I’ve written about RRSP transfers a few times and will continue to do so because the way some large institutions treat their investment clients is ridiculous, abysmal, maddening, inexcusable, disrespectful, unnecessary, unethical, despicable, appalling, dishonorable, preventable, indefensible ... you get the picture.

To summarize the issue: If you transfer money to a firm, they will help you get it invested within minutes. They’ll jump through hoops to get the right forms filled out and the account set up. If you transfer out, it can take a month or more, even though the process is much less involved.

We have 6+ years of experience doing RRSP transfers and always have a large number of files in progress. What we’ve learned is that many firms have elevated their ‘foot dragging’ strategy to a fine art. Some of them don’t even start the process for a couple of weeks. No amount of ‘encouragement’ from Sher or Jennifer seems to help. And to add insult to injury, some firms will charge a transfer fee (up to $125) while sitting on the paperwork.

This is truly an industry embarrassment. The industry associations and SRO’s complain bitterly when regulators bring in new rules, and yet, they won’t clean up their act until said regulators force them to.

Note: We treat a transfer ‘out’ the same way we treat a transfer ‘in’ – same day. That’s not remarkable, it’s just expected.

I guess I’m more optimistic than executives at the major banks. When we lose a client (we’ve been lucky so far, our clients have been very loyal), I fully expect she/he will come back one day when circumstances change. As a result, when a client takes money out, or heaven forbid, redeems their whole account, we do it quickly, pleasantly and as professionally as when they signed up (Note: it’s not really marketing, it’s just our nature).

There is a story by Rob Carrick in the Globe and Mail yesterday about the way mortgage clients are treated when they leave the bank. For someone who has been fortunate enough to not have had a mortgage for a few years, I was blown away by the variety of fees being charged. Rob reviewed the situation of a client who was paying off his TD/Canada Trust mortgage. In addition to the standard mortgage penalty for paying off the mortgage early (three months of interest), the client also had to pay the following fees:

• Reinvestment fee: $300
  
• Discharge fee: $260
  
• Transfer fee: $260
  
• Government charge for discharge: $71

This was a bit of an eye opener for me and makes me wonder if there’s a marketing opportunity for Steadyhand. I’ve always wanted to trumpet to prospective clients that we’re the easiest firm on the street to leave – i.e. no exit fees or commissions, no three week delays on RRSP transfers, no ‘save the account’ calls from the branch manager and no scowls. But whenever I’ve considered pitching the idea to the team, I’ve shelved it. It just sounds too negative – “Mrs. Luongo, we’re excited that you’re considering Steadyhand for your investments. I want to let you know that when you want to leave us, it will be very easy and won’t cost you anything”.

After Rob’s story, however, I’m wondering if such a campaign would really resonate with people. After all, it’s not just the banks that make you even madder when you leave. The cell phone companies are right up there too.

Forbes magazine came up with a list of the 15 most outrageous ETFs last year. The winners included the Market Vectors Mongolia ETF, the PowerShares Lux Nano Tech ETF and the HealthShares Dermatology and Wound Care ETF.

We thought we’d seen it all. Recently, however, we came across a number of candidates that should be added to the list. They include:

• FocusShares ISE-Reverse Wal-Mart Supplier ETF
  
• Global X Fishing ETF
  
• VelocityShares 2X Inverse Palladium ETN
  
• Global X Brazil Financials ETF
  
• AdvisorShares TrimTabs Float Shrink ETF

This is obscurity at its best, which is why it comes as no surprise that the first two on the list are being shut down this year and the other three may not be far behind. Indeed, ETF closures are a growing trend, as noted in a recent Globe and Mail article (The Trendy Term in ETFs: We’re Closed).

In the Globe piece, Shirley Won references a website (www.investwithanedge.com) which identifies ETFs that are on “Deathwatch”, defined as those that have been trading for more than six months but have had less than $5 million in assets for three consecutive months. The site currently identifies over 400 products in the U.S. that are in danger of closing.

