Vern Fauth, an advisor based in Calgary, has moved about 80% of his book to private investment counsellors. Not only are his clients enjoying lower management costs, but they’re also getting more consistency in the investment approach.

“I’m getting a lot of accolades from clients,” says Fauth, president of Fauth Financial Group Ltd. “Money goes where it’s well treated. It’s the advisor’s job to seek out the best managers for clients’ money based on the clients’ needs.”

As clients become wealthier and more financially sophisticated, many financial advisors are finding that managed products such as mutual funds and wrap accounts are not satisfying their clients’ increasingly complex needs. That’s one reason why a strategy of referring high net-worth clients to investment-counselling firms is gaining traction in the financial services industry. Investment counsellors manage each client’s portfolio according to individual needs and goals — all at a lower cost than mutual funds or pooled products.

The strategy has appeal for investment counsellors as well. Foyston Gordon Payne Inc., Barrantagh Investment Management Inc. and McLean Budden Ltd. , all of Toronto; Dixon Mitchell Investment Counsel Inc. of Vancouver; and Cardinal Capital Management Inc. of Winnipeg are among the firms embarking on “client-sharing” relationships with advisory firms.

From the investment counsellors’ point of view, these arrangements are a great way to grow their businesses, diversify their client bases and enjoy the economies of scale that come with a larger asset base. Many are entering into a variety of arrangements to manage money for clients of all kinds of financial advisory and brokerage firms, from the smallest offices to the big bank-owned dealers. Typically, the minimum account size is in the $500,000-$1 million range for separately managed accounts, although some offer units in their own mutual funds or pools to clients with smaller amounts.

“It’s part of a business trend that investment counsellors are looking for new ways to distribute their services,” says Jay Welsford, vice president of Montreal-based Connor Clark & Lunn Private Capital Ltd. , a leading firm in developing referral relationships with advisors.

While this solution may raise fears among some advisors of losing clients, a growing number of dealers are approving relationships with a select list of investment-counselling firms. The investment counsellors maintain close communication with both advisors and clients, and may ultimately help cement client/advisor relationships as clients’ needs evolve. To make it more worthwhile for advisors, investment counsellors pay an annual “referral fee” to the advisors.

“Referral arrangements with investment counsellors allow advisors to receive what is essentially an ongoing trailer fee based on the size of the assets,” says Dan Richards, president of Toronto-based financial services consulting firm Strategic Imperatives Ltd. “The clients receive customized investment management and detailed reporting. They may also have better access to the portfolio managers who are looking after their money than they would with a run-of-the-mill mutual fund.”

These arrangements are particularly appealing to mutual fund dealers and managing general agents that specialize in insurance, Richards says. They are less appealing to investment dealers, which are able to offer their clients the full range of securities products on their own platforms.

“The advisors with a mutual fund or insurance orientation may have difficulty competing on the investment side when it comes to the million-dollar clients,” Richards says. “A referral arrangement with an investment counsellor allows them to compete with the big bank-owned securities dealers in the marketplace and to meet more fully their clients’ needs.”

CLIENT-DRIVEN RELATIONSHIPS

These large, full-service investment dealers often engage investment counsellors as subadvisors on wrap accounts, separately managed accounts and private pools that are maintained on the books of the securities dealers. But even some of those investment dealers are finding they can offer more benefits to clients if they enter into a partnership arrangement that actually moves the clients’ assets to the investment counsellor. The investment counsellors offer greater accountability to individuals than a mutual fund or pool with thousands of retail investors, and this direct relationship is particularly appreciated by high net-worth clients.

“The relationships are being driven by the client, and the advisor is seeking out an appropriate investment-management arrangement on the client’s behalf,” says Katie Walmsley, president of the Investment Counsellors Association of Canada in Toronto. “The advisor maintains clients by continuing to meet their various financial planning needs and offering advice.”

@page_break@Barry Twerdun, a financial planner with Premier Financial in Brandon, Man., agrees. Using investment counsellors leaves him with more time to manage client relations and do the detail-oriented financial planning, he says: “I’m able to put my arms around the client and help with their needs. The relationship with the portfolio manager frees up my time to provide other services.”

The lion’s share of Fauth’s clients’ money is managed by Cardinal. “I’ve chosen managers that have a strong philosophy and low portfolio turnover, and I know I can count on them,” Fauth says. “If clients are worried about their portfolio or financial markets, they can talk directly to the firm that’s managing their money, and that’s reassuring for them.”

Indeed, at some boutique firms, the top portfolio managers make an effort to meet regularly with small groups of clients and update them on investment trends and portfolio strategies.

