CANADA’S MAGAZINE FOR THE FINANCIAL PROFESSIONAL • …€¦ · Rogers Publishing Limited, One...

Rogers Publishing Limited, One Mount Pleasant Rd., Toronto, Ont. M4Y 2Y5 • PM 40070230 R10969

CANADA’S MAGAZINE FOR THE FINANCIAL PROFESSIONAL • APRIL 2006 • WWW.ADVISOR.CA

DODGING DOWN MARKETSFOR RETIREES

UNDERWRITING CLIENT FUNERALS

DISCLOSINGINSURANCE

COMPENSATION

RISKABSOLUTE

How to spot a BAD hedge fund By Ken Stern

AE04_OFC 3/20/06 8:08 PM

5Inside EdgeIt may only be a matter of time beforebank branches start routinely offeringinsurance policies, but how about ironingout the kinks first?By Deanne N. Gage

9Final DecisionsA new insurance-funded solution allowsadvisors to ensure their clients’ final

wishes are carried out.By Bruce Cumming

12COVER STORY Absolute RiskHedge funds are often seen as an alternative to “mainstream products”like mutual funds. But make no mistake,they’re extremely complex. Navigatinghedge funds requires you to dig deep andask tough questions.By Ken Stern

23Income FixProtect retired clients from market dipswith guaranteed return products.By Clay Gillespie

28Insurance Insights with David Wm. Brown

30CLOSING BELL with Beasley Hawkes

THE

APRIL • 2 0 0 6 •VOLUME 9NUMBER 4

ONCOVER

www.advisor.ca ADVISOR’S EDGE | APRIL 2006 3

12ACCIDENT AVERSION

9LAST SUPPER

9 Underwriting Client Funerals

12 How to Spot a Bad Hedge Fund

23 Dodging Down Markets forRetirees

28 Disclosing Insurance Compensation

For a special report about how to leverage technology, make your business moreefficient, and better serve your clients, please visit www.advisor.ca/interact/beginning April 10th.

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My bank has been phoning me a lotlately. And every time they call, panicautomatically sets in: Have I been thevictim of identity theft? But as it turnsout, they’re always just thrilled to offer me “an extraordinary new service onlyavailable to select accounts.” You canimagine how privileged I feel to have mydinner or TV show interrupted for this.

So as the federal government reviewsthe Bank Act and considers grantingbanks the power to sell insurance intheir branches, I’m already aware of thepossible implications: even more salespitches offering me stuff I simply don’trequire!

Seriously, who can blame the banksfor wanting insurance information intheir branches? They see it as a newgrowth area—not surprising, as there’sa renewed focus on retirement incomeplanning strategies.

The issue is especially an aggravationfor RBC chief executive officer GordonNixon. At a speech in Toronto lastmonth, Nixon noted the banks couldprovide “broader choice and better pricing,” creating a win-win for theinsurance industry. He highlighted theabsurdity of grocery stores Loblaws andCostco offering insurance while “the

banks that are in the business ofproviding financial advice cannot.”

He has a point. Opening insurance upto the bank branches means exposing theproduct to more consumers—notablythose with modest incomes who are noteven targeted by financial advisors. Thatshould be seen as a good thing.

So what’s the problem? For starters,the lack of consumer protection. Onefear is the banks will hold their credit-granting authority over the average con-sumer’s head. In other words, a bank repmay suggest (ever politely, of course)that if Jim wants that competitive mort-gage rate, he’d better open an RRSPaccount, or in the future, buy someinsurance.

Is mild coercion in itself reason torestrict the banks from providing insur-ance in their branches? It very well maybe. Tied-selling may be illegal but thatdoesn’t necessarily stop the practicefrom occurring. Many advisors hearclient complaints about the currentpractice of bank coercion. In a lot ofthese situations, the clients are bucklingunder the pressure because they feelthey have no other choice.

While the banks have lovely, colour-ful brochures that speak out against

tied-selling, this in itself does nothingto actually enforce the rules. The onusshouldn’t be on the consumer to pointout to the bank rep that “coercion isagainst the law.” The consumer alreadyhas enough on his mind, worryingabout someone rejecting that all-too-important loan if the bank doesn’t getany more of his investment business.

Advisors themselves can do more toget the word out. Make sure clients areaware of these possible scenarios andare equipped to deal with them.

There are other issues with insurancein bank branches. While increased dis-tribution definitely has its advantages,it can’t be taken lightly. Buying insur-ance shouldn’t be equated to buying ashirt. And how accredited will thoseselling insurance in the bank branchesbe? Will reps be doing a complete insur-ance needs analysis with prospects orjust simply trying for the biggest salepossible?

Let’s hope these details are hammeredout well before the feds revise the Bank Act.

DEANNE N. GAGEEDITOR

[email protected]

INSIDEEDGEBANKING ON INSURANCESome issues must be worked out before policy sales become routine branch business.


