollar) in a very short period of time. And there is no way of forecasting when, how much or for what length of time the market will rise or fall.

Would you think differently if there is a one-in-three chance of a 10% loss, as opposed to a one-in-10 chance of a 20% loss? How about a one-in-20 chance of a 50% loss? Twice since the year 2000, we have seen drops of almost 50% in a two-year period. In reality, what happened in 2008 was not that uncommon. Some industry opinions suggest higher volatility is here to stay. So, what will 2012 bring?

Appropriate Risk

The US and Canadian stock markets generally increase and decrease by more than 10 per cent within any given year. If you are not prepared to accept a 10% loss in a one-year period, you should not allocate most of your investments to the stock market. And, even if you are prepared to accept a risk of loss in the range of 10% in one year, you should be advised that the next year may see further declines. Just as a decline in the market doesn’t guarantee a subsequent rise, nor does it guarantee a halt to the decline as time passes.

Understanding the Market(s)

The “market” is actually made up of a number of markets. During the course of any given market week, investors buy and sell more bonds than they do stocks. They also buy and sell more currency and more commodities. Bonds, currencies, commodities and stocks each represents a different market, with a different risk profile. Also, within the stock market as well as the bond market, there are different economies and governments, different sizes of company, and different sectors of the economy, each of which can be considered a market in its own right.

Risk and Your Investment Policy Statement (IPS)

Typically, people do not invest to gamble. They invest to accomplish a purpose, most often to retire comfortably. What risk really means in that circumstance is that inappropriate investment choices may not accomplish that purpose. A professional financial advisor must try to establish reasonable goals with you and to allocate investments that will help you meet those goals, all of which should be reflected in your IPS. Should your financial circumstances change, your advisor must re-establish appropriate goals and investment allocations. This is best accomplished with regular communication between your advisor and you, and regular updates to your IPS.

Understanding Risk

When a financial advisor discusses risk with a client, the advisor must determine whether the client understands the true meaning of the word “risk” and of the levels of risk. Many investors do not know that meaning, and many advisors would be hard-pressed to explain it correctly. And, shockingly, many investment firms do not even have a standard definition of the term or the ranges for “high,” “medium” and “low” risk.

In the case of the discretionary financial advisor (one who is mandated by a client to make day-to-day investment decisions without consulting the client) the advisor has an obligation to keep all investment allocations within the risk expectations of the client. These expectations should be set out in the IPS only after the client provides instructions and gives informed consent, based on the advisor’s careful and complete explanation of the risks. An uninformed client cannot give informed consent.

If your financial advisor has not fully informed you of the risk of your investments, you have the right to complain to your provincial securities regulator and to retain legal counsel. For a free consultation, please complete and submit our online form.

• Clients wanting steady income will have an objective of fixed income.
• Clients wanting growth without declaring taxable interest or dividend income will have an objective of growth.
• Clients wanting to achieve the growth by holding an investment over a long period of time, (five to 10 years or longer), will have an objective of long-term capital gain.
• Clients wanting to achieve growth with more frequent turnover will have an objective of either short-term (under a year) or medium-term capital gain.

Unfortunately, each financial management firm, and often each individual financial advisor, may have different definitions of these investment objectives. What is long-term for one maybe medium-term to another, and what is income to one may be growth to another. Also, there is some debate as to what “income” refers to; for instance, whether it includes the dividend stream that can be expected from capital stock of a chartered bank.

Clarifying Your Investment Objectives

If you retain a lawyer or consult a medical doctor, you know your reasons.  However, your reasons for retaining the services of a financial advisor are not always obvious.  Your initial goals may, or may not, be reasonable, and the options available to you to reach your goals may not all be immediately obvious. Therefore, to ensure any investment recommendations are suitable for you, your financial advisor is duty-bound to clarify your investment objectives and to ask about your financial circumstances.

The first major consideration is what you want to accomplish with your investments, in other words, your ultimate goals.  For example:

• Do you want to save for retirement?
• Do you want to pay for a new house?
• Do you want to finance a child’s education?
• Do you need cash for a business or personal project?

Your financial advisor must break down these goals into financial “objectives,” to ensure the investment choices you make will enable you to achieve your goals. It is for this financial expertise that that you hire an advisor, and that advisor has an obligation to provide it.

Your IPS Reflects Your Goals

Your financial advisor should clearly set out your goals in your IPS, to ensure you are both clear as to what the advisor will work to accomplish.  The amount of money necessary to achieve your goals should be specified. Only then will the strategy recommended by the financial advisor make sense. The goal provides the context for the strategy. If you don’t have the one, you can’t reasonably be expected to have the other.

Your Goals, Your IPS and Your Discretionary Advisor

When you retain a discretionary investment advisor, it is understood that you will not receive calls to discuss each investment recommendation. The only time you can relate your goals to the progress made in your account is at your periodic client/advisor meetings. This is why it is essential to have an established IPS, so you can review with the discretionary advisor how the strategy is working, or whether it should be changed.