Fauth’s clients also like the personalized reporting they get from the investment counsellor, which consolidates all their holdings on one statement that details exactly what they’ve contributed and their individual rate of return. Fees are separated and clearly disclosed. And they appreciate owning the individual stocks in their portfolios rather than units in a fund.

“Wealthy clients, in particular, like to know that every security is held in their own name,” Fauth says, “as it makes them feel more secure about their assets.”

According to Walmsley, clients’ increasing awareness of management fees is one of the drivers moving them toward investment counsellors. Because investment-counselling firms do not depend on distribution of product through a vast network of commission-driven salespeople, they are able to keep their management costs significantly lower than those of regular mutual funds.

The average Canadian equity fund carries a management expense ratio of 2.4%, according to Toronto-based Morningstar Canada, and foreign equity funds are usually even more expensive. By contrast, investment-counselling fees typically start in the 1.25% to 1.5% range, and decrease as assets rise. Furthermore, fees charged by an investment counsellor are tax-deductible on non-registered accounts, which enhances the cost advantage.

“There is a huge opportunity for fee reduction with investment counsellors,” Walmsley says. “And the larger the account, the more significant the reduction.

“What’s important,” she adds, “is that there be transparency and disclosure, so clients understand how their advisor and the investment-counselling firm are being compensated.”

There are other advantages to moving client assets to investment-counselling firms, regarding tax and investment planning. An investment counsellor can manage an individual account with a view to controlling the timing on the realization of capital gains and losses. For example, if the client has a large capital loss in any given year on any investment holding — be it a security or a piece of real estate — the portfolio manager may choose to take capital gains on certain securities that have appreciated significantly and allow the gains to offset the loss.

CUSTOMIZED SOLUTIONS

Alternatively, the client may want to defer the sale of a particular security to another year to avoid the realization of capital gains. Because the securities managed by investment counsellors are registered in the name of the individual owner, there is some leeway to employ individual strategies, and clients are obligated to pay capital gains taxes only on those gains that pertain to their own portfolio. In mutual funds or other forms of unitized pools, an investor may be taxed when a security that has accumulated a large gain over many years in a fund is sold, even if that investor has not been in the fund long enough to enjoy all those years of gains.

“A core component of what we offer is a customized investment policy for each client situation, as well as access to asset classes that may not necessarily be available at all firms,” says Welsford. “With a choice of Canadian and U.S. equities, small- to large-capitalization stocks, bonds and income securities, as well as private equity and alternative-strategy products, we bring more tools to the table than traditional mutual funds.”

Portfolios may also be customized according to socially responsible investment screens or the client’s individual tax strategy, he adds.

Financial advisors are being buffeted by a variety of trends that are encouraging many of them to hook up with investment counsellors, Welsford says. With consolidation among dealers in recent years reducing the number of dealer firms, the narrowing of competition has led to skimpier commission payouts for advisors and pressure on compensation. Advisors are being driven to expand their books to make up for the income squeeze, but a bigger book makes it harder to provide a high level of service to every client. Greater client awareness of fees and the move away from deferred sales charges has also squeezed commission income.

“Advisors are concerned about differentiating their level of service and want to offer both products and a relationship with clients in which they can take pride,” Welsford says. “In many cases, they’re finding it makes sense to delegate the portfolio management and allocation of monies across asset classes — particularly with high net-worth clients. Advisors can then focus on the financial planning side of the business, as well as relationship-building and new-client development.”

CC&L has relationships with about 48 firms in Canada in which CC&L manages money for the advisors’ clients through various vehicles. These relationships contribute about 20% of CC&L’s revenue and are the fastest-growing component of CC&L’s business.

“Competition from the banks has become a growing concern of advisors,” Welsford says. “The banks have picked up their game, in terms of the product and advice they offer, as well as investment performance. A lot of advisors are losing business to the banks and are wondering how to defend themselves.”

STEADY INCOME

Advisors at mutual fund dealers, in particular, are threatened by discount and full-service brokerage firms that offer a wider array of products. Introducing an investment counsellor into the client/advisor relationship is a way for advisors to maintain a steady income from clients’ assets and provide the clients with stocks, bonds and other securities — without losing the clients.

“Many advisors don’t have the experience, tools or confidence to go after million-dollar accounts and compete in that area of the marketplace,” Welsford says. “If you can present a customized, higher-end approach, you may be able to grow your business faster than by focusing on the traditional offerings of a mutual fund complex.”

Minimum account sizes vary, depending on the investment counsellor. The minimum threshold at CC&L is $800,000, based on the account’s ability to generate a minimum fee of $10,000 at 1.25% of assets. The fee paid to the advisor, or “referring agent,” typically ranges from 25 basis points to 75 bps, depending on what the advisor negotiates with the client, and is added to the 1.25% investment management fee.