AE04_005 3/20/06 10:08 AM Page 5

CULTURAL DIVIDE ADVISOR’S EDGEDeanne N. Gage, Editor Scot Blythe, Bert Vandermoer(416) 764-3803, [email protected] Contributing EditorsPhilip Porado, Associate Editor Jennifer Molleson, Production Manager(416) 764-3802, [email protected] (416) 764-3928, [email protected] Staseson, Assistant Editor Marie Atkins, Executive Assistant(416) 764-3804, [email protected] (416) 764-3847, [email protected] Nicholson, Art Director(416) 764-3850, [email protected]

SUBSCRIPTIONSCornerstone, [email protected]

SALESDonna Kerry Gisela StephanyNational Account Manager Sales Manager, Eastern Canada(416) 764-3805, [email protected] (514) 843-2133, [email protected] Mooney, National Account Manager(416) 764-3809, [email protected] Murphy, National Account Manager(416) 764-3838, [email protected]

CIRCULATION AND RESEARCHKeith Fulford, Circulation Director Elizabeth Hall, Research ManagerCindy Younan, Circulation Manager Rosa Regula, Research AssistantTricia Benn, Director of Research

Garth Thomas, Publisher, Advisor’s Edge, Advisor’s Edge Report, Advisor.ca (416) 764-3806, [email protected] Williams, Vice-President, Healthcare & Financial Services Group

EDITORIAL ADVISORY BOARDElaine Andrew John OrdInvestors Group BMO Nesbitt BurnsDavid Wm. Brown Jim RogersAl G. Brown and Associates Rogers Group FinancialDavid Christianson Nancy ShewfeltWellington West Total Wealth Management Wellington West Capital Inc.John De Goey Thane StennerBurgeonvest Securities The Stenner Group, CIBC Wood GundyRobert Fleischacker Lynne TriffonAdvocis, Stonehaven Financial Group T.E. WealthCynthia J. KettStewart & Kett Financial Advisors Ltd.

ROGERS MEDIA INC.Anthony P. Viner, President and CEO

ROGERS PUBLISHING LIMITEDBrian Segal, President and CEOJohn Milne, Senior Vice-President, Healthcare & Financial Services GroupHarvey Botting, Marc Blondeau and Michael Fox, Senior Vice-PresidentsImmee Chee Wah and Larry Michieli, Vice-Presidents

, established 1998, is published by Rogers Publishing Limited, a division of Rogers Media Inc. Advisor’s Edge subscriptions include 24 issues per year, consisting of 12 issues of Advisor’s Edge in magazine format and 12 issues of Advisor’s Edge Report in tabloid newspaper format.

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We acknowledge the assistance of the Government of Canada, through the Publications Assistance Programtoward our mailing costs. Contents copyright © 2006 by Rogers Publishing Limited, may not be reprintedwithout permission.

Advisor’s Edge receives unsolicited materials (including letters to the editor, press releases, promotional items andimages) from time to time. Advisor’s Edge, its affiliates and assignees may use, reproduce, publish, re-publish, distribute, store and archive such submissions in whole or in part in any form or medium whatsoever, without compensation of any sort.

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6 ADVISOR’S EDGE | APRIL 2006 www.advisor.ca

LETTERSRe: “Advice For the Rest ofUs” (January, page 5)I was delighted to read your edito-rial. It’s rare to find common senselike this in any of our industry’spublications. We have a long histo-ry of idolizing those who havefigured out how to work the least

and earn the most, so it takes courage to point out that thismindset is not without its flaws.

I was disappointed then when the rest of the magazine failedto support your position in any way—even the story onCarmela Harnum, which you referred to. Her work with “Jackand Joan,” while admirable, hardly fits the profile of helpingthose of lesser means.

The “trends” we speak of so often—things like movingto a fee-for-service platform—are most often driven by U.S.surveys. In some cases, it is relevant—we do share an awful lotwith our neighbour to the south. But it’s important to remem-ber that we also have distinct cultural differences. The U.S.culture clearly supports all things that make the rich richer,and the poor poorer. Canada’s doesn’t. I think there are a greatnumber of advisors out there who truly work with people—lots of them—because they want to help. They don’t makethe most money, and so, they don’t appear in magazines andstories about success. Too bad.William Bell, CFP, CLU, RHU, Bell Financial Inc., Aurora, Ont.

HOW DO WE BEAT ’EM? (November, page 46)We have become an industry of shoulder-shrugging, “hands-up” capitulators. I don’t believe it is anyone’s business exactlywhat we make. I never deny how I am compensated, but weare not public servants. We should not have to publiclyannounce what we get paid.

I was brought up to believe that was no one else’s businessand is a terrible invasion of privacy. So what is BeasleyHawkes’s advice: Let us reveal before we are forced to. I havea better idea. Why don’t we tell the abusers of power to takea hike and keep out of our industry unless they truly havesomething to contribute. All they do now is take our moneyfor every frivolous reason and then cry mea culpa when theyare caught screwing up.Heather Snipper, CFP, R.F.P., Snipper Financial Planning, Ottawa

AE04_006 3/20/06 10:10 AM Page 6

When completing insurance appli-cations for clients, it’s often necessary toaddress touchy subjects—sometimes hittingon potentially embarrassing issues such asclients’ spending habits, their medical his-tories and even the quality of their mar-riages. But it’s a process that’s critical if weare to help people effectively plan for theirfinancial futures.

Which raises the question: Are there anytopics you should never discuss with yourclients? Back when I started my practice, onesubject I swore I’d never broach was funeralplanning. Talking shop about wills and pow-ers of attorney, including dying-with-dignity provisions, was never a problem.However, I drew the line when it came to discussing types of caskets desired or preferred musical selections.

But I soon reached the conclusion that these subjects shouldbe talked about because it’s during these emotional familytimes that a lot of purchasing power is revealed. Aside fromthe regulars—tax and estate planning, family planning, andbusiness succession planning—I’ve come to the opinion thatfuneral planning should be the final subject discussed underthe Estate Planning banner in a client’s binder.

When people pass away, their families are confronted witha myriad of decisions that must be made quickly and oftenirrevocably. It’s said a wedding requires people to make 100decisions, but they’re spaced out over the course of a year orlonger. When someone dies, a similar number of decisionsmust be made but the time frame is compressed into a fewdays, or at most, a week.

