What Are Some Questions To Ask Your Financial Advisor? – Part 2

In September’s issue of Canadian MoneySaver, I presented a list of eight questions to consider asking your financial advisor, and a basic overview of the sorts of answers you should be looking for. If you haven’t read that article yet, I’d suggest you go back and review it before diving into this one.

In this follow-up article, I will suggest specific questions based on whether the registrant is licensed to recommend mutual funds, a wider range of securities (including ETFs and OM products) or as a portfolio manager who can use discretion in a fiduciary capacity. While the thrust is the same in all cases, there are some practical limitations regarding the advice given due to the limitations of the products they are licensed to offer.

As a reminder, the answers don't need to be verbatim; however, they should demonstrate a comprehension of the situation, a purposeful rationale, and, if possible, be supported by empirical evidence.

Mutual Fund Registrants  

Question 1: Do you use A-class funds or F-class funds? What's the difference, and how much is this costing me? 

Possible answer: you are just looking for decency, clarity and intellectual honesty. Mutual funds are not free. The difference between A-class and F-class is just the difference in trailing commissions and the associated tax. Let's say an A-class mutual fund has a Management Expense Ratio (MER) of 2.23%. The same fund will be available in an F-class format at 1.1%. The only difference is the 1% trailing commission and associated 0.13% in HST/GST. Holding advisor compensation constant, there is no difference in price. The A-class (costing 2.23%) will remit 1% to the advisor. The F-class (costing 1.1%) will see the advisor charge 1% plus HST/GST for a total cost to the client of… 2.23%. If the products are identical and the advisor’s fee is identical, then the total cost to the client will be identical. More expensive products cost more, and higher advisory fees cost more, so an apples-to-apples comparison is a wash.

Question 2: Do you prefer actively managed products, passively managed products, or are you indifferent?

Why is that?

Possible answer: There is a theme here: you're looking for intellectual honesty and consistency. Actively managed products are almost always available in an A-class format, whereas passively managed products are seldom available that way. 

Stated differently, if an advisor’s business model is based on embedded compensation (i.e. receiving trailing commissions), that advisor is almost certainly going to be biased against low-cost passive investment alternatives. That could be a problem from their perspective of client suitability and product merit, since we've already agreed that cost and performance correlate negatively. The bigger problem, as I see it, is that many mutual fund registrants will claim to be “independent”, without ever acknowledging that their true independence has been compromised by their business model. 

A killer follow-up question to people who prefer actively managed products, therefore, is: Do you claim to be independent? If they say they are independent while refusing to use passively managed products (maybe ask to see what percentage of their book of business is passive), they are flat out lying to you.

Securities Registrants:

Question 1: What would you say is your primary role as an advisor?

Possible answer: There are many ways to answer this question, but some of the best answers involve being comprehensive, proactive and inclined toward behavioural coaching. There are wrong answers, too. The red flags include tales of superior stock picking and/or beating the market through fundamental or technical analysis. Security selection has long been discredited as a viable, repeatable value proposition.

Question 2: Do you engage in portfolio rebalancing, and if so, how and how often?

Possible answer: yes! The how and how often part is personal, and usually involves reducing both risk and return in some fashion. The timing and mechanics are secondary, however. The only thing that matters is that portfolios are rebalanced when needed.

Question 3: How open is your firm's product shelf regarding offering memorandum (OM) products?

Possible answer: As is so often the case, there is no definitive right or wrong answer, but you should be looking for a firm that will have a large offering of OM products. As a quick reminder, Offering Memorandum (OM) products are available only to “accredited investors”, which is a proxy for sophistication. 

Over the past decade or so, dozens of excellent private firms have brought hundreds of excellent OM products to market. Despite this, some firms have restricted their product shelf, and kept otherwise useful products off. Too often, this is due to internal policy being overly restrictive, especially at bank-owned firms. Given what we've said about pension-style management and the need to offer alternative assets to retail investors, that restriction might do more harm than good in terms of building portfolios that can meet client-specific, risk-adjusted goals.

Portfolio Managers:

Question 1: Given that you can use OM products for all clients (even those who are not otherwise ìaccreditedî), and you have a fiduciary obligation, in that your ultimate test is one of client suitability, what percentage of your practice involves alternative OM products?

Possible answer: Although the recurring theme of “it depends” applies here as well as it does elsewhere, it should be intuitively obvious that the percentage ought to be higher here than it is for conventional non-discretionary retail accounts. One of the great benefits of being a portfolio manager is that it maximizes the range of product options available to more thoroughly customize risk and return. 

Many OM products will take over 60 days before the client can achieve liquidity. That's a relatively modest constraint, but it is a constraint nonetheless. Whatever amount a retail account might have in OM products, a discretionary account would likely benefit from a higher percentage. For accounts where the investor would otherwise not be accredited, adding at least a moderate exposure to alternative assets via OM offerings strikes me as being table stakes as a meaningful value proposition.

Final Thoughts:

These questions only matter if you ask them. Your advisor may be well-intentioned, but no one will ever care more about your money than you do. Engaging in thoughtful, sometimes uncomfortable conversations is one of the best ways to protect your interests and make sure your financial plan truly reflects your needs, not someone else’s agenda. You don’t need to know all the answers, but you do need to be willing to ask better questions.

John De Goey is a Portfolio Manager with Designed Securities and the author of Bullshift – How Optimism Bias Threatens Your Finances. The opinions expressed are those of Mr. De Goey and may not be shared by Designed.