Investor awareness of long-term damage of fees ‘is growing,’ says veteran adviser

One year back Larry Bates, a veteran of the world of fixed-income investment banking, unveiled the concept of the T-Rex Score — an investor’s total return efficiency index that combines the gross return and the fees paid to earn that return.  

“Your T-Rex Score represents the percentage of your total investment gain you actually get to keep,” said Bates, noting investors need to be aware of the impact fees have on a portfolio’s overall return over different time periods. Bates also launched a website with a book scheduled for this year.

The fees, over time, add up, reflecting the compounding effect of lower annual net returns. For example, a $10,000 investment generating annual returns of 6.4 per cent — with all distributions reinvested, with annual fees of 1.75 per cent and a 25-year time horizon — generates a T-Rex Score of 57 per cent, meaning fees eat up 43 per cent of the return.

This year, a similar message about fees has again been front-and-centre in the advertising campaign of Questrade, an online brokerage company. The firm’s latest advertisement features a client who wants to move her account because of high mutual fund fees and low returns. The adviser says: “It’s your money, but trust me it’s probably not the best move.” The client replies: For whom, “my family or you?”

Bates said investors’ awareness around the long-term impact of fees “is growing.”

“Two per cent fees can wipe out half of your return and investors are becoming more cognizant of this, particularly as more efficient providers emerge,” he said.

For Bates, the Questrade advertisements, along with those of other online investment providers, “are raising awareness of the long-term damage of fees.” Calls to Questrade weren’t returned. 

All the focus on fees leads to the role financial advisers play in selecting investments for their retail clients. That discussion is heightened because regulatory bodies have not universally implemented a fiduciary duty for advisers.

Given the discussion around the need for such a standard, and the need or otherwise to get rid of trailer fees, lots of research has been produced showing the negative effects of such a move — although the assumption would be that advisers would recommend products that pay the highest commissions.

But a recent academic paper (updated in December) tosses another variable into the mix. Titled the Misguided Beliefs of Financial Advisers, the paper is authored by three U.S. academics and published as a research paper of the Indiana University’s Kelley School of Business.

What’s interesting is that the paper uses data provided by two large unnamed Canadian financial institutions. (Both are mutual fund dealers who manage $20 billion of client assets, none in individual stocks.) The authors had “comprehensive” trading and portfolio information from more than 4,000 advisors and almost 500,000 clients during the period 1999 to 2013. They were also given the advisers’ personal trading and account information.

Guess what? According to the analysis, advisers “invest their personal portfolios just like they advise their clients.” In other words, they trade frequently, prefer actively managed mutual funds, chase returns and under diversify. Both the client’s and adviser’s return trailed the market by about three per cent.

“Advisers give poor advice because they have misguided beliefs,” the authors conclude, a situation they argue can’t be solved by eliminating conflicts of interest.

Maybe, but Bates gets the final word. Most of the advisers “can only offer expensive product which damages return. The advice should be to buy inexpensive product,” he said, adding he hopes the two institutions with the laggard performance numbers have been offering remedial training to their advisers and better advice to their clients.

Financial Post

Marijuana grower Green Organic Dutchman said to raise $100 million in IPO

Medical marijuana grower Green Organic Dutchman Holdings Ltd. (TGOD) raised $100 million (US$78 million) in its initial public offering, according to a person familiar with the matter.

The raise by the Mississauga, Ontario-based pot producer came in at the high end of the previously disclosed range of $75 million to $100 million. The company priced its shares at $3.65 apiece and is expected to begin trading next week in Toronto.

The sale was several times oversubscribed and the over-allotment is also expected to be exercised, bringing total proceeds to about $115 million, said the person, who asked not to be identified because the matter is private.

A spokesman for the company couldn’t be reached for comment.

The IPO follows the January listing by pot producer MedReleaf Corp., which fell 22 per cent on its first day of trading. That was the largest decline in 16 years for a Canadian IPO larger than $100 million.