Fortunately, there’s a new service emerging that can help advisors address this very issue, while at the same time

removing some of our potential pangs of embarrassment.Everest Canada (www.everestfuneral.ca) is offering a com-prehensive funeral planning service that is available in allprovinces except Quebec, Newfoundland and Prince EdwardIsland. Everest isn’t an insurance company or financial serv-ices provider, but rather an independent consumer advocatethat provides the planning services through advisor firms. Allclient contacts are handled by telephone.

With this service, after discussing how the client’s wills andpowers of attorney should be designed, I can then confidentlybring up the subject of funeral planning as the natural con-clusion to the “end-of-life issues” topic. I stress to the clientthat although this is a deeply personal subject, it’s also fraughtwith problems for the family members if left unplanned.Many personal development coaches ask people to thinkabout what their obituaries would look like if written today.

A new insurance-funded solution lets advisors ensure their clients’ final wishes are carried out.

FINAL DECISIONS

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TOOLBOX

Continued on page 10

Strategies for advisors from advisors

By Bruce Cumming


AE04_009-010 3/20/06 9:52 AM Page 9

TOOLBOXI take it a step further by turning thequestion around and asking clients,“What would your funeral look like?Who would be invited? What hymnswould be sung? Would there be a cremation or a burial?”

Everest’s process is simple. Clientscomplete and submit a form to thecompany and an Everest advisor con-tacts them directly and welcomes themto the program. Clients are sent a pack-age, including a planning guide whichdetails key decisions to be reviewed andcompleted. This can be done by theclients themselves or with the help ofan Everest advisor over the phone. Dur-ing this process, all the funeral decisionsand details are arranged—right downto the casket selection and the music.The client’s instructions are recorded ina “My Wishes” plan, a copy of whichis mailed to the client to distribute tothe family member who will take careof the funeral. Changes can be made asoften as necessary and at no charge.

The second part of the service takesplace when the client dies. Since theEverest documents are kept with thewill, the executor or other family mem-ber calls the company, any time of dayor night, using a toll-free number, anda representative goes over the same “MyWishes” portion with the family. Therepresentative would then provide aspreadsheet of local funeral homes sothe family can find the best price. Ifrequested, they’ll even help negotiate thepricing with the selected funeral home.

Once the family makes a selection,Everest communicates the client’swishes directly and continues to serveas an advocate to ensure each elementof the plan is understood and respected.They will also help the family to selectother service and product providers,

such as cemeteries and monument ormemorial suppliers.

Everest’s payment policy and servicesare rather unique. The client buys a per-manent life insurance policy, under-written by Winnipeg-based WesternLife, for an amount ranging between$5,000 and $10,000. The premium canbe paid monthly or in a single lumpsum. The underwriting requirements aresimple: You need to have had goodhealth for the previous five years andnot have been declined for insuranceduring that period.

The clients also must not have hadany alcohol or drug problems or havebeen hospitalized for more than fourweeks during the past three years. That’sthe extent of it, but the underwriterdoes place a heavy reliance on the two-year contestability period.

By buying the coverage, the clientreceives both the services of Everest, aswell as the tax-free death benefit to payfor the funeral. The insurance premi-ums are much higher than term-to-100prices but given the services you receive,and the potential savings from havingEverest shop for the best deal, pricingshouldn’t be the issue. This is not areimbursement product and we’re nottrying to augment the client’s otherinsurance coverage. The deal with Ever-est and Western Life simply works outto pay for the funeral. A client, forexample, is going to put about $3,500into premiums to get $5,000 out. That’snot the traditional insurance win, but itdoes allow the client to essentially pre-pay for his or her funeral and solidifythe arrangements beforehand.

The average cost of a Canadianfuneral is trending down to approxi-mately $6,000, according to theNational Obituary Service, becausemore and more people are choosing

cremation over traditional burial. Thoseintending a more elaborate funeralwould be able to purchase a policy witha larger face value. The actual cost ofthe policy obviously depends upon theage and smoking status of the client. Ifone of the spouses is uninsurable orolder than 81, then he or she can pay aone-time fee of $995 in lieu of pur-chasing the policy. However, the otherspouse has to be insurable and enrolledin the Everest plan.

A colleague once told me a storyabout a family member diligently can-vassing several funeral homes to getquotes for an elaborate burial. He gaveexact details, right down to the casketmodel number, yet stunningly, thequotes ranged from $10,000 to$16,000. This does not appear to be anisolated case. The U.S.-based FuneralConsumers Alliance recently launchedan antitrust lawsuit against several com-panies, including the Canadian-basedAlderwoods (formerly Loewen Group),that alleges “consumers of funeralproducts and services, who are undersevere emotional distress and time pres-sure at the time of purchase, have beeneasily and routinely preyed upon.”

That’s certainly not to say all funeralhomes are crooked, but these types ofstories do build the case for havingclients express their final preparationwishes, and then have an unbiased third-party step in and handle the financialnegotiations on behalf of the grievingfamily. It’s a useful tool for advisors whowant to help clients plan for the laststep.

Bruce Cumming, CFP, R.F.P., CIM, CLU,Ch.F.C., RHU, TEP, is the founder ofCumming & Cumming Wealth Management Inc. in Oakville, Ont. [email protected]

Continued from page 9


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ABSAE04_012-020 3/20/06 9:53 AM Page 12

Cover Story


ROLUTEISK


The recent insolvency of BayouManagement, the disappearance ofhundreds of millions of dollarsentrusted to it, and the attempted sui-cide by its CFO, highlight the risks ofinvesting in the secretive and unregu-lated world of hedge funds.