If you have suffered a loss in the financial markets, your advisor will likely say the investments were suitable for you and the markets simply turned out to be unfavourable. If there is no rhyme or reason for your investments, it will be impossible to determine whether the investments were, in fact, suitable for you.

Therefore, your financial advisor’s supervisor can and should review the IPS, compare it to the Know Your Client (KYC) information your advisor was required to gather, and decide on its suitability. The IPS will then enable the supervisor and you to determine whether the advisor has complied with your directions.  Only if your goals are accurately reflected in the IPS, can you review your progress to ensure you are on track.

If you have become the victim of a discretionary advisor who has shown a lack of experience and integrity, you may have the right to receive compensation. For a free consultation to discuss your rights, please complete and submit our online form.

• Know Your Client (KYC)
• Know Your Product (KYP)

To some degree, each investor is unique. Therefore, advisors are not permitted to make “one-size-fits-all” investment recommendations. Examples of “one-size-fits-all” advice include:

• advising all clients to borrow to invest
• advising all clients to buy gold, or gold mining stocks
• advising all clients to invest their whole balance in small company stocks, or emerging markets.

What financial advisors are required to do is to take the unique circumstances and knowledge of the client into account (KYC) and then to tailor their investment suggestions (KYP) accordingly.  To learn the circumstances of the client, the advisor should determine what the client knows, understands, and appreciates about investment concepts.  Just as a teacher will adapt a lesson to the ability of the student, so should the advisor present information to a client based upon the client’s ability to understand it.  In the KYC jargon of the industry, this is referred to as “investor knowledge” and sometimes as “sophistication.”

Levels of Investor Knowledge

All KYC forms include a space for financial advisors to describe the level of investor knowledge, after speaking with the client.  Depending on the form, any of the following terms might be used to describe the levels of investor knowledge:

• “novice” or “limited” or “none” (low level of investment knowledge)
• “medium” or “moderate” (middle level of knowledge)
• “sophisticated” or “extensive” or “commercial” (high level of knowledge)

Protecting the Investor

A novice investor cannot be expected to understand a sophisticated investment strategy (for example, investing in options, using leverage, or day-trading). Therefore, the KYC process is essential to the creation of a suitable Investment Policy Statement (IPS) for the client. It will be obvious to a trained and experienced professional whether the client does or does not appreciate different investment concepts and strategies. The financial advisor must accurately identify and record the extent of the knowledge and update this record, should the extent of the knowledge change.

This record will help a supervisor or compliance officer to judge whether a recommended investment activity is suitable for the client.  Without the KYC process and a suitable IPS, the investor cannot be properly protected from making bad investments.

A word of warning: just because an investor has a history of investment activity does not make the investor an expert.  Someone can hit golf or tennis balls for years without achieving any skill or knowledge of the game.  An investor who accepts all recommendations, and does not receive (or understand) details about the recommendations will still have little investment knowledge.

If you have become the victim of a discretionary advisor who has not fulfilled the KYC process or created an appropriate IPS, you may have the right to receive compensation. For a free consultation to discuss your rights, please complete and submit our online form.

Investment counsel/portfolio managers (ICPMs) and all discretionary financial advisors who have the designation of Certified Financial Planner (CFP), are required to create a client contract that outlines an agreed-upon course of action.  This is called an investment policy statement (IPS). Failure to create an IPS is a breach of duty on the part of the discretionary advisor.

In a Globe & Mail article published August 19, 2011, financial writer Rob Carrick describes an IPS as representing a contract by which financial advisors:

• identify the client
• describe  the client’s needs
• outline what the financial advisor is permitted to do
• explain how the advisor is compensated

Protecting the Client

In most cases, the investor cannot be expected to understand all of the opinions and judgments that form the basis of an IPS. These come from the professional expertise of the advisor. Therefore it is not enough for the advisor to ensure that the client’s portfolio complies with the IPS. The advisor must also ensure that the IPS is suitable for the financial circumstances of the client.

For example, if an elderly client with lifetime savings but little other income consults a discretionary advisor, the advisor must take that client’s cash flow needs into account before recommending a course of action.  It is therefore unacceptable for the advisor to recommend a high-risk investment plan for such a client. While this client might be able to appreciate the risks involved in purchasing high-risk securities, such as penny stocks or commodity derivatives, the client should not be willing to accept the risk of such investments, and the advisor should not recommend them.

Fulfilling the Professional Obligation

The discretionary financial advisor has an obligation to make sure the IPS takes into account the financial circumstances of the client, which include the following four areas, each of which should form a future discussion during the investment process:

• the financial sophistication of the client  (how much the client understands and appreciates)
• the investment objectives of the client (how much the client has to earn to accomplish these objectives)
• the risk tolerance of the client (how comfortable the client might be with small or large losses)
• the investment horizon of the client (when the client expects to convert growth assets into assets that generate income)

If your discretionary investment advisor has not fulfilled these obligations, you have the right to complain to your provincial securities regulator and to retain legal counsel.  For a free consultation, please complete and submit our online form.