Green Organic’s IPO was led by Canaccord Genuity Corp. and PI Financial Corp. The company intends to use the proceeds from the offering to fund its ongoing operations, according to a a regulatory filing. It said that will include completing its facilities in Hamilton, Ontario, and Salaberry-de-Valleyfield, Quebec, as well as funding various licensing and approvals, it said.

Earning the big bucks: Why money managers are paid so much is a mystery

Why do workers in the financial industry get paid so much? There are many possible explanations, none of them completely satisfying. The financial industry commands a much larger share of the U.S. economy than in the past, causing some to worry that the industry gets more money than its economic contributions merit. The question is also important to workers thinking of going into finance, but for a different reason: Everyone wants to know how to get the big bucks.

The really big bucks, of course, go to people who start successful fund companies — titans such as Ray Dalio of Bridgewater Associates or Ken Griffin of Citadel LLC. But well below those lofty heights, there are many thousands of people making a comfortable living doing things like managing mutual funds.

The mutual-fund industry, to put it mildly, is big.

What are all those people getting paid to do? One possible answer is that they’re getting paid to earn market-beating returns. If you just want to do an average job, you don’t really need a trained investment professional to pick your assets — just invest in an index fund. And if you want to beat the market, a mutual fund probably isn’t your best bet. While there is evidence that active managers do beat the market before fees are deducted, after fees they tend to underperform. That’s unsurprising, since mutual funds tend to be big, and beating the market gets much harder as the amount of assets under management increases.

Even if investors don’t realize how difficult it is to outsmart the market, mutual-fund companies seem to get it. New research indicates that a fund manager’s performance probably isn’t even that big of a factor in determining his or her pay.

A recent paper by economists Markus Ibert, Ron Kaniel, Stijn Van Nieuwerburgh and Roine Vestman looked at the mutual-fund industry in Sweden. Sweden has both a large, well-developed fund industry and highly detailed tax records. Ibert et al. connect managers with funds, and with families of funds, and try to figure out what accounts for the differences in their compensation.

Fund performance, they found, has a very weak relationship to manager pay. Managers’ returns vary a lot, as one might expect in an industry where performance is subject to the vagaries of the stock market. But the authors estimated that a one-standard-deviation increase in fund returns, relative to a benchmark, netted the manager only a 2.9 per cent increase in compensation — meaning that even very strong outperformance doesn’t get rewarded much at all.

Fund size, the authors found, is related to pay, but the relationship is again weaker than one might think — on average, only about 15 per cent of the fee revenue a fund gets from managing more assets gets passed through to the manager. And the relationship is even weaker for larger funds. Most of those enormous management fees are captured by mutual-fund companies, not by the people managing the funds.

So what do managers get paid for? Another recent paper, by Galit Ben Naim and Stanislav Sokolinski, offers one possible answer. Ben Naim and Sokolinski looked at Israeli mutual funds, using extremely comprehensive data collected by the Israeli government. Like Ibert et al., they found that market-beating performance was only weakly related to compensation — a one-standard-deviation increase in the amount that a manager beats his or her benchmark meant only a 5 per cent boost in pay, slightly better than what Ibert et al. found, but still pretty small.

Interestingly, Ben Naim and Sokolinski found that manager pay is more strongly related to overall fund performance, without the benchmark subtracted. That’s odd, because benchmarks are ostensibly just a bunch of things managers don’t really have control over, like the performance of the broader market.

Ben Naim and Sokolinski found a larger effect of fund size on manager pay — about 30 per cent, or roughly twice the size of what Ibert et al. found. Furthermore, they found that managers captured 40 per cent of the fee revenue that comes from investors putting more money in the fund (rather than increases in size that come from market returns, or from the company handing the manager more assets to manage).

These findings suggest that mutual-fund managers are paid less for beating the market than for marketing — i.e., the ability to collect assets. High passive returns, even if they aren’t due to skill, attract new investor money, which gets the company more management fees. And when more investor money comes in, managers get rewarded.

This bolsters the notion of “money doctors” — the idea that managers mainly add value by building trust with investors. Investors are naturally wary about putting their money in stocks and other risky assets, and want a qualified professional to tell them it’s safe to do so. This could potentially be a win-win relationship; investors pay fees, but get higher returns than they would if they had stayed out of the market. Or it could be a potentially toxic relationship, if managers use personal or cultural affinity to sell investors on a bad deal. More research is needed in order to tell how many money doctors are really quacks.