Portus Alternative Asset Manage-ment still can’t account for $650 mil-lion in investor assets, while Norshieldand its Univest Funds are embroiled in

controversy and have been recently shutdown. Investors are likely to recoveronly a small portion of their capital.Consequently, more and more funds—both hedge and mutual—are fallingunder the scrutiny of regulators.

Investors and their advisors are justi-fiably nervous, and the latter are discov-ering the hard way just how critical duediligence is to the overall hedge fundselection process. If you plan to offer

hedge funds to clients, there’s no excusefor not delving as deeply as possible intothe nitty-gritty of those funds.

Hedge funds and traditional invest-ments differ in a number of ways.However, one of the key distinctions isthe shedding of market risk in favourof manager risk. This means you haveto consider what would happen if thebrain behind a fund (i.e. the manager)

Navigating hedge funds requires you to dig deep and ask tough questions. By Ken SternR

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were hit by a truck. Hedge funds also carry myriad risks,

some of which are common to tradi-tional investments and others unique tothe hedge fund space. Largely unregu-lated, governance is coming under moreand more scrutiny, and it’s almost cer-tain this watchful eye will becomekeener in the relatively near term. How-ever, as of today in the U.S., literallyanyone can offer a hedge fund. As longas the asset level is under $25 million,and has fewer than 15 investors, no reg-istration or other submission to publicscrutiny is required. At least here inCanada the portfolio manager isrequired to be registered with provincialsecurities regulators.

The risk universe for hedge funds issubstantially larger than for traditionalinvestments. They include, but aren’tlimited to, the following:• Manager risk—based on integrity

and expertise. • Liquidity risk—often hedge funds

will hold illiquid or semi-liquidpositions.

• Maverick risk—or rogue risk, such as when the fund managertakes off with the money, i.e. Nick Leeson and Barings Bank.

• Operational risk—can they actually keep the books straight?

Due Diligence So given all this risk, where do youeven begin? Hedge funds are subject toless regulatory scrutiny than traditionalasset classes, and therefore due diligencemust include extensive questioning andinvestigation of both the manager andthe fund.

Your first step should be to read the

fund’s sell sheet and some of the mar-keting material. Be clear on the termssince this is the material you would giveto your prospect. Next, it’s imperative toread the offering document. Most offer-ing documents are similar in structure andafter reading a number of them you’llbegin to know where to look and what tolook for. Highlight any sections thatcause concern so you can refer to them asnecessary. Discuss your initial reactions—both positive and negative—with a fundrepresentative. Ideally it should be thefund manager, but more often it will bea senior person such as the complianceofficer or vice-president of sales.

Once satisfied with the answers, youmight think it’s time to invest. Wrong!You are still in the preliminary phase.All you’ve accomplished so far is toallow this fund to move to the next levelof the process. Remember, if you haveany doubts or concerns whatsoever, youcan do one of two things: Either passon this fund or engage in more due dili-gence to see if you can clarify all theissues you’ve uncovered.

But if all looks good, you can nowsend your preliminary due diligencechecklist to the company. Request somebasic information in a useful formatand add the data to a master spread-sheet for comparison with other

similar hedge funds you are tracking. The next objective is to gain an in-

depth understanding of the risks you’llbe accepting. This involves a series ofboth quantitative and qualitative checks,and the information elicited at this stagewill determine whether or not you willultimately place yours and your client’smoney with the fund.

Learn and understand the fund’sstructure. Is it long/short equity, orconvertible bond arbitrage? Risk arbi-trage, or distressed securities? Marketneutral, or enhanced beta? Find out howinvestment decisions are made and askthe following questions: • Is there a black box or a disciplined

rational process? • Can the manager override the

model? Under what conditions? • How often does this happen?• When was the last time and why? • What are the buy-and-sell disci-

plines? Do they employ stop losses? Ask for an example of a trade

that didn’t work out. How was it discovered? How was it wound down?Was there much of a loss?

Quantifying Risk There are numerous metrics used toquantify risk in the traditional invest-ment world—each important, but whencombined paint a more comprehensivepicture of quantitative risk.

Two of the most common metrics arestandard deviation and beta. Standarddeviation can be misleading because itdoesn’t discriminate between the desir-able upside volatility and the downsidevolatility, which is attractive only to shortbias strategies. Beta indicates systemicrisk measuring volatility relative to the



‘‘If you plan to offer hedge

funds to clients, there’s no

excuse for not delving

as deeply as possible into the

nitty-gritty of those funds.”

AE04_012-020 3/20/06 9:53 AM Page 14

overall market. Look at the amount of leverage used relative to the

strategy being employed and determine the peak-to-troughdrawdown and the Sharpe ratio. Value at risk is also a usefultool, as it attempts to ascertain the most one can expect tolose over a specific period of time.

The Sharpe ratio is one of the easiest numbers to find, oreven to calculate on your own, and most hedge funds publishthis. It measures the amount of return an investment deliversrelative to the amount of risk undertaken. The calculation issimple: Use the fund’s return to determine the excess returnover the risk-free rate, then divide your answer by the standarddeviation. There’s your Sharpe ratio. The problem is that stan-dard deviation, which is the denominator in the equation,includes both upside and downside volatility. And while no onelikes downside volatility, most of us welcome it on the upside.

The Sortino ratio removes upside volatility from the equation using downside standard deviation to highlight onlythe bad volatility. Sortino is useful but it is more difficult tocalculate and not all funds provide it.