• The advisor recommends that the client purchase a security and the client agrees.  The advisor then exercises discretion in choosing the number of shares or units to purchase in the security and at what price.
• The client instructs the advisor to purchase shares or units of a security, but leaves it to the advisor to determine the best time to make the investment. The advisor then exercises discretion in picking the timing of the purchase.
• The client subscribes to a service that triggers a “buy” or “sell” signal, authorizing the advisor to take action based upon notification from that service.  The advisor then exercises discretion when making a purchase or sale based upon this signal, and not upon the circumstances of the client at the time of the signal.

Licensing Regulations

Securities regulators have also determined that only some licensed professionals can exercise investment discretion, for example, the investment dealers who are governed by the Investment Industry Regulatory Organization of Canada (IIROC). The regulators also take into account the knowledge, training and experience of the advisor, as in the case of investment counsel portfolio managers (ICPMs).  Note that not all salespeople are licensed to use discretion, as the license sets specific training and experience standards.

Securities regulators do not permit mutual fund dealers to exercise discretion beyond the selection of recommendations made to a client.  For example:

• They cannot take instructions to execute a trade at some future time.
• They cannot take instructions to sell if and when the price reaches a fixed level.
• They cannot choose how much of a mutual fund to place in a client’s account.

All trades handled by mutual fund dealers must be documented, either with the client’s specific written instructions or with notes made of a conversation between a licensed advisor and the client. These instructions must provide the details of the fund, the number of units involved and the amount of money to be invested. Many mutual fund dealers have adopted the practice of using limited trading authorities to provide the documentary support for telephone instructions. The regulators accept this practice on the condition that the mutual fund dealer makes notes of specific conversations in which the required trading details are set out.

Advisor Accountability

Securities regulators limit discretionary trading because most advisors lack the knowledge, training and experience to effectively protect their clients’ interests. The intent is to ensure that only financial advisors who have the highest levels of experience and integrity will conduct discretionary trades on behalf of investors.  In other words, financial advisors are accountable for their actions.

If you have become the victim of a discretionary advisor who has shown a lack of experience and integrity, you may have the right to receive compensation. For a free consultation to discuss your rights, please complete and submit our online form.

In healthy client-advisor relationships, highly-trained investment professionals can do a better job of investing money than can most individual clients. They can also manage a portfolio for a lower fee than those associated with individual mutual funds and commission salespeople. However, this service comes with a risk, and investors should always consider this risk before handing control of their money over to an advisor.

Who are discretionary investment advisors? Are they regulated?

Discretionary investment advisors include:

• investment counsel\portfolio managers – governed primarily by provincial securities regulators, such as the Ontario Securities Commission (OSC)
• full-service investment advisors – typically employed by investment dealers, such as the investment arms of major banks, and regulated by the Investment Industry Regulatory Organization of Canada (IIROC)

In most cases, these advisors are Chartered Financial Analysts, or Canadian Investment Managers, and belong to professional associations that impose standards of care that are somewhat stricter than those imposed by the regulators. In the case of mutual fund investments, the Mutual Fund Dealers Association (MFDA) does not permit mutual fund dealers to take on discretionary engagements with the accounts they regulate.

This is the discretionary investment dilemma. However, for investors willing to do their homework and keep on top of their investments, the mystery and “magic” of the market can become far less intimidating.

According to provincial securities regulators, there are four types of financial advisors available to the investing public. These include:

full-service investment dealers

• mutual fund dealers (cannot play discretionary roles)
• insurance professionals (cannot play discretionary roles)
• investment counsel portfolio managers (ICPMs)

There are four steps every investor should take to develop a healthy and profitable relationship with a discretionary advisor:

Interview the advisor.

• Decide whether the advisor is trustworthy and competent.
• Work with the advisor to create an investment strategy.
• Meet regularly with the advisor to ensure the investment strategy remains on course.

Accountability

Discretionary advisors who depart from the directions provided in the initial investor/advisor discussions are not fulfilling their professional obligation, and can be held to account by securities regulators and by the courts, which will impose sanctions.

If a discretionary advisor properly advises the client as to the choices available, and then complies with the instructions provided at the outset of the investor/advisor relationship, professional obligation is being fulfilled. The creation of a successful investment strategy depends very much on the professionalism and skill of the advisor. The investor cannot be expected to understand all of the options available, unless the advisor fully explains these. For example, if a discretionary advisor has only one product to sell, that advisor is obliged to point this out to the investor, and to identify alternatives available elsewhere. This enables the investor to judge the merits of the investment advice by comparing financial products.

If your discretionary investment advisor has not fulfilled these obligations, you have the right to complain to your provincial securities regulator and/or to retain legal counsel. For a free consultation, please complete and submit our online form.