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Fixing Broken Portfolios: Case Studies

Consider the following case study. It reveals how common it is for intelligent and successful people to end up with broken and dysfunctional portfolios. Fund names have been changed.

Portfolio Audit Case Study: Mutual Fund Charges

Synopsis

  • Clients in their late 50s
  • Owner/manager of a successful pipeline company
  • Portfolio worth $2,600,000
  • Frustrated with portfolio returns

Portfolio breakdown

Fund

MER

Market
Value

% Of
Total
Portfolio

Asset Class Exposure

ABC Emerging Markets DSC

3.07%

$141,756.60

5.33%  

Emerging markets

ABC Emerging Markets FE

3.07%

$45,679.00

1.72%  

Emerging markets

ABC Canadian Stock DSC

2.46%

$50,121.00

1.89%  

Canadian

DV Fund of Canada FE

2.39%

$176,035.20

6.62%  

67% Cdn, 33% U.S.

DV Fund of Canada DSC

2.39%

$254,660.00

9.58%  

67% Cdn, 33% U.S.

Dynamo Focus + Resource Fund

4.78%

$417,234.60

15.70%  

77% Cdn, 23% int'l

Dynamo Focus + Resource Fund

4.78%

$606,292.40

22.81%  

77% Cdn, 23% int'l

Dynamo Power Cdn Growth Fund

2.40%

$275,869.60

10.38%  

70% Cdn, 20% U.S., 10% int'l

Dynamo Precious Metals FE

2.65%

$225,647.80

8.49%  

80% Cdn, 14% int'l, 6% U.S.

Ingenuity Canadian Small Cap

3.05%

$63,057.60

2.37%  

Canadian

MC Recovery DSC

2.62%

$33,491.40

1.26%  

International

MC Universal World Resource

2.62%

$124,953.60

4.70%  

35% Cdn, 30% U.S., 35% int'l

MC Universal Canadian Resource

2.57%

$63,353.40

2.38%  

35% Cdn, 30% U.S., 35% int'l

NW Specialty Equity DSC

2.63%

$17,981.20

0.68%  

Canadian

NW Specialty Equity DSC

2.63%

$161,475.20

6.08%  

Canadian

 

Asset mix and fee summary:


Total Asset Class Exposure

Canadian equity

68.06%

U.S. equity

10.06%

International equity

14.82%

Emerging markets equity

7.05%


Weighted MER


3.29


Analysis

  1. This broken portfolio consisted of a smattering of mutual funds from five different fund families. The asset mix was 100% equity and a full 45% of the portfolio was in resource related mutual funds with a strong correlation to the clients private business (pipeline company). This occurs when clients are prone to buying what they are familiar with and advisors recommend what the client will buy rather than what the portfolio needs.

  2. Most mutual funds were purchased with a deferred sales charge (DSC), which paid the advisor 5% of the invested amount up front. Although the clients paid nothing initially, they were subject to a declining sales charge for any redemption in years 1 through 7.

    It also became evident the advisor was redeeming 10%–free amounts each year and rolling it back into DSC funds to earn additional commissions, with absolutely no benefit to the clients.

  3. Through a detailed discovery process, it became clear the clients' wealth and investment objectives had changed over the years. A strict growth portfolio was no longer appropriate, yet the advisor had failed to keep the portfolio current with the client's changing circumstances and ages.

    A balanced portfolio was recommended with 40% of the new portfolio allocated to bonds to reduce portfolio risk and protect the clients from stock market declines.

  4. These frustrated investors had over $2,600,000 invested in mutual funds with an average management expense ratio of 3.29% not including the trading costs charged by the mutual funds.

    It was recommended that these clients adopt a fee–for–advice model. For a fee of 1.40%, which includes the custody fee and index fund's MER, the clients received advice, portfolio management, and proper reporting. It allowed them to save more than $45,000 annually, before tax efficiencies were considered.

Corrective steps

  1. Meet with Mr. and Mrs. Balanced Fund to determine their objectives, circumstances, and constraints.
  2. Identify an appropriate asset mix, adding sufficient asset classes to reduce risk.
  3. Build an investment policy statement to document steps 1 and 2 and to guide management of the portfolio.
  4. Implement asset mix with index funds to avoid underperformance and capture market returns.
  5. Correctly locate assets among account types for tax efficiency.
  6. Reduce management fee.
  7. Reduce portfolio turnover and tax. Rebalance only when necessary.
  8. Implement proper reporting of returns and expenses and taxes.

 

Final thought

Investors must recognize that they can't control markets or accurately predict their direction. Yet, there are things that they can control, which are ultimately their responsibility. Better results require different thinking and investing.

Fixing Broken Portfolios:
Case Studies

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