For well over a decade, I’ve been a crusader for low-cost products. One of my investing heroes is the late, great John Bogle—a man whom I have had the privilege to have met. It’s funny how some people (read: me) can be self-satisfied about being “ahead of the curve” by smugly comparing oneself to those who don’t ‘get it’, while not fully appreciating how much more could be done. Everything is relative.
When I met Mr. Bogle in his office in the autumn of 2017, he asked me about my practice and what I recommend to clients. Unsurprisingly, he asked about cost and I informed him that most of my products were of the low-cost variety. His first question was: “why only most—why not all?” I answered that there are some asset classes (private equity real estate) that are important diversifiers where I wanted my clients to get access to the asset class but could not find a true low-cost option. His second question was about portfolio turnover. Again, I was feeling pretty self-satisfied when I told him my clients’ portfolio turnover was well below the industry average. When I told him how low it was, he suggested that it was still outrageously high—causing me to sputter an awkward explanation about preparing to move my discretionary practice to model portfolios and having recently completed a re-balancing.
Now that we’re into 2019 and my new book, STANDUP to the Financial Services Industry is due out in a couple of months, I can’t help but wonder if I’ve still been too timid in implementing what I have long felt is the right thing to do. In effect, my question to myself is: ‘have you done a good enough job in managing product costs for your clients’? My attitude, just like it was before I had an audience with a man that I revered, had been one of confidence and assurance. In truth—and upon further reflection, I’m feeling a bit more chastened these days.
I’ve found a competing private equity real estate product that costs less than half of what my current recommended product costs. It is also purer and has greater liquidity. Both are Offering Memorandum products that all my clients can get access to by virtue of their being deemed to be accredited due to my being a portfolio manager. I’m glad that I found the new product and, although the due diligence is not yet complete, it looks as though I’ll be using it to replace the incumbent by the mid-year product review cycle.
Similarly, I had four income products in my model portfolio, but one of them was for a specialty strategy that is difficult to implement cost-effectively. Unlike private real estate, however, the portfolio attributes (i.e., the impact on risk-adjusted return) is far more modest (nearly non-existent, in fact) than other alternatives. As with the real estate option, this one product cost more than twice as much as the next most expensive product used in my modelling. In the end, I’ve decided that three income products are enough and that the added marginal product cost of the fourth option is not worth the added marginal portfolio diversification. Clients have also told me that they prefer simplicity to the greatest extent possible.
The exercise, while still ongoing, has already been quite rewarding. I think many people can accidentally fall into the same trap that I seem to have fallen into. Sometimes, in trying so very hard to do what we think is best for our clients, we overthink things and effectively force square pegs into round holes. Asset allocation and product cost are two of the most important determinants of risk and return, but by focusing primarily on risk (i.e., by insisting on adding good diversifiers), I was almost certainly sacrificing return. Of course, there are going to be trade-offs involved, but the perspective needs to be maintained. In 2019, I’ll be moving to model portfolios featuring three income products, six equity products, and one tangible/alternative product. The difference in risk will almost certainly be imperceptible. The difference in cost (and therefore in expected return) might be over 20 bps. Moving a portfolio from a 4.8% real return to a 5.0% real return might not sound like a big deal, but if the risk is essentially unchanged, it’s a clear win for clients—and one that more advisors should consider implementing on their clients’ behalf.
John J. De Goey, CIM, CFP, FELLOW OF FPSC™ (the author) is a registrant with Wellington-Altus Private Wealth Inc. (WAPW). WAPW is a member of the Canadian Investor Protection Fund (CIPF) and the Investment Industry Regulatory Organization of Canada (IIROC). The opinions expressed herein are those of the author alone and do not necessarily reflect those of WAPW, CIPF or IIROC. Investors should seek professional financial advice regarding the appropriateness of investing in any investment strategy or security and no financial decisions should be made solely on the basis of the information and opinions contained herein. The information and opinions contained herein are subject to change without notice.
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