You can't walk into a Burger King and ask for an organic kale salad. It's not on the menu. But if it were, I'm pretty sure their employees would happily fill your order.
They might even commend you for making a healthy choice. But try something similar at one of Canada's banks. Ask for a portfolio of low-cost index funds. My guess? The adviser will talk you out of it.
When it comes to mutual fund investing, costs are the best predictors of future performance. The lower the cost, the better. Canada's banks offer index funds. They aren't cheap, compared with ETFs. But they cost much less than the banks' actively managed products. On average, they also perform better.
But here's where things get greasy. Banks earn higher profits when they sell actively managed funds.
This summer, I asked three young people to walk into a different Canadian bank. Two of them carried paper and pencil. A third brought her iPhone so she could record what the adviser told her. I wanted to see what would happen if they asked for a portfolio of index funds. Would the advisers respect the healthy choice? Or would they choose to juice the banks' profits by insisting on actively managed products?
Marina McKercher, a 30-year old dental hygienist from Victoria, chose to see an adviser at CIBC. The adviser immediately showed her CIBC's Balanced Portfolio fund and CIBC's Managed Income Portfolio fund. "He had data sheets on each of these two funds already printed out," Marina says. The management expense ratios for the funds were 2.25 per cent and 1.8 per cent per year, respectively.
The bank's index funds cost less than half that. Marina asked for them instead. "The higher fee balanced funds are worth the extra costs," the adviser said, "because the money is managed. The index funds would just sit there, not doing much of anything."
I asked CIBC's spokeswoman, Caroline Van Hasselt, if she could provide an explanation. She said CIBC considers each client's financial goals and their stage of life. "Index Funds can offer lower cost, [but] younger investors with longer time lines can also benefit from factors such as asset allocation, portfolio rebalancing and diversification of investment management styles that come with actively managed funds."
The bank's representative may not have realized that she could focus on asset allocation and portfolio rebalancing with index funds.
Tim Godfrey wondered the same things after he visited Bank of Montreal.
Tim, an economics and finance graduate of Dalhousie University, had once worked at the Australian Treasury. "I was advising the government on the regulation of financial advice," he said. "We were determining how investment fees should be disclosed to clients."
Without knowing it, I had recruited Sidney Crosby for a beer league game. "The adviser said that index funds are riskier than actively managed funds," Tim said. "That surprised me. After all, risk has nothing to do with whether a fund is active or passive [indexed]. Portfolio allocation is what determines risk."
Tim is right. Take two portfolios. One is made of actively managed funds. It's split four ways between Canadian government bonds, Canadian stocks, U.S. stocks and international stocks. In other words, 25 per cent of the portfolio is invested in Canadian government bonds, 75 per cent is invested in global stocks.
Compare that to a portfolio of index funds. If it contains 40 per cent in Canadian government bonds, with the remaining 60 per cent invested in global stocks, such a portfolio would have a far lower risk profile than an actively managed portfolio with 25 per cent in bonds.
(A spokesperson for BMO did not respond to my repeated requests for comment.)
Deborah Bricks, a 36-year-old events planner, was my next secret reporter who walked to a bank. She chose Royal Bank of Canada. "I asked if she [the adviser] could build me a portfolio of index funds," Deborah says. "But she dismissed that idea pretty quickly."
Deborah already owned RBC's Select Balanced fund in her RRSP portfolio. It's an actively managed fund that charges 1.94 per cent per year. The adviser suggested that she keep it.
"An index fund just holds a single market," said the adviser. "If you did buy an index fund, you would have to figure out which one to buy. Do you want a U.S. index fund or a Canadian one? RBC's Select Balanced fund is more diversified. It's better because it's actively managed."
The adviser, it seemed, didn't seem to realize that she could build a diversified portfolio of index funds. Instead, she spoke about choosing one index over another. I asked RBC's spokesperson, A.J. Goodman, why Deborah would have been dissuaded from a portfolio of indexes. "It is possible that our adviser felt a solution other than an index portfolio would best meet the client's needs," Mr. Goodman said. "The RBC Select Balanced would have outperformed the simple index portfolio by over 100 [basis points] per annum net of investment management fees."
RBC's Balanced fund has about 40 per cent in Canadian bonds, with the rest split between Canadian, U.S. and international equities. It averaged a compound annual return of 8.44 per cent per year to Aug. 31, 2016. It's tough to figure out what a simple index portfolio might be. But a similar allocation into RBC's index funds, five years ago, would have averaged a compound annual return of 9.55 per cent per year.
Tangerine's Balanced Portfolio of index funds is similarly allocated. Over the five year period ending Aug. 31, 2016, it gained an average compound return of 8.66 per cent per year. That also beat RBC's more expensive Select Balanced Fund.
Dan Bortolotti, an associate portfolio manager with PWL Capital, says, "I'm not surprised many advisers have no clue about how to properly build a portfolio of index funds or ETFs. The way advisers are educated and trained presumes that their job is to beat the market by analyzing stocks and picking winning funds. The idea that an adviser might add value in other ways is foreign to them."
One day, Burger King might offer an organic kale salad. Order one. They'll certainly let you eat it. Canada's banks, in contrast, continue to push fat funds.
Andrew Hallam is the index investor for Strategy Lab. Globe Unlimited subscribers can read more in the series at tgam.ca/strategy-lab.
Andrew Hallam