You can learn a lot from the name and mandate of an investment product. ETFs with abstruse names and narrow mandates tend to have little investment merit and often don’t last long. Industry expert Dan Hallett (HighView Financial) suggested in an article yesterday that investors are worse off for having access to highly specialized products because they are largely speculative plays which tend to be highly volatile and in turn lure investors into poor timing decisions and frequent trading (ETFs are the New Mutual Funds (and Not in a Good Way))

If it looks like a duck, swims like a duck, and quacks like a duck … it’s probably a duck.

Related reading:
Say It Ain't So
ETF Providers Have Cluttered a Pristine Landscape
Buyer Beware: Leveraged ETFs
The ETF Diaries - Part V: All Dressed Up and Nowhere to Go

The investment banking league tables came out this week and they showed that Scotia Capital was at the top of the equity list. BNS was lead underwriter on $2.4 billion worth of deals in the first quarter. What pushed them to the top was a $1.66 billion stock issue by their employer, Scotiabank.

That’s right. The bank was the lead underwriter on its own issue. Yes, this is a huge conflict of interest. The seller of shares (BNS) was seeking the best price it could get and the investment banker (BNS) was charged with doing independent due diligence on behalf of the buyers. How does that work?

The fact that the regulators (and buyers) allow this practice to go on is beyond me. Why risk the perception of a conflict ... ever. What leg would the bank and regulators have to stand on if one time there were improprieties?

Canadian banks are well run, but they do make missteps from time to time. Indeed, I write this on a day when Canada’s banking leader, RBC, is facing allegations of improper trading in the U.S. and JP Morgan is being fined $20 million for improper conduct with respect to Lehman Brothers. Going back a few years, BNS was caught with their hands in the till on the ABCP debacle (pursuing its own interests over that of its clients).

I get particularly steamed about this because investment banking appears to be the ‘wild west’ compared to how tightly the asset management and mutual fund industries are regulated with regard to conflict of interest.

(Note: I disclose that I am a shareholder of BNS through my ownership in the Steadyhand Income Fund. Also, I have a friend in their equity research department, Lori and I ski with a branch manager on occasion and we recently went to a movie at the Scotiabank Theatre downtown.)

Be warned. I write this after a long day, a glass of wine and having just read an article on ‘Target Date’ funds in Monday’s Report on Business (Target-date Funds Miss Their Mark). Shirley Won’s piece on these packaged, marketing-driven, fee-laden, deceptively complex, misrepresented products has got me stirred up.

First some background. These funds are part of a group of products called ‘life cycle’ funds. The original idea was to design and manage each fund for a particular demographic (i.e. investors retiring in the year 2010, 2020 or 2030). The manager would adjust the asset mix as the retirement date approached. For instance, a 2030 fund would be invested mostly in equities right now, but would be more conservatively managed 10-12 years from now. As it nears its 2030 target date, it would largely be invested in stable income-oriented securities.

When offered as a simple mutual fund, there is nothing wrong with these products, although there are cheaper, more flexible ways for investors to accomplish the same goal. They went off the rails when marketing and investment banking departments tried to enhance sales appeal and profitability by adding features, such as guaranteeing the highest net asset value.

Every fancy add-on sounds appealing and makes the product easier to sell, but it eats into the long-term return, increases the number of possible unanticipated outcomes (see below) and puts the manager in a conflict of interest. With a guarantee for instance, the fund’s first priority is to make sure the bank doesn’t lose any money. The client’s interests come second.

Consider one of Shirley’s examples, ‘Guaranteed’ funds with target dates that are more than ten years into the future. Many of these funds are now invested 100% in bonds because the asset mix was shifted to ‘guarantee’ the banks’ profitability. When a rational investor should be taking advantage of lower prices, depressed valuations and a less risky market, these managers were forced to sell their stocks and buy bonds.

As investors, we all have the misfortune of sometimes buying high and selling low, but to do it intentionally and without fail just doesn’t make sense.

The target date funds are not the only products that encourage the manager to act against the clients’ best interests. Over the last five years, we have seen a whole generation of products develop that force a similar behavior. Some products use leverage in a counter-intuitive way – i.e. increasing it when markets are going up and decreasing it when they fall. Again, it sounds good, but what it means is that investors go up with less leverage than they go down with.

