Robo-advisers have barely been around two years in Canada, but their run as the cheapest place to get investing advice is already being challenged.
A new investment firm called Transcend is offering light financial planning and portfolios built using equity funds that have a very low fee of 0.25 per cent. On top of that, the firm charges a quarterly performance fee that works out to 20 per cent of gains beyond the returns of benchmark stock indexes for its funds.
If the S&P/TSX composite index made 5 per cent over a quarter and the firm's Canadian equity fund makes 7 per cent, 20 per cent of the two percentage points of outperformance go to Transcend.
"When we outperform the benchmark, then we earn our money," said Chris Ambridge, who is president and chief investment officer at Provisus Wealth Management, which created Transcend as a subsidiary to broaden its customer base.
Investors, we are in a golden period of fee competition. Low-cost exchange-traded funds, online brokers and robo-advisers – they manage online for a modest fee – are a big part of the story. But the recent introduction of Transcend shows the innovation doesn't stop there in trying to deliver investment advice and financial planning to clients at lower costs than the traditional financial industry.
None of these low-cost solutions is the killer app, mind you. Transcend's reliance on active management for the most part, rather than low-cost ETFs, will be a turn-off to some, and its bond portfolio is no bargain. Still, there's a theme here. Canada's financial-industrial complex is under attack from new, low-fee competitors. This is going to be fun to watch in the years ahead.
Mr. Ambridge said Transcend reduces base investing fees on equity funds below what you'd pay as a do-it-yourselfer using ETFs or someone getting portfolio management from a robo-adviser. He pegs the average ETF management expense ratio at about 0.31 per cent, while robo-advisers' fees typically start around 0.5 per cent, plus the cost of the ETFs used to build portfolios.
Your Transcend portfolio needs to be big enough to allocate at least $50,000 to the firm's equity funds, but you can combine your account and your spouse's to reach that level. The firm covers off bonds in client portfolios using a pooled fund of bond ETFs with an administration fee of 0.6 per cent (add 0.2 to 0.25 of a percentage point for the bond ETF fees). There is no performance fee for beating the benchmark on this fund.
The 0.25-per-cent fee for equity funds covers all costs for investing in the six in-house options the firm offers. Transcend will not make any money with a fee of 0.25 per cent, which explains the performance fee.
Linking fees to returns is commonly done in hedge funds, but rare elsewhere. Two examples of outfits that have this kind of fee arrangement are Avenue Investment Management, which cuts fees in half in the year after a client holding the firm's equity portfolio loses money, and the ROMC Fund, a global-equity fund for high-net-worth investors with a version where clients pay a tiny administration fee and then a performance fee on returns above 6 per cent.
Transcend's take on performance-related fees highlights the need for investors to consider the tradeoffs they're making in exchange for low costs. With ETFs, for example, the low fees only apply if you run your own portfolio and don't incur the extra cost of having an adviser. Robo-advisers run a portfolio for you, but for the most part they do minimal financial planning.
Transcend's "direct" service provides a basic level of financial planning (more comprehensive planning is available). Clients complete a comprehensive questionnaire with one of the firm's people over the phone, and then receive an investment policy statement laying out their objectives and a plan for managing their money on a tax-efficient basis. The firm also shows clients how well their portfolio is on track to meet their investing goals.
The tradeoff for clients of Transcend is that their returns are tied to the ability of the people managing the firm's equity funds to match, never mind beat, benchmark indexes. That low 0.25-per-cent fee won't do you much good if your results are well below indexes you can easily buy through cheap ETFs, such as the S&P/TSX composite, S&P 500 and MSCI Europe Australasia Far East (EAFE) indexes.
The firm itself has a lot riding on its ability to beat the benchmarks. Unless it manages this feat on a consistent basis, it won't make any money from clients holding equity funds.
Five-year data to June 30 are published for the six funds and each has outperformed its benchmark over that period, with some misses in the shorter term. The Canadian equity fund lost an annualized 1.3 per cent before fees for the two years to that date, while the S&P/TSX total return index lost 0.7 per cent. For the five years to June 30, the fund made an annualized 7.6 per cent and the index made 4.2 per cent.
Mr. Ambridge said the firm tries to match the risk levels of the index using a select group of stocks chosen through proprietary analysis. "Rather than going for home runs, we're going for bunt singles to add a little incremental return over time," he said. "We don't outperform every quarter on every fund, but we do on a year-in, year-out basis."
In tying fees to performance, Transcend has adopted an idea that has never caught on in the world of retail investing aside from a few random cases. Most firms don't like it because variable revenues aren't a good match for an industry where the cost of doing business is steady. Investors may complain about having to pay fees when their funds lose money or underperform, but they don't seem to be demanding performance-related fees, either.
Transcend's novel spin on performance fees is to use them as way to present an attractively low base fee of 0.25 per cent on equity funds to investors seeking a modest level of advice. We don't yet know if there's a market for this, but the innovation it represents is significant because it shows that fee competition in the financial industry is gaining momentum. This is a very good time to be a fee-conscious investor.
Three takes on cheap investing
|DIY Investing with ETFs||Robo-advisers||Transcend|
|Basic costs||As low as 0.06%, but 0.31% on average||Typically start in the 0.5% range and decline as accounts get larger||Equity funds: 0.25% base fee plus a performance fee set quarterly that takes 20 per cent of returns above the benchmark; Bond fund: 0.6% plus the fees for bond ETFs in the portfolio|
|Trading costs||$10 per trade at most firms, but some have zero commissions for ETF purchases||Some charge extra for trades, some don't||None|
|Platform||Any online brokerage firm||Your robo-adviser's website||Transcend.ca|
|Who runs your portfolio||You make all the decisions||Your robo invests your money and manages your portfolio||Same as robo-advisers|
|Financial planning||Zero||A minimal amount is done to set your mix of stocks, bonds||Basic. Transcend says it provides a "core financial plan."|
Source: Provisus Wealth Management, Transcend, company websites