Cardinal, on the other hand, has a minimum account size of $500,000 per household. Fees are 1.5% of assets for the first $2 million, 1.25% for the next $3 million and 1% for the next $5 million, and are negotiable for accounts over $10 million. The fees are split on a 50/50 basis with the referring agent.

While fee structures vary among investment-counselling firms, referring agents’ fees typically amount to 50 to 70 bps, shared by the advisor and his or her firm.

“Advisors have often spent many years growing their relationships with their clients,” says Megan Adams, vice president of marketing at Cardinal. “But when the client gets to a higher asset level, the relationship is at risk as the client’s needs become more sophisticated. Our service is a win/win solution that supports the advisor in retaining high net-worth clients, and helps in the acquisition of these clients as well.”

Cardinal works closely with the advisors in serving their clients, providing advisors with advance copies of client portfolio statements and inviting both the advisors and the clients to regular meetings. Cardinal’s president and chief investment officer, Tim Burt, often makes himself available for discussions directly with clients.

“The advisor shares in the relationship with us from Day 1,” Adams says. “It is in our interest, the client’s interest and the advisor’s interest to facilitate a long-term relationship. If the client wants to understand our investment philosophy or how the market is affecting his or her holdings, then the client can arrange a one-on-one conversation with a portfolio manager. We are not just selling a product.”

While establishing referral relationships with investment counsellors has its advantages, John Novachis is wary of sending a client to a manager who is one step removed from the firm. Novachis, executive vice president of advisory services for Investment Planning Counsel in Mississauga, Ont., says his firm plans to develop an arrangement with its affiliated investment counsellor, IPC Portfolio Management Inc. , to keep more assets under the umbrella of the group.

“By packaging something together within the IPC group, we believe we can create a better solution for advisors,” Novachis says. “We will continue to offer access to other investment counsellors, as well as the internal opportunity.”

Novachis is concerned that if assets are held at an outside firm, they are vulnerable should the investment-counselling firm be sold. “Once the assets are outside the firm,” he says, “the advisor is distanced from the management of assets and the client relationship as it pertains to the management of those assets.”

IPC currently has referral arrangements with about six outside investment counsellors, but these arrangements account for only a small portion of IPC’s business. IPC also has an investment dealer within its group: IPC Securities Corp. The firm’s securities-licensed financial advisors can do business from this platform, which is less restrictive than a mutual fund dealer.

CLIENT RETENTION

Adams stresses that the investment counsellor’s responsibility starts and ends with portfolio management. Advisors are free to offer their clients other products or provide advice on a fee-for-service basis.

“We are the investment experts, but the advisor brings a lot of other expertise to the table, in terms of advising clients on legal structures, tax strategies, corporate and family integration and estate planning,” she says. “There are lots of ways for the advisor to stay involved.”

Although the assets in these investment-counselling arrangements officially move off the advisor’s book and onto those of the investment counsellor, the advisor still has a due-diligence responsibility when referring clients to an investment-counselling firm.

“The advisor retains know-your-client responsibility for making an appropriate recommendation to an investment counsellor,” says Guy Armstrong, senior consultant with Investor Economics Inc. in Toronto. “In many cases, the client is moving to a better situation, in terms of being able to obtain discretionary money management, a variety of products and price advantages.”

Even if the assets have moved off the advisor’s book to that of the investment counsellor, the revenue they provide to the advi-sor is still a key consideration when valuing the advisor’s or the firm’s business.

Fauth ultimately plans to pass his Calgary-based advisory business to his sons, and views the income generated from his relationships with investment counsellors to be as valuable and stable as trailer fees. As long as the client is satisfied with the investment counsellor, there is a strong likelihood the relationship will remain in place if the dealership or the book of business is sold, and there would be a seamless transition to any buyer.

Bringing an investment counsellor into the client/advisor relationship can make the assets more “sticky,” as the client enjoys personalized portfolio management as well as more attention from his or her advisor on other aspects of wealth management.

“The client’s relationship remains with the advisor, and we are not trying to get in the way,” says Susan Eagleson, vice president with McLean Budden. “In fact, if a client wanted to do business with us directly, we would not accept the account unless there was a one-year gap between the client leaving the advisor and coming to us. We are developing a strategic relationship with advisors as they become one of our distribution arms, and the relationship must be built on trust.

“There is a shift in what the advisor brings to the relationship,” she adds. “The focus moves from selling product to relationship management, understanding the client and offering appropriate solutions and strategies.” IE