The wealth management industry’s marketing imperative and urgency to get new products out the door is leading to the sale of billions of dollars worth of flawed, misleading and sometimes abusive products. Perhaps it should do what the software industry does – ask the product designers, marketers and executives of the bank to 'beta test' these products before they’re made available for broad distribution. Let them work out the bugs and live with the fees, illiquidity and unexpected consequences for a few years.

In the meantime, it’s time for that second glass of wine and an episode of The Family Guy. That will settle me down.

The ad was from the Bank of Montreal and it was referring to the return of one of our favorite products here at Steadyhand – the principal-protected note (PPN).  The note in question was the 5-year BMO S&P/TSX 60 Market Index GIC.  It matured on November 1, 2007 and provided a return to investors of 12.2% compounded annually.  Not bad at first glance.

When I went on to read the fine print, I learned that the actual return of the note over the 5-year holding period was 78.1%, based on a participation rate of 65%.  In other words, investors participated in 65% of the gains that the index produced over the relevant period.  According to BMO, the index upon which the note was based returned 133.8% over the same period – that’s 18.5% compounded annually.

Time for some quick math.  If you invested $10,000 in the BMO note back in 2002, you would have received $17,781 at maturity on November 1, 2007 (12.2% compounded annually).  If you invested in the same index (through an ETF) without the principal-protection wrapper, you would have received $23,376 at maturity (18.5% compounded annually).  That’s 34% more than what the PPN provided.

An obvious question arises at this point.  Is principal protection worth 1/3 of your return?

Let’s dig a little deeper.  Because of the structure of PPN’s, the gain on the product is taxed as interest income.  The gain on an ETF is taxed as a capital gain.  We all know capital gains receive much more favourable tax treatment than income, so add another strike against the PPN.

Now let’s revisit that index.  As noted, the return of the PPN is based on the return of the S&P/TSX 60 index, which returned 18.5% compounded annually according to BMO.  Upon closer look, this excludes dividends.  The return of the S&P/TSX 60 Capped Total Return Index from October 31, 2002 to October 31, 2007 was 21.7% (this includes dividends).  12.2% isn’t looking so good anymore.  To be fair, you would’ve had to pay an annual fee of 0.17% for holding the ETF, as well as a commission for purchasing the fund.  So let’s call the net return 21.5%.  That’s over 40% more than what the PPN provided.

When you factor in taxes and dividends, you are giving up a lot more than what you may think for principal protection.  But that’s not in the fine print.

It isn’t my intention to pick on TD - it’s a well run consumer bank and is not alone in its investment banking practices. But their name was prominent in the Globe & Mail’s feature article on Saturday about Telus and its failure to make a bid for BCE (As an aside, I personally like Telus’, and Rogers, chances against a floundering, overleveraged franchise like Bell).

As the Globe story goes, TD was approached by Ontario Teachers Pension Plan (OTPP) to advise it on the Bell transaction. On March 30th the bank approached Telus CEO, Darren Entwistle, to ask for his blessing to take on the OTPP/Bell assignment.

Why am I writing about this? Because TD’s call to Mr. Entwistle goes down as one of the most amazing things I’ve seen in 24 years in the investment business. Prior to the call, Telus and TD were joined at the hip. TD’s retired CEO, Charlie Baillie, is on the Telus board. Mr. Entwistle is on the TD board. Telus has been a very active player in the capital markets over the last 10 years and TD has been by far its closest advisor and has reaped the rewards. I hate to think of what TD’s fees amounted to over those years...huge. If TD had a better client than Telus, I’d be surprised.

So why would TD jeopardize the Telus relationship in what was the early days of the Bell saga? Although TD’s revenues from the Bell deal would be considerably higher in the short term if Telus did not enter the fray (which on March 30 was a ridiculous presumption), they risk losing a key client by ‘blindsiding’ Telus. Perhaps TD wanted to get closer to OTPP in hopes of participating in future trading and private equity transactions. I’m sure there were lots of other reasons and revenue possibilities that led TD to do this, but I still don’t get it.

Telus is the one telecom company we know is going to be around after all of this. Whether they end up buying Bell or not, they are an ambitious, aggressive firm that will continue to be a cash cow for a well-placed investment banker. On the other hand, who knows how the OTPP/Bell transaction will play out? There is a good chance that OTPP/Bell’s first line advisors will all be American.

