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Dan Hallett, CFA, CFP, is director of asset management for HighView Financial Group and a contributor to

Securities regulators have recently sanctioned a few mutual fund companies for spending excessively on promotional events and gifts to financial advisers who sell their funds. This is harmful to investors since it really treats the adviser – not the investor – as the most important client. While it’s impossible to know what happens behind closed doors, there are ways to sense whether a firm is more sales-oriented than it is investor-oriented.

The rule

Securities regulators finalized National Instrument 81-105 in 1998, a result of the many recommendations made by securities lawyer Glorianne Stromberg. NI 81-105 allows mutual fund companies to, for instance, pay commissions to advisers selling their funds, but cannot make those commissions contingent on the level of sales or types of products. It also outlines limitations when fund companies hold marketing events or trips to promote their funds to advisers – the subject of the allegations against Sentry Investments Inc. last year and Mackenzie Financial Corp. and 1832 Asset Management LP (Dynamic Funds) this April.

The role of advisers and analysts

Individual financial advisers and their firms have an obligation to understand the structure, features, costs and risk-return potential (among other aspects) of every product recommended or sold to clients. But the practical reality is that most investment dealers don’t do extensive due diligence on mutual fund companies because they are well known, have long working histories with dealers and offer highly regulated products (i.e., mutual funds sold by prospectus).

The bar for deep due diligence that I and my partners at HighView set gets higher each year. As analysts, we are outsiders trying to peer inside of the organizations we cover to make a high conviction assessment – and ultimately decide whether the firm and any of its offerings deserve a spot in our clients’ portfolios. There are signals that we can use as indicators of whether the firm is a good steward of the assets entrusted to them:

1. Investment offerings

We tend to take a cynical view of investment management firms that launch gimmicky products that are designed more to sell than to perform. Examples abound from the late 1990s (technology), early 2000s (high-payout structured products), mid-2000s (BRIC, China, emerging markets) and 2010s (bank loans, high-payout income funds, cannabis funds, bitcoin). Retail-oriented firms – such as the aforementioned firms cited by regulators – tend to launch more trendy products. More institutional quality firms never launched these trendy products. An investment theme can easily be included in a firm’s existing products or strategies. Launching a bunch of new products can be a legitimate way of exploiting an investment opportunity, but often it’s just a way to attract more money from investors.

2. Costs and compensation

Over my career, a few standout mutual fund companies offered higher-than-normal compensation across all of their products. Offering more than 1 per cent per year to advisers selling funds, for example, is unjustifiable. If an adviser is providing a higher level of service that can be justified by a higher fee, the adviser can charge it directly. Products offering higher commissions are simply trying to attract more sales. And that almost always leads to higher investor costs and lower returns – not very investor-friendly.

3. Governance: policy and practice

During our due diligence on one firm that offered above-market commissions, we asked for a copy of the firm’s policies and procedures manual. They refused, which led us to suspect that they had something to hide. We later found out that this firm failed on both its written policy and its implementation.

In 2009 we detected a conflicted trade by a fund manager at another of the above mutual fund companies. We had zero doubt that it was a trade that should have been reviewed (and ultimately rejected) by the funds’ Investment Review Committee (IRC). It wasn’t and the trade went ahead with very few aware of it. When we challenged this firm’s head of compliance at the time, he offered a weak argument. That put a black mark on that firm’s due diligence file.

4. Communication

Investment management firms communicate through websites, advertisements and direct communications. Those that are forthcoming and genuine are usually more client-centric. The same firm that refused to give us a copy of its policy manual also had a very sales-driven communications strategy.

Their ads were sometimes misleading – such as the ads I wrote about in 2016. They would reach out to us to brag about superficial things such as a performance award/rating or their top ranking in sales (i.e., money flowing into their funds). But when we reached out to ask them questions of substance, they were tight-lipped.

Another firm’s older ad promoted its two monthly income funds – one of which I first wrote about in 2001 – as “Miracle Funds.” Its years of excessive distributions resulted in significant erosion of capital and a distribution that is a fraction of what it once paid.

Most investors and advisers won’t be able to replicate our type of due diligence, but the above factors will help in deciding whether a firm is deserving of your hard-earned investment dollars.