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portfolio management

When was the last time you got a hot tip from your broker? If you deal with an investment adviser at a full-service dealer, you likely haven't.

The traditional, commission-based stockbroker model has evolved first to a fee-based service and, more recently, to an increasingly discretionary one where independent investment counsellors do the stock picking, and investment advisers – trained and licensed as portfolio managers – slot their clients into one of a handful of model portfolios designed by the professionals.

"We're in the first five years of the trend toward discretionary management," says Marc Henein, a fee-based investment adviser and financial planner at ScotiaMcLeod in Mississauga, Ont. He calls it "the next evolution of our business."

The trend is still in the early stages, with only a small percentage of advisers licensed to act on a discretionary basis, says Warren MacKenzie, a principal at HighView Financial Group, a Toronto-based investment counselling firm.

So how much discretion should you give your investment adviser? And what questions should you ask before you sign up?

"The belief that someone is going to call you with a hot tip and you make a bundle is a myth perpetrated by Hollywood," says Jason Pereira, an investment adviser and financial planner at Bennett March/IPC Investment Corp. in Toronto. Mr. Pereira also holds the chartered financial analyst designation.

Indeed, if you walked into your adviser's office and asked to buy some get-rich-quick penny mining stock, they would likely march you down the hall to their do-it-yourself online brokerage arm.

In the past, discretionary money management was only for the very rich. The discretionary service to which investment dealers are shifting now is a simplified version of that model. This new version is designed for people with at least $500,000 in investable assets.

Investors coming to a full-service dealer for the first time might find the array of services dismaying. Not only do they differ from firm to firm, but often from one adviser to another within the same firm.

"From the outside looking in, we're effectively franchise owners," Mr. Henein says of the 500 or so advisers at ScotiaMcLeod. "I have my own group and we service clients in a specific way. The next guy might do it completely differently."

Mr. Henein has no plans yet to make the switch to discretionary portfolio management, preferring instead to build individual portfolios for his clients from a list of securities approved by his firm (his clients have the final say). "I like interacting with people," he said in an interview. "I like the relationship you build with your clients versus just managing a portfolio."

The fee model "gets you out of the old school stockbroker, what-have-you-done-for-me-lately mindset," Mr. Henein says. "It focuses clients more on longer term goals." It also puts the adviser "on the same side of the table as the clients" because the fees generated rise as clients' assets grow, he notes.

Discretionary portfolios have a clear advantage when an individual stock is dropped from the approved list, advisers say.

"Instead of having to call each individual client, the investment counsellor [rather than the adviser] does a bulk trade for the entire model portfolio," says Mr. Pereira, who manages money on a discretionary basis for his clients. In the time it would have taken an adviser to call each client and discuss the sale, the stock price could drop substantially, angering clients who were notified later in the day.

But problems can arise with fee-based accounts when hidden costs creep in, Mr. Pereira says.

If a model portfolio filled with mainly individual stocks and bonds uses a mutual fund to give it diversification into the Far East, for example, the mutual fund's management expense ratio should be included in the quoted fee, he says. "Sometimes, it isn't." As well, bonds typically have embedded costs that are not always clear.

Perhaps the biggest advantage of the new model is the division of labour – and the level of expertise it brings. The pros visit the companies whose stock they recommend and do extensive analysis based on fundamentals as well as statistical screens, for example. "Does the average broker have the time and resources to do that?" Mr. Pereira asks rhetorically. "No."

Like Mr. Henein, Mr. Pereira says the bulk of his job is financial and estate planning. "If you get it right, by using a third party [investment counsel], the adviser is free to do this equally important job," he says.

Before you sign on with an adviser, be sure you know what to look for, says Mr. MacKenzie.

The degree of discretion should be clearly laid out in an investment policy statement, he says. If the statement indicates that the acceptable range for Canadian equities is between 20 per cent and 30 per cent of the portfolio, it may make sense to let the adviser or portfolio manager call the shots as long as the total allocation to Canadian equities is within the agreed range, he adds.

"Under no circumstances should the adviser or portfolio manager make a recommendation that would take the client outside of the acceptable range as laid out in the investment policy statement," he says.

Whether the discretion is formal or informal, "the client should measure the results by comparing them to the proper benchmark," Mr. MacKenzie says. "If by following the adviser's advice you are matching or beating the benchmark over a full market cycle, you should continue with the relationship."

If you are underperforming relative to the benchmarks, ask your adviser or portfolio manager why, Mr. MacKenzie says. "If the underperformance continues for a year or more, end the relationship."