If Telus is indeed out of the picture for now, it’s conceivable they will soon reappear as a buyer of some pieces of the BCE empire. They are well positioned if they keep their balance sheet healthy and improve their customer service. (Another aside: Service screams out at me as a huge opportunity for differentiation given how abysmal it is from all telecom providers. Take it from someone who has been building a team of business partners to help us operate Steadyhand and is at wits end with both Telus and Bell.)

I could go on forever on this topic. Suffice to say that I find it amazing that TD has turned its back on one of the most lucrative and impenetrable investment banking relationships in this country. I think it was short sighted and short-term greedy.

I can only hope that Mr. Entwistle resigns from the TD board and tells their investment bankers to get lost. They deserve it.

I get grouchy when I see products being offered that are just plain bad for investors.  I've been grouchy a lot lately, particularly with all the high-fee, principal-protected products that are coming out.  My wife and business partners tell me I have to focus on more positive things, but when I see a product like the one that Claymore Investments is currently offering, I feel compelled to comment.

Claymore is selling a closed-end fund called the Claymore Equal Weight Banc and Lifeco Trust.  The fund is pretty simple.  It will own 10 stocks - 6 banks and 4 insurers.  The stocks are equally weighted and rebalanced twice a year. 

The fund will endeavour to pay out a 5% distribution, which is well above the income generated from stock dividends.  So, while some of the distribution will come from dividends, most of it will be a return of capital.  The latter is paid out in anticipation that the portfolio will appreciate over time and dividends will grow.  In effect, the fund is converting an equity portfolio into an income product by turning the variable and unpredictable price performance of the stocks into predictable, monthly distributions.

This strategy of 'pre-paying' the anticipated capital appreciation beats a lot of other methods being used to generate 'bond plus' yields.  It only makes sense, however, if it is based on a balanced, well-diversified portfolio.  Basing it on 10 stocks in the same industry is quite a different matter.

I say that because products like this are path dependent. 

First of all, the underlying assumption here is that financial stocks will provide an annual total return greater than 5%, let's call it X%.  If the stocks go up after the issue closes, everything should be fine and the distributions will be secure.  But if, on their way to that X% return, the stocks take a downward path first, sustaining the 5% distribution rate may be difficult to do. 

That's because the fund must sell shares to pay distributions.  If the stocks are down for the first couple of years, the fund will have to sell more shares and will have less capital at work when the stocks turnaround and head north.  Looking at the charts of the 10 stocks in the fund, it's hard to see how they could ever go down.  But financial stocks do go down or they can sit dormant for a number of years.

This fund is more conservative than some path dependent products that went bad in the past.  I'm referring to some of the 'covered-call writing' funds (also called hybrid income funds), which had more aggressive assumptions built in.  When the bear market hit at the beginning of this decade, these funds didn't have the capital required to fund their distributions.  In the Claymore case, it would appear there is some cushion built in. 

If you are a buyer of this or any other initial offering of a closed-end fund, you should know that for every $100 you put in, about $93 will be invested.  That's because all underwriting and sales commissions are paid by the fund before the investments are made.  Essentially, you are paying for the startup of the fund. 

The Claymore offering has a unique feature that has garnered some attention from other industry players.  Closed-end funds aren't as easily traded as mutual funds.  As a result, investors usually have to sell in the after market at a discount to net asset value (NAV).  After six months, if the Claymore fund trades at a price that is more than 2% below its NAV for 10 consecutive days, it will automatically convert into an exchange-traded fund (ETF).

This feature seems to make sense given the simplicity of the fund.  For the unitholder, the discount disappears and for Claymore, they can grow the fund.  There is a hitch however.  If the fund converts to an ETF, the fee goes up.  Initially, the fund will have a fee of 0.85%, which is made up of a 0.55% management fee and 0.30% service fee which goes to the selling broker.  A fee of 0.85% for acquiring and re-balancing 10 of the most liquid stocks in Canada seems high enough, but after conversion it goes up to 1.25%.