Another key risk metric you need to understand and monitor is leverage. Ascertain how leverage fits into the fund’spolicy and decide whether the fund’s strategy calls for highor modest amounts of leverage. Find out whether the fundhas ever been run without leverage; the average amount ofleverage used; the highest amount of leverage used in the last 12 months and since inception; and whether leverage has ever been revoked from the fund.

An affirmative answer to the last point would be a very badindicator. Try to find out why it happened.

Transparency When you read the offering document you’ll begin to understand how much latitude the manager has in termsof where he or she can invest. Therefore, the greater the transparency in this process, the better.

Transparency is key and you should always try to find out,and monitor, exactly what investments are held by the fund.With too much flexibility in the mandate, as outlined in theoffering, the manager could literally buy tickets to a TorontoMaple Leafs game and attempt to resell them at a profit. Man-agers often defend limited transparency as one of their great-est advantages, arguing (with some merit) that if they had toopenly report current holdings, other funds could see theopportunity and jump in. What they really mean is they don’twant to disclose their short positions.

Since most managers won’t provide you with the transparencyyou might want, you may ultimately have to make a judgmentcall based on the total picture provided by your due diligenceprocess. You must also consider things such as market exposure.For instance, in a long/short equity fund that has 80% longand 40% short, the market exposure is 40% net long. The totalexceeds 100% because the investment is leveraged.

Find out the fund’s target range for market exposure by asking: • What is the highest and lowest net market exposure over

the past 12 months? Since inception? • Does the fund hedge against currency risk or interest

rates? • What is the largest concentration of any one security? • Is there a set number of positions allowed? • What is the average number of positions held by the fund? • How many positions are currently in the portfolio?



The future of investing

Abria, Canada’s leading alternative investmentmanager, invites you to join them for an educationalseminar on hedge fund due diligence. Learn howAbria’s expert team reviews potential hedge fundmanagers, what red flags to look for, and the“tough” questions to ask so that you can invest withhigher levels of confidence and integrity.

Sessions are held at Abria twice a month. Sessionscan also be hosted at dealer offices or on site at yourcontinuing education conferences.

YOU WILL EARN CE Credits

NEXT SESSION April 18th or 20th at noon May 16th or 18th at noon

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AE04_012-020 3/20/06 9:55 AM Page 16

Ultimately, performance is what allinvestors are looking for. By slicing anddicing these numbers you will add a sig-nificant amount of detail to the com-posite picture that defines the hedgefund you’re considering.

When a hedge fund is first made morewidely available to arm’s-length investors(those who will invest beyond initial incu-bation capital and money from friendsand family), pro forma returns are oftenused. This means historical returns aremodelled using the current portfolio ona back-tested basis to show how the fundwould have performed had it existed inthe past. Decide whether you are com-fortable using pro forma numbers. Viewthem with a healthy dose of skepticism.When evaluating the whole process, you can’t place the same weight on performance as you might have done otherwise.

Find out if the returns stated are netor gross of fees and check if there is a

fairly even distribution of monthlyreturns or whether there are monthswhen the returns were unusually high orlow. Sometimes known as fat tails, theseoutlying months can tell you a lot aboutthe fund’s consistency. Ask:• How bad were the worst months? • How deep was the worst

drawdown? • How long did it take to recover?

Weeks? Months? Years? • Why did the recovery occur?

If the fund had a significant draw-down, you need to be extra cautious andaware of the potential consequences.Since performance fees are usually paidon net new profits and the fund is nowsignificantly “under water,” the managermight become discouraged at theprospect of an extended period of timewithout performance fees. In this case,one of two things might happen. Themanager could close the fund and startover, or even worse, to make up the lostground he might begin to take more

risk than you signed on for. You might set a maximum drawdown

target for each fund you offer clients, withsimilar strategies having similar draw-down thresholds. A long/short equityfund should be given more leeway thana market neutral fund of funds, becauselong/short will normally have a higherstandard deviation. If the fund reachesthe drawdown target, consider redeemingfairly quickly, absent a mitigating factorto convince you otherwise.

Fees and Principals A typical hedge fund can charge any-where from a 1% management fee anda 10% performance fee to a 2% man-agement fee and 20% performance fee,excluding the advisor’s trailer fee. Any-thing higher should sound an alarm. Ifsomething seems too good to be true,it usually is. Understand this is an areasusceptible to abuse, so thoroughlyexamine the fund’s fee structure. Anexperienced advisor almost intuitivelyknows when the deal is too rich. That’swhat kept me away from Portus fromthe get-go. Enquire:• How adequately are the fees

disclosed?

Advisors tell us that they plan to increase the amount of

Principal Protected Structured Notes they sell in 2006.

Presented by:

■ ISSUE:Advisors tells us, that they don't:

• understand the underlying investment structure

• understand the overall cost

• understand the guarantee

■ SOLUTION:Advisor's Edge presents THE PRINCIPAL PROTECTED STRUCTURED

NOTES INVESTMENT SERIES – an advisor education program that provides

advisors with information they need to understand and properly explain structured

products to their clients. Look for it in the May issue of Advisor's Edge.

FACT:



Continued on page 20‘‘ It’s time for a gut check.Your intuition can

tell you a lot. If you are not totally comfortable,

there’s no harm in taking a pass.”

AE04_012-020 3/21/06 9:35 AM Page 19

• How do they compare to similarly structured funds? • Is there a hurdle rate and/or a high watermark provision? • Do they charge fees irrespective of returns delivered to

investors? • What are the investment management fees?

