In Defense of Profit and the Wealth Management Industry

I’ve spent much page space on the website explaining and illustrating the cost of financial advisory services and how the cost is detrimental to your financial health. The industry needs a little defense.

First, let’s look at profit. Profit is misunderstood. Most companies, especially the banks, do a poor job explaining and justifying profit. It seems every time banks report earnings they hunker down and endure criticism of gouging their clients. Specific to the banks, some of the criticism rings true. They operate in a government sanctioned oligopoly. Any obscene profit is due to a government sanctioned oligopoly. Those who yell “obscene profit” would be the first to yell louder if the oligopoly was broken and foreign banks competed under the same rules. Imagine the outcry if Citigroup was allowed to open 500 branches.

But, back to the point. Profit alone tells us little. Profit needs to be put in context. What was invested to generate the profit? Think of investing in a GIC. Someone may say, “I made $2,000 on a GIC investment, isn’t that great”. Maybe yes, maybe no. If $4,000 was invested, they had a great 50% paying GIC. If $40,000, they had a good 5% paying GIC. If $200,000 they made 1%, not so great. Profit / Amount Invested provides context.

Apple Inc. earned $48.4 billion in fiscal year 2017. That sounds obscene! It doesn’t sound obscene when compared to what was invested to generate the $48.4 billion. Apple Inc.’s balance sheet showed $322 billion in assets at the beginning of fiscal year 2017. Apple Inc. generated 15% on its capital. $48.4 billion sounds massively huge (and is). 15% sounds and is great but isn’t obscene.

Over the long term, a company grows its asset base by reinvesting profit. When a company generates profit, it reinvests what it does not pay out in dividends. Reinvestment grows the asset base over time. The company is in business to make a reasonable return on its asset base. If the company can't, they should close, liquidate assets, pay debts, and return the residual value to shareholders. Imagine the Canadian banks. I think each has over 100 years of existence. They generated profit in most years. They paid dividends and reinvested the balance. This adds up to a large asset base over 100 years.

Second, and I am building to a conclusion. A theme throughout the website is cost matters. Cost to the investor is high when hiring a financial advisor or planner. Cost to the investor is revenue to industry participants. Who is making all the money? There are many successful advisors. There are substantially more struggling advisors. It is a competitive business. As a group, it isn’t the advisors generating obscene profit.

Nor is it fund companies generating obscene profit. AGF, a fund company, had a 3% return on assets in fiscal year 2016 and CI Financial, another fund company, had 14.5%. This is the return on capital invested by the owners (shareholders) of AGF and CI Financial. (This has nothing to do with performance of the funds nor money invested in the funds. Money invested in funds is not the fund company’s money; it is investor’s money.) Neither company displays obscene profit. It isn’t the fund companies generating obscene profit. We have excessive fees charged without obscene profit generated.

So, where is the excessive investor cost going? In my opinion it is going to the compliance department. The wealth management and financial advisory sectors are heavily and excessively regulated. Regulation is costly. The head count in compliance departments has grown commensurately with the growth of regulation. Excess cost is paying compliance department salaries at firms and government agencies.

Regulation is necessary, but regulation is costly. Often the cost factor is ignored. Think of a politician introducing new legislation. They tout the good and ignore the cost. Regulation has been foisted on the wealth management industry with speed for the last 20 years. Regulation adds to cost and the company that does not pass along 100% of cost to clients is soon bankrupt.

Who, then, benefits from the excess cost? Those working in the compliance department and government regulatory agencies drawing a salary for obvious reasons. And, those working with a shady or incompetent financial advisor or hold product from a shady or incompetent fund management company. They are better protected from the shady and incompetent. Who is hurt by the excess cost? Those working with a competent advisor or planner whose main motivation is to help the client. Almost all individuals working within the wealth management industry, or any industry, belong in the second category. Because cost is increased by excessive regulation, MERs are higher and long-term rates of return are lower. My guess is that substantially more investors are harmed by lower rates of return than helped by regulation.

The wealth management subsector of the financial service sector takes its cues from the Ontario Securities Commission. Other provincial securities commissions take their cues from the Ontario Securities Commission. The Ontario Securities Commission is a crown corporation that is accountable to the Ontario Ministry of Finance. Here is how the OSC describes itself;

The Ontario Securities Commission (OSC) is an independent Crown corporation that is responsible for regulating the capital markets in Ontario. Our statutory mandate is:

To provide protection to investors from unfair, improper or fraudulent practices and to foster fair and efficient capital markets and confidence in capital markets.

We contribute to the health and performance of Ontario’s economy by using our rule-making and enforcement powers to help safeguard investors, deter misconduct and regulate participants involved in capital markets in Ontario. We regulate firms and individuals who sell securities and provide advice in Ontario. We also regulate public companies, investment funds and marketplaces, such as the Toronto Stock Exchange.

Our powers are given to us under the Securities Act (Ontario) the Commodity Futures Act (Ontario) and certain provisions of the Business Corporations Act. We operate independently from government and are funded by fees charged to market participants. We are accountable to the Ontario Minister of Finance.

I doubt the OSC is about to place itself through a rigorous cost / benefit analysis soon. Few government entities do.

Excessive cost is a fact when hiring the services of a financial advisor or planner. The industry can credibly defend itself. Much of the cost has been foisted on them by regulators and inevitably passed on to the client. If you want to eliminate the cost, you must be your own financial advisor.