This Claymore fund is an example of how closed-end funds are being overused today.  A closed-end fund is appropriate when there is a high expertise quotient; leverage is used as part of the investment strategy; the fund invests in illiquid assets that are inappropriate for an open-end fund; and/or the fund is amenable to a split share structure.  This product has none of those elements.  Indeed, a novice investor could put this strategy in place at a fraction of the cost.  By offering a future ETF as a closed-end fund, the issuer gets the initial investors to pay for the launch and help build a critical mass of assets. 

If this product is appropriate for anybody, it would be the small investor who can't buy 100 shares in 10 high-priced stocks.  My advice to those small investors, however, is to wait until the end of the year.  As an ETF, there will be a share class offered with a much lower fee and the big guys will have paid all the startup costs.

TD Securities was the advisor to Kinder Morgan on the sale. But they also took a leading role (they were on the top line with CIBC and Scotia) in Fortis’ equity issue to raise money for the purchase. The article noted how rare it is that an investment bank ends up working for the seller and the buyer on a transaction (Note: TD had permission from Kinder Morgan to participate in Fortis’ issue).

I think this example speaks volumes about the state of investment banking today and the many conflicts that bankers face. At its most basic, investment banking is fraught with conflicts (i.e. pricing the issue to please the seller and the buyer). It is always a balancing act.

But some conflicts are self-inflicted. In this case, TD decided to play for both teams at the same time. In the U.S., there are numerous examples of this. Banks like Goldman Sachs act as advisor and selling agent on one side of a transaction (conventional investment banking) and are the buyer of the business on the other side (through their private equity division).

I’m amazed that the authorities have not made a bigger deal of this, particularly in the U.S. where it is more prevalent. Perhaps, the impact of Elliot Spitzer’s move into the political arena is already being felt.

This issue highlights to me the inconsistencies that are so apparent in securities regulation today. Without a second thought, investment bankers can put themselves in a situation like the one outlined above, while executives of public companies have to jump through all kinds of hoops to satisfy the SEC. For hedge funds, it’s like the wild, wild west whereas mutual funds are scrutinized from every angle.

You may remember a few years ago when Spitzer led the blitzkrieg against Wall Street. He forced the integrated investment banks to separate their research departments from the investment bankers. He wanted the research to be independent. In the context of what is going on today, that whole kafuffle is laughable.

I think the regulators have got to recalibrate their priorities and they need to do it soon. There are areas of the market that are flying below the radar (i.e. hedge funds, structured products, investment banking conflicts) while other areas are experiencing extreme levels of regulatory due diligence (i.e. mutual funds, corporate governance).

Unfortunately, any changes won’t come soon enough for Steadyhand. We’ve already gone through all the hoops.

In this month’s issue, Doug introduces us to the notion of “shrouding”, a word coined by David Laibson of Harvard and Xavier Gabaix of MIT. Shrouding means “hiding key information from consumers.” The academics divide the world into two types of businesses – those that inform their customers up front about everything they need to know about the service or product, and those companies that don’t. Doug gives us a few examples of shrouding, but he doesn’t wade into the murky waters of retail investment products, perhaps because the examples of shrouding are too numerous to mention.

I, along with other independent voices, have ranted and raved about the lack of transparency of most of the structured products being sold today. The banks and other big distributors have clearly taken a shrouding strategy to sell billions of dollars of principal-protected notes and other closed-end funds:

• Investors don’t know what fees they’re paying.

• They don’t know if they even need insurance built into an investment product (i.e. principal protection).

• They don’t know the investment tradeoffs they are making (i.e. limited upside in exchange for no risk of capital loss).

• And they don’t know how (un)likely it is that they will achieve the advertised rates of returns.

On the latter point, a few months back I wrote about a CIBC product (PPNs III: Believe Me. I'm Not Making This Up) that advertised in bold letters that the annual return would be ‘up to 10% per year’. As my simple analysis showed, you’d have better odds of winning big at the lottery than getting a 10% return.

I think the shrouding strategy that the big distributors are using is one of the most shameless activities going on in business today. Everyone knows these products aren’t good for the client, but nobody is willing to stop selling them. PPNs and other structured products are just too profitable. Taking them off the shelf would mean a big hit to the bottom line and make it impossible to meet the budget for wealth management earnings in the year ahead.