A fund of funds is comprised of a number of differenthedge funds, each with its own fee structure. Find out howthese fees are passed through and if the advisor compensa-tion (if embedded in the fees) is reasonable and fair.

Evaluation of people is about as qualitative as it gets. Trustis one of the most important aspects of the due diligenceprocess. It’s hard to trust someone you’ve never met, so wherever possible, personally meet the hedge fund manager andprincipals of the fund company. Keep in mind the following:• Where did they earn their hedge fund stripes?• Who were their mentors? • What is their performance history? • Is this fund their entire focus? • Do they have any other interests that might distract them

or constitute a conflict? You also want to confirm the managers and principals have

invested a substantial amount of their own money—or thatthey are “eating their own cooking.” Ask them how much andinvestigate the fund’s policy with respect to employees andtheir personal investments.

Governance If the fund managers and/or administrators are involved inareas of governance, it’s like having a fox in the hen house.Ensure that NAV calculation, custodial, and trustee servicesare all performed by independent, arm’s-length third parties—especially the fund’s auditor. Determine the methodology andfrequency of these calculations and find out where the datacomes from. Is every trade reconciled? Is there a formal pol-icy related to the valuation of non-public assets held in thefund? And how are illiquid or semi-liquid positions valued?There are some funds which unequivocally state they will notinvest in any securities not traded on the public markets. Everyhedge fund should have an external auditor and be auditedon an annual basis. In my book this is a deal breaker. Noexternal auditor, no business. Ask:• What is the name of the audit firm? • Is the auditor experienced in these funds?

• How long has the auditor worked with the manager? • Is the auditor aware of any previous audit problems? • Were other audit firms previously involved with the fund

and if so, how and why did the relationship end? • Is the auditor aware of any other business activities the

manager or other key people are involved in? • Were any irregularities discovered? If so, get detailed

information. • Who ensures the terms of the fund’s offering are being

upheld? • Who ensures fair and equal fee distribution and fair and

equal liquidity constraints? • Who monitors leverage and whether the fund stays

within its stated limitations? • Who monitors whether minimum investment provisions

are being adhered to?

Decision Time So, you’ve done your due diligence and the hedge fund haspassed all your tests. Now it’s time for the big decision. Is this a hedge fund into which you will feel comfortable placing your client’s—and your own—money?

It’s time for a gut check. Your intuition can tell you a lot.If you are not totally comfortable, there’s no harm in takinga pass. There are enough funds out there that will pass yourdue diligence scrutiny.

Due diligence is not just a one-time exercise. I regularly con-duct meetings with managers and/or distributors, check out myusual hedge fund Internet research sites, and read periodicals andother publications. I also keep a monthly tracking chart which,among other things, monitors returns, volatility, leverage, Sharperatios, standard deviation, beta and drawdown status.

If you always do your homework, the right hedge fund(s)can be an excellent addition to any investment portfolio, eitheras a risk reducer or a return enhancer. In addition to gaininga lot of valuable knowledge, you’ll be known to both col-leagues and clients as a true hedge fund professional. In theend, your clients will be happy and you will prosper.

Ken Stern is an investment and insurance planning advisor with

Creative Planning Financial Group in Toronto. He regularly speaks

on the topic of hedge funds. This is an edited version of an article that

originally appeared in Canadian [email protected]



AE04_012-020 3/20/06 9:55 AM Page 20


INCOMEFIX

generate sufficient retirement income,advisors must outline strategies that willtake advantage of the good times butwill also assuage clients by withstand-ing volatility in the equities markets.

Many Canadians will need to use allor most of their investment assets tomaintain their current lifestylesthroughout the retirement years, or tocomply with income tax regulations,such as the statutory RRIF minimum.In a properly diversified client portfo-lio, an advisor strives to minimize therisk of stock market volatility whileaccumulating assets, but diversificationmay not be enough once the clientstarts taking income from the accumu-

lated savings. To make the most effec-tive use of retirement income resources,I suggest the following:• Develop an investment policy state-

ment (IPS) that captures your client’sunique objectives—along with his orher particular risk tolerance.

• Design a tailor-made and detailedretirement income illustration foryour client. This allows you to estimate how much income can begenerated from investment assets,pensions and any other income enti-tlements. The illustration shouldreport the results in a net spendableincome form (after-tax and after-inflation).

• When estimating a client’s life

expectancy, add at least five or 10 years, since national statistics arebased on medians—in other words,half of the people will die before andhalf after the stated age.

• Construct an investment and with-drawal strategy for your client.

SEEK BALANCE

In generating retirement income, it’simportant to avoid withdrawing fundsfrom asset classes that are declining invalue. If your client is unlucky enoughto retire when the stock market is per-forming poorly, he or she could depletecapital at an alarming rate, and reducethe chances the portfolio will be able to


Protect retired clients from marketdips with guaranteed return products.

By Clay Gillespie

TO HELP CLIENTS

AE04_023-026 3/20/06 9:55 AM Page 23


generate the required net spendableincome for her expected lifetime.

For example, the average Canadianbalanced fund earned 7.4% over thepast decade, according to Morningstar.If $100,000 was invested in such a fund10 years ago, with income being with-drawn at a rate of 7% ($583 permonth), the account would be worthapproximately $107,700 today.

From this, it can be assumed a 7%withdrawal rate from a balanced port-folio allows a client to maintain capital.However, if $100,000 was invested inthe same average Canadian balancedfund five years ago, and the client with-drew $583 each month, the accountwould be worth approximately $75,600today.