But the new research into fund-manager pay also shows that a large percentage of compensation remains unexplained, having apparently little to do with fund size or returns. There is a lot of money sloshing around in the financial industry, and much of how it gets divvied up remains a mystery.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

Aurora-CanniMed decision raises poison pill concerns

The reasons for decision in the Aurora Cannabis Inc./CanniMed Therapeutics Inc. January merger, delivered by securities regulators this week, have attracted the attention of M&A lawyers, given that it marks the first poison pill ruling since new takeover rules went into effect almost two years ago.

The implications for poison pills — shareholder rights plans as they’re known — was the focus of commentary from Osler Hoskin & Harcourt, the firm that in 1998, helped design the country’s first poison pill for the since-departed Inco Ltd.

Jeremy Fraiberg, co-head of Osler’s M&A practice, didn’t like all that he read. “The ability to use a plan to prevent creeping 5 per cent and hard lock-ups could be imperiled,” he said. “This is the biggest takeaway from the decision.”

A quick recap: CanniMed was pursuing a transaction with Newstrike Resources; Aurora, with the “hard” locked-up support of four CanniMed shareholders (who owned a total of 35.66 per cent) made an offer for CanniMed conditional on the Newstrike deal being cancelled; CanniMed adopted a tactical shareholders rights plan to prevent Aurora from acquiring any more shares or signing up other shareholders. The matter ended up before Ontario and Saskatchewan securities regulators, who struck down the plan last December (partly on the grounds that it wasn’t in the public interest), allowing Aurora to purchase another five per cent (taking its stake to more than 40 per cent) and potentially locking up other shareholders.

Fraiberg bases his assessment on three key parts of the 30-page reasons document. One part focuses on the regulators’ claim the takeover bid regime would become “far less predictable and the planning and implementation of shareholder value-enhancing transactions (would be made) more difficult or inappropriately discouraged,” by arrangements in which “tactical shareholder rights plans could, as a general matter, operate to prevent lock-ups and permitted market purchases.”

The second part was the regulators’ view that some tactical plans “can be confusing to investors and market participants,” and besides would serve “no useful purpose.”

The final part focuses on the regulators’ conclusion that the rights plan constitutes an “impermissible defensive tactic.” They said it will be a “rare case” in which a tactical plan will be permitted to interfere with established features of the takeover bid regime. Those features include the opportunity for bidders and shareholders to make decisions in their own interests regarding whether to tender to a bid by entering into lock-up agreements.

How did we get here? One starting point is the May 2016 decision to implement a new takeover bid regime with little reference to poison pills. (Three years earlier Quebec’s Autorité des marchés financiers issued a consultation paper calling for an expanded role for defensive tactics and a greater emphasis on the board’s business judgment. )

The “implicit” understanding at the time was that regulators would get out of the business of adjudicating rights plans given the new takeover rules that required a deal to be completed in 105 days, with a 10-day extension, and a 50 per cent minimum tender were more generous than what was allowed under a so-called permitted bid. (But issuers still kept seeking shareholder approval for rights plans.)

But gaps remain between what was allowed under old rights plans and the workings of the new takeover rules. Previously, bidders weren’t allowed to purchase another five per cent (if it took them above 20 per cent) until the pill expired; now the regulators are saying the 5 per cent is available immediately.

“Under the old regime, participants had confidence that rights plans would prevent a 5 per cent creep and hard lock-ups; now there is some uncertainty,” said Fraiberg. “If this interpretation is correct, the irony is that the new regime potentially provides less board protection,” than previously.

Financial Post

Aecon trades at widest gap to CCCC offer as concerns mount

Investor skepticism appears to be growing that Aecon Group Inc.’s takeover by a Chinese company will be approved by the Canadian government, at least in its present form.

Shares of the Toronto-based construction company have dropped to their lowest level relative to China Communications Construction Co.’s offer price of $20.37 since the deal was announced in October. The gap between the share price and the offer stood at $1.78 at midday on Wednesday.

