Monitor your shelf

With so many products available from your dealer, it’s impossible to research and speak succinctly to clients about each of them. That’s why you winnow the shelf before recommending funds.

You’ve pored over performance, vetted the fund managers, and assessed the fund’s reporting quality. You’ve used in-house statistical modelling and assigned scores to each of your criteria. All that investigation produced a first-tier selection of managed products, as well as a few high-quality backups.

But have you given much thought to what would make you stop recommending those products? I’m not talking about jettisoning good investments just because they’ve fallen out of favour, but rather a process that alerts you whenever a fund becomes too correlated or drifts from its mandate.

If you haven’t, you’re not alone.

Alfred Slager, a professor of pension fund management at Holland’s Tilburg University (check out his blog InvestmentBeliefs.org) writes that many people don’t develop a process before choosing investments.

That’s problematic, because without defined criteria, you may be stuck with inappropriate funds long after they’ve passed their sell-by dates.

Assessing funds

Be careful about using benchmark underperformance as a criterion for divestment, warns one advisor.

“I have mutual funds that underperform the benchmark all the time,” he says, suggesting some indices, such as the TSX, are undiversified, and can be unworthy of being yardsticks. “Maybe the manager doesn’t want to make sector bets. If he’s getting good risk-adjusted returns, what’s the problem?”

Why? Slager suggests it’s because you put so much time into perfecting a suite of offerings that you feel protective of that tour de force. So when people see something that contradicts their choices, they react by diminishing the importance of the evidence. Some shift focus to alternative data, or even convince themselves their assumptions and criteria were different in the first place.

Protect yourself against this mental quirk: Clearly document your divestment criteria; commit to periodic, dispassionate shelf reviews; and ask colleagues for second opinions.

This type of discipline is going to be even more important if regulators have their way. Late last year, the Canadian Securities Administrators proposed repealing decades-old suitability standards and replacing them with rules requiring you prove clients’ interests come first (see “Prepare to be squeezed,” Advisor’s Edge, December 2012).

Complying with that will necessitate a broader shelf that includes products defined by more nuance than just “moderate risk.” And that means manufacturers will respond with dozens of spin-off funds, each similar to its parent save substitutions to tweak the risk level along the continuum between medium-moderate and low-moderate.

If you think understanding and maintaining your product shelf is difficult now, just wait.

Your best protection against regulatory change? Get ahead of the game and develop methods to ensure you can cut a drifting mandate before it bites your clients.