Why the difference? In the first sce-nario, the market performed very wellfor the first five years—enough to builda sufficient cushion for the client. Whenstocks turned down for a few years, theportfolio was able to weather the storm.But in the second scenario, the port-folio never had a chance to develop acushion, so it took an immediate hit.This illustrates why it’s difficult (andimpractical) to try to plan retirementaround the short-term performance ofthe stock market. It’s also the reason Igenerally recommend clients not with-draw at a rate of more than 5.5% in agiven year.

But there is a way to create a cushionfor the client, even in a dipping market.I suggest the following strategy to eachof my retiring clients:• Invest one year’s income from the

retirement portfolio in a money mar-ket account that will be used for thefirst year’s retirement income.

• Invest another year’s worth of incomein a fixed income product, such as aone-year bond or GIC.

• Invest a third year’s income in a two-year bond or GIC.

• Invest the balance of the investmentsin a growth portfolio based on theresults of your client’s IPS.It’s important the fixed income vehi-

cle (bond or GIC) be owned directly bythe client, and not through an institu-tion such as a pension fund. This avoidsthe impact of unpredictable market

conditions on the fund’s values and alsoallows the client to control both thematurity values and the maturity dates.Bond funds or mortgage funds are alsonot suitable for this purpose becausethey fluctuate alongside interest rates.

The strategy assumes the moneymarket account will deplete itself dur-ing the first year. If the stock marketperforms poorly and the growthaccount loses value, then the maturingGIC should be used to replenish themoney market fund. The GIC serves asa reliable source of backup cash to keepthe client’s income levels at expectation,even if the stock market can’t providethe returns. Of course, if the stock mar-ket performs well, use a portion of the

client’s growth portfolio to replenish themoney market account and fund thenext retirement year. Likewise, if theGIC isn’t used for income, it should bere-invested for two years. That putsfunds in place to serve as guaranteedincome should stocks perform poorlydown the line.

This strategy works because incomeis being withdrawn from a separateaccount, instead of from the decliningportion of a client’s portfolio. Unlessthere’s a stock market falloff lastingmore than three years, the client won’tbe forced to take income from his or herinvestments while they’re dropping invalue. Implemented properly, this strat-egy lets clients keep their hands offtheir capital for at least three years.

Using the previous example, if$100,000 was invested 10 years agowith the aforementioned withdrawalstrategy in place, the portfolio wouldbe worth approximately $105,500today. This is about $2,000 lower thanif the entire account was investeddirectly in the average Canadian bal-anced fund. But that $2,000 is a smallprice to pay for the security, because ifthat same $100,000 had been investedfive years ago, in an average balancedfund, and with the withdrawal strategyin place, the portfolio would be worthonly $87,000 today. That’s a decline ofroughly $13,000, so the protectionstrategy acts to increase the portfolio’slifespan.

MANAGE EXPECTATIONS

The portfolio has to be monitored andeach year the client must consider mar-ket returns and decide whether to takethe following year’s income from the



This STRATEGYlets clients keeptheir hands off their capital for at least threeyears.

AE04_023-026 3/20/06 9:56 AM Page 24

fixed-income portion or from thegrowth portion of the account. In yearswhen the market makes extraordinarygains, not only should the growth beused for income purposes, but gainsshould be capitalized upon and addi-tional funds moved to the fixed-incomeportion of the account. Doing thatrebalances the portfolio.

One of the most difficult aspects ofany client relationship is to convincepeople to focus on diversification as along-term investment strategy. Investorstend to overreact during rising or fallingmarkets. They often start buying a cer-tain stock, or stocks within a specificsector, after the media has hyped themand much of the price growth hasalready taken place. As a result, justprior to a market correction, average

investors end up holding portfolios thatare heavily weighted in asset classes thathave demonstrated the best short-termperformance. And that means thoseportfolios often decline dramaticallywhen the stock market corrects. Fur-ther, during declines, clients like totransact frequently in their accounts, asit gives them the sense that somethingis being done on their behalf. But, inreality, all that extra trading tends tofuel declines and racks up additionalfees and costs for the clients.

My strategy is to instead moveclients’ attention to the long-termnature of retirement-income planning.This is achieved by drawing incomefrom the profitable positions in a port-folio, rather than trying to persuadethem to stay the course on their diver-sified portfolios. If you can do that, the

clients will be able to focus on incomegeneration rather than the absolute rateof return in their portfolios from oneyear to the next.

This approach allows you to rebal-ance the client’s portfolio as required,and demonstrate that you’re providingthem with value-added service byactively managing their accounts. Ulti-mately, increased service levels lead toimproved client satisfaction. In additionto being easy to explain and understand,this strategy gives clients comfort bycombining capital protection withgrowth possibilities.

Clay Gillespie, CIM, CFP, is a vice-

president, financial advisor and portfolio

manager at Rogers Group Financial

in Vancouver.

[email protected]



AE04_023-026 3/20/06 10:13 AM Page 26

INSIGHTSINSURANCE

New disclosure requirements can help the industry ease conflict of interest concerns. By David Wm. Brown

MANDATORY MEMOS

I’ve just completed drafting ourcompany’s Advisor Disclosure Docu-ment, which we will be sending to clients for their signatures startingthis year.

The document is required by Reg-ulation 347/04 of the Ontario Insur-ance Act. Other provinces have simi-lar requirements. The new rule, whichupdates its predecessor, Regulation663, introduces a new provision ondisclosure of conflicts of interest andalso carries forward requirements thatagents disclose the insurers andproviders of other financial productsthey represent.