The Canadian government launched a full national security review of the takeover bid last month under a section of the Investment Canada Act that allows the government to block deals that could be “injurious to national security.” It hasn’t given any updates since then.

The transaction could see additional delays, be blocked altogether or have conditions set that would require divestiture of some of Aecon’s assets, according to Chris Murray, an analyst at AltaCorp Capital Inc. If a divestiture is required, it would most likely be Aecon’s telecom business, which generates annualized revenue of about $150 million, he said.

“We believe there is a very low probability of the transaction being approved as is, given security concerns expressed by the federal government and other allies around telecom infrastructure, particularly as Canada embarks on a once-in-a-generation process of replacing its fiber and wireless networks,” Murray wrote in a note published Tuesday.

Hedge funds sink in February, suffering worst month in two years

Hedge fund returns overall fell 2.19 per cent in February, wiping out January gains and leaving them nearly unchanged for the year at up 0.07 per cent, according to the latest numbers out of the Bloomberg Hedge Fund Database.

That came as markets were roiled by a 47 per cent jump in the VIX Index in the month, a 3.9 per cent slide in the S&P 500 and as 10-year yields backed up to 2.86 per cent, leading to the worst month for hedge funds since January 2016, when they slumped 2.57 per cent.

Commodity Trading Advisors/Managed Futures strategies had the steepest drop for both February and the year, falling 6.01 per cent in the month and 3.02 year to date. Macro Funds saw the second-largest monthly drop, slipping 2.31 per cent, underperforming the hedge fund database by 12 basis points. Fixed Income Relative Value Funds were the only group spared, ending the month up 0.06 per cent.

From a strategies perspective, Systematic and Discretionary CTA fell the most at 6.87 per cent and 6.19 per cent, respectively, as about 88 per cent (23 of 26) of the strategies were down in February. Currency strategies posted the biggest gains for the month at an average 2.24 per cent, below their 3-month average of 3.39 per cent, putting them in the red for the year at 1.62 per cent. Long-Short funds finished February down 1.47 per cent, outperforming the S&P by 222 basis points. Emerging Markets, the third best style in 2017 and best YTD, fell 1.03 in February, as markets contracted outside the U.S.

No Pain, No Gain: Despite nearly across-the-board declines in February, five of the eight strategies maintained positive results for the year, paced by Equity Hedge funds, the best performers in 2017, at 1.04 per cent. Fixed Income Relative Value funds followed closely at up 1.02 per cent for the year after barely breaking even for the month. Event Driven funds were also in the black, up 0.92 per cent for the year, overcoming a monthly of 0.99 per cent.

Health Care-focused funds were down 0.64 percent in February, reversing gains in January of 4.6 per cent. Energy-focused funds dropped 3.7 per cent for the month, after gaining of 2.6 per cent in January.

NOTE: All data are total return including reinvested dividends; February data are the most recent available; March numbers become available around 4/15/2018

NOTE: “Equity Hedge” refers to a Bloomberg-created term for strategies where the largest subset of funds is L/S Equity and Long Biased hedge funds


Aurora-CanniMed reasons offer ‘reasonable guidance’ for future takeovers: lawyer

Almost three months after two provincial securities regulators issued a seven-page order in the Aurora Cannabis Inc./CanniMed Therapeutics Inc. hostile takeover, the highly anticipated reasons for decision have been released.

Within those 30-plus pages about what was a complicated underlying matter, there are enough indications that new takeover bid rules established in May 2016 remain in place. But as with all rulings, some questions remain unanswered.

For Patricia Olasker, a partner at Davies Ward Phillips & Vineberg and a veteran of the world of contested M&A transactions, a key conclusion was that “predictability” in such battles has been maintained.

“The parties are entitled to know what rules will govern. That was the central theme,” said Olasker, who has read the reasons issued last week by the Financial and Consumer Affairs Authority of Saskatchewan and the Ontario Securities Commission.

The reasons detail “a reasonable amount of guidance” for future M&A battles. “In the main they got it right,” Olasker said.

