Industry reacts to mutual fund allegations

(June 21, 2004) Investor confidence may be set to take another hit, as one of Canada’s largest newspapers launches a week-long series probing the mutual fund industry.

A report in today’s Globe and Mail estimates that a “select few” institutional investors have reaped profits of between $550 million and $650 million through market timing, leaving rank and file investors holding the bag on trading fees.

The bear market, executive fraud and mutual fund scandals in the U.S. have all contributed to shaky investor confidence. The Ontario Securities Commission (OSC) has rather quietly been probing the Canadian fund industry and OSC chairman David Brown said in April that abuses were not systemic. But more recently he has warned that the OSC will be taking a closer look at a handful of companies.

“It’s another case where doubts are raised about the mutual fund industry,” says Rudy Luukko, investment funds editor of Morningstar Canada. “It’s not something to inspire confidence, because this has come out through a news media outlet, as opposed to the regulators who are still going through their investigative process.

“The churn rate, as defined in the Globe methodology, does not constitute proof of market timing,” says Luukko, pointing out that Morningstar neither endorses the Globe‘s methodology, nor is it casting aspersions on it.

“The IFIC data are not proof of that type of very short-term activity happening, but again the fact that there were these exceedingly high transfer-in and transfer-out rates, would be consistent with market timing activity the Globe infers,” says Luukko.

So how does a financial advisor deal with clients who are losing faith in one of Canada’s most commonly held investment vehicles?

“All we can do is say that we believe the companies we are dealing with are very reputable companies,” says Doug Lamb, a CFP with Spera Financial Inc. in Toronto. “When we’re talking with fund companies, one of the questions I’ll be asking for sure is ‘What policies do you have in place to handle this?'”

He says he has already seen “a little bit” of client concern since problems first started to surface with the U.S. mutual fund industry.

“I’m not uncomfortable with the organizations I deal with, but I want to know what they have in place,” says Lamb. “It’s a level of detail and a new level of governance we’ve not really experienced.”

He says the investment advisor community needs to be aware of the policies of the various companies they deal with. The fund companies in turn need to provide the advisors with a level of comfort they can pass on to the client.

“If we don’t get good explanations, then maybe we should be thinking about reallocating where we have invested the client’s money,” Lamb says. “We need to know that we’re recommending companies that have policies and procedures in place that we’re comfortable with.”

Tina Tehranchian, a CFP and branch manager at Assante Capital Management Ltd. in Richmond Hill, Ontario, says studying a fund’s churn rate is all part of the due diligence process.

She says it comes as no surprise to find higher churn rates in the overseas sector funds mentioned in the Globe and Mail article, but that such investments should make up a very small percentage of a client’s portfolio to control the risk level.

“I think it’s about time we talk about these issues in more detail,” says. “Obviously in the U.S it has already been started and we need to take a more serious look at these governance issues in Canada as well.”

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Tehranchian says shedding light on these issues is the only way for the problems to be identified and addressed.

“Even though it could shake investor confidence in the short term, in the long run I think it is very positive for the industry, for investors and for advisors, because the more we focus on shortfalls in the governance system, the better we can address those shortfalls,” she says. “In the long run it should boost confidence in the industry.”

Luukko disagrees, saying the report might only serve to dampen investor confidence in an environment that looks too clubby.

“What happened in the States — where the perpetrators were caught and punished — I think when something like that happens it serves to promote investor confidence,” he says. “In this case, it casts a cloud. It puts the onus on the industry and the regulators to respond. It certainly gives them gives them cause to pursue their investigation vigorously.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(06/21/04)