Writing up our firm’s disclosurepolicy made me realize how importantit is to have a client see, read, and thensign a document of this type. In fact,I think its introduction and wide-spread use will enhance the reputationand professionalism of insuranceagents and advisors across the coun-try. Hopefully, it will bolster con-sumer trust and confidence duringwhat’s become a period of suspicionand uncertainty.

When a prospect is consideringbuying a life or health insurance prod-uct, he or she requires informationabout not only that product but alsoabout the company offering the prod-uct, the advisor who’s making the rec-ommendations, and that advisor’s rela-tionship to the offering company. Byproviding more written disclosure, the

professionalism and goodwill ofinsurance advisors will be reinforced.It will also provide a measure of con-sistency in the standards of practiceacross the country and prove theindustry can be self-regulating.

Although specific guidelines maydiffer in each province, they’re allbased on the same general principles.A properly drafted disclosure docu-ment should concentrate on severalareas. The first is to identify thenames of the companies an advisoruses in his or her practice.

Inform clients if there are any spe-cial ownership relationships betweenyou and the insurance company,because these will help them under-stand whether there are any factorsthat may influence the advice yougive. Even though specific dollaramounts are not necessary, theyshould still have an understanding ofhow you are paid.

If you’re eligible for additionalcash or non-monetary compensationbased on the volume of businessgoing to the provider during a spe-cific period of time, then the clientdeserves to know that. Finally, he or she has the right to request and obtain additional informationabout qualifications and the natureof business relationships.

Questions about compensation areoften on the minds of people whopurchase any type of product or

service. In many cases, these are questions the client would like to askbut often feels too timid to bring up.But they’re particularly relevant whenthe product is as complicated andmysterious as life insurance or relatedfinancial products.

Case in point: Last week I was talk-ing with a client about increasingeither his disability insurance or crit-ical illness insurance plan. He onlyhad enough money available to beefup one or the other. After discussingall the alternatives, he asked me, “Isthere any reason with respect to yourcompensation that you would suggestone contract over the other?”

It was only after working on thedisclosure statement that I realizedthis question would not have come up had he seen the disclosure docu-ment. In fact, its content would haveput the client’s mind at ease becauseour position would have been clearlystated at the outset.

Over the years, our industry hasmatured and developed. I believe themajority of advisors act for the bene-fit of their clients and put those inter-ests ahead of their firms’. Now it’stime to put that in writing.

David Wm. Brown, CFP, CLU, Ch.F.C.,RHU, is a member of the MDRT. He is apartner at Al G. Brown and Associates inToronto. “Insurance Insights” appears everyother issue.


AE04_028 3/20/06 10:16 AM Page 28


A lot of people I know give tremendous amounts of time and value on a volunteerbasis. Some of it is obviously self-serving, scratching your way onto a board filledwith rich, nubile prospects you figure are itching for your services—if they onlygot to know you.

Other gifts of time appear to be selfless, like volunteering with your professionalorganization, or a church soup kitchen, where you know you won’t get any business.

However, my early life underwriter’s training course taught me that people dothings for their own reasons, not for the greater good. There is no true altruism.These volunteers, no matter how noble, get something out of this—ego fulfill-ment, assuaging guilt, who knows? But that’s OK.

Where am I going with all of this? I’ll wager you’ve done a lot of volunteer workin your life. As a dutiful advisor, you have probably donated way more than the aver-age person. But why have you done it? Has it been satisfying? Do you know why youdo it? Has it cost you time with your family or taken away from your business? Orhas it added value to these relationships, and made your life more complete?

Many of my volunteer activities (and there have been plenty) rank among themost satisfying experiences of my life. Making a difference with an organizationthat was in trouble, helping another refine its strategic direction and improving thefinancial planning profession—all of these were well worthwhile. And being a socialanimal, the relationships formed have also been particularly important to me.

Volunteering my time also created fabulous learning experiences, since a lot ofit was done when I was young. When still intimidated by successful rich andpompous professionals, I learned that humour is never inappropriate. If you’re actu-ally funny, go ahead and crack up the room. You can be irreverent as hell, so longas you’re respectful. On the other hand, if you’re not funny, take a different tackto get noticed, like doing some useful work.

Common to these great experiences was a commitment to the cause and a feel-ing of making a difference. Lately, I’ve lacked that feeling. These last few years, Ihave increasingly cursed myself for not being able to say no. I resent time away from

my family and the need to work week-ends to get caught up—an irony, as Ihave more free time now than ever,according to the spousal unit.

This is the point where I want to closeevery column I write. However, the editor insists I tie these ramblings up into some kind of lesson. So, here goes.

Choose carefully how to donate yourtime, in the same way you do yourmoney. Even if it’s just one cause ortwo, choose those in which you believeand can commit fully. If not, have thegonads to say no.

When you say yes, give it 100%, likeyou do everything else in your life thatyou find satisfying. It’s the level ofeffort that will determine your satis-faction, not something extrinsic.

Finally, be honest with yourselfabout why you’re doing something. Ihave no problem with your volunteer-ing on a board for the contacts; justdon’t merely go through the motions.

Make the effort sincere and make adifference. Here’s the bonus—doing itright is the only way you’ll get business.If people are impressed with you, they’llseek you out. And there’s nothingwrong with that!

Beasley Hawkes is a pseudonym. He is a practising financial advisor with a firm he’drather not name. Hawkes can be reached [email protected]

CAN’T SAY NO?

B Y B E A S L E Y H A W K E S

closingBELLWe all want to give back

to the community. Or maybe I should

correct that to say most of you want

to give back to the community. I have my days.

AE04_030 3/20/06 10:16 AM Page 30

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