Save a client from bad advice

The expert

Jason Vincent, PFP, TEP, president and chief operating officer at Matco Financial Inc. in Calgary.

Client profile

Netanya Abramowicz, 68, is a retired former owner of a successful dry-cleaning business. Prior to 2008, her portfolio was worth $4 million, and she intended to leave $1 million to each of her two children. By 2009, the financial crisis left her with only $1.92 million.

The issues

Netanya knows a lot of people lost money in 2008, but thinks her advisor did a poor job by losing more than half her money.

She’s right, says Jason Vincent, president and chief operating officer at Matco Financial Inc., who explains that when times are good, you can get away with a mediocre portfolio. But when things turn sour, the cracks appear.

Her previous advisor put her in securities riddled with conflicts of interest, including stocks his firm had underwritten four or five years earlier. Vincent says the portfolio was built with the firm’s interests in mind, not Netanya’s.

Further, her asset allocation, while suitable on the surface, masked bad investments. On the fixed-income side, she owned a slew of unrated corporate bonds. “Once you get below ‘BBB,’ ” notes Vincent, “the big [ratings] agencies are saying, ‘Investor beware.’ ”

10

Degree of difficulty

10 out of 10. Redesigning the portfolio wasn’t the hard part. The difficulty came on the communication front, says Vincent.

Often, a client goes advisor-shopping until she finds someone who says what she wants to hear, without understanding it means too much risk. Vincent says he had to tell Netanya he couldn’t get her back to $4 million with his risk-sensitive approach—a message that makes some clients walk away.

He stressed the high-risk investments made her predicament worse. “And I don’t view your baseline at $4 million; I see our starting point at under $2 million,” he said to her, adding that the level of risk she’d have to take to have the opportunity to get back to $4 million in a short period of time could mean dire losses in the event of another downturn.

These types of conversations are necessary if you want to be transparent and keep clients long-term. “If you bring client[s] in under the wrong expectations,” he says, “you’ll never keep them.”

The equity side was just as bad. As a retiree, Netanya needs income and that makes dividend-paying stocks a good bet. But not everything that pays a dividend is safe.

Netanya owned about a dozen securities paying dividend yields between 12% and 14%. That, Vincent says, usually means they’re high risk (in this case, small- and micro-cap firms with unsustainable distributions).

He notes Netanya’s portfolio also included highly speculative issues shy of penny stock status.

Then there were the misplaced preferred shares. While these stocks share characteristics with fixed income, causing some advisors to use them in this part of the portfolio, they don’t behave like fixed income when the investor requires safety.

Netanya’s fixed-income allocation was 30%, but her advisor told her it was effectively the 50% she needed because of a 20% allocation to preferreds. This gave her the false impression that half her portfolio was in low-risk investments. Worse, the preferreds he put her in were poor quality.

Vincent notes Netanya’s former advisor wasn’t discretionary, so from a legal point of view, she made all those bad decisions. “The broker would call her up and say, ‘You should buy this.’ And she would say, ‘Is it good?’ and he would say, ‘Yeah, it’s really good,’ ” so she agreed to the recommendations.

The solution

Vincent had to trade out Netanya’s entire portfolio and rebuild from scratch.

On the tax side it was quite simple: “There were so many capital losses [that] you’re not really costing the client money; in fact you’re putting losses in [her] pocket for future gains.”

At 68, Netanya has a short time horizon and relatively low risk tolerance. Vincent says a suitable portfolio would generate approximately 4.2% annually, which means about $80,000 in gross income without eating into principal. Netanya said that wasn’t enough: she wanted $120,000.

Vincent devised an alternative to maintain the portfolio’s conservative profile, but produce the extra $40,000 from annual capital gains when market conditions permitted.

The benchmark asset mix is half equities, half fixed income, with about 10% manoeuvrability. Vincent says his market outlook justified bumping up the equity weighting the full 10%. But he didn’t shift out any of the high-quality holdings the mix is built on; only the weightings get modified.

On the equity side there were no micro-caps, and only a few mid-caps with sustainable distributions. Income-biased large caps made up 45% to 50% and, of that, about 50% was Canadian. The rest was global, which included the U.S.

Warning

If you don’t let clients shop around for advisors, they may turn out to be poor fits for your practice.

The fixed-income allocation was built on corporates, municipals and provincials. Corporates made up 40%. Vincent says, in mid-2009, ‘A’-rated corporates had just come off a 20% to 30% hit. He was confident these quality names would bounce back, so he overweighted them. The remaining 60% was split almost evenly between municipals and provincials, with a slight edge to the latter.

Client acceptance

7/10

Netanya took Vincent’s advice, but not before checking out the competition. He speculates her motive was to determine whether his methods were too conservative.

“She was so damaged, and so worried about taking a step backwards,” Vincent notes. But his methodical risk management process won the account. Things have turned out well because markets have favoured high-quality names in the last five years. Netanya’s principal is now $2.7 million, even as she’s been clipping $120,000 in yearly income.

But she’s had to modify her estate-planning goals. Instead of $1 million, she’ll now be leaving $500,000 to each of her children.

Dean DiSpalatro is a Toronto-based financial writer.