She was also supportive of the decision not to interfere (as Aurora wanted) with the relatively new takeover bid rules that, among other matters, allow for a minimum 50 per cent tender requirement, a 10-day extension and 105-day time period. The regulators decided that “we have just rebalanced the rules to shift more power to the board room,” she said. “It’s going to take a really compelling case to tinker with the rules on a piece meal basis. And this is not that case.”

The third positive theme, Olasker said, was the determination that lock-up agreements “are important as a planning tool to facilitate bids.”

Four CanniMed shareholders holding almost 36 per cent of the shares outstanding backed Aurora’s bid. CanniMed, which had signed a deal to merge with Newstrike Resources, filed an objection arguing the four were “joint actors.”

In their reasons, the two regulators “did not find the lock-up agreements objectionable in this case,” in large part because the voting rights “are tailored to be consistent with and to support otherwise permissible commitments to tender securities to a bid.”

Olasker noted that one of the surprises about last December’s hearing was that none of the four investors who signed lock-up agreements was called to testify. “Without their evidence, it would have been very hard to delve into the joint-actor issue,” she said, adding the four shareholders would have been called had her firm been advising CanniMed.

As for matters that weren’t addressed, Olasker mentioned the “preclusive effects of lock-up agreements,” a situation in which so much of the stock is locked up that an alternative bid is not possible.

“That is a possibility on the facts as they arose here,” noted Olasker, noting that after CanniMed’s shareholders rights plan was struck down, Aurora was allowed to purchase another five per cent and to enter into other lock-ups, further strengthening its hold on CanniMed.

Since the regulators didn’t comment on that matter, Olasker’s interpretation was that they opted not to intervene given that an arms-length bidder is locking up with arms-length shareholders. The same result may not apply, she opined, if an insider is launching a takeover.

Olasker also mentioned the scant attention devoted to the topic of information sharing, noting that some CanniMed shareholders had contacted Aurora as a potential buyer after voicing their disapproval of the Newstrike transaction. Through these communications, said the regulators, Aurora learned “two facts material to its potential bid: that CanniMed was pursuing an acquisition and that such an action “was imminent.”

The takeover also affected Canaccord Genuity. Originally it was acting for Newstrike, but changed when Aurora entered the frame “because it had a contractual first right of refusal on any Aurora engagement.”

More on this tomorrow.

Financial Post

Blackstone, Thomson Reuters weighing Tradeweb IPO, sale: sources

Blackstone Group LP and Thomson Reuters Corp. are considering an initial public offering or a sale of their stake in the bond-trading platform Tradeweb Markets LLC, whose users and co-investors include the world’s biggest banks, people with knowledge of the matter said.

The two firms have held talks with the bank shareholders, which include Deutsche Bank AG, UBS Group AG and Royal Bank of Scotland Group Plc, about selling the company or taking it public this year, said the people, who asked not to be identified because they weren’t authorized to speak publicly. Tradeweb, now majority owned by Thomson Reuters, is likely to be valued at more than US$4 billion in an IPO or sale, the people said.

A sale or IPO wouldn’t happen until after Blackstone completes its purchase of Thomson Reuters’ financial and risk unit, the people said. Blackstone and Thomson Reuters consider an IPO to be the most likely option and seek a sale or listing that would include the banks’ shares as well as their own stake, one of the people said.

No final decision has been made and the owners could elect to keep the business, the people said.

Representatives for Blackstone, Reuters and Tradeweb, along with investors Barclays Plc, Citigroup Inc., Deutsche Bank, Goldman Sachs Group, JPMorgan Chase & Co. and UBS, declined to comment.

Representatives for Morgan Stanley, Bank of America Corp. and Royal Bank of Scotland Group Plc didn’t respond to messages seeking comment.

Blackstone’s Deal

The plan to explore an IPO or sale comes as Blackstone is leading a group of investors in buying a 55 per cent stake in the Thomson Reuters financial and risk unit. That transaction, which values the Thomson Reuters data and information business at about US$20 billion, is scheduled to close in the second half of this year.

The new standalone company won’t include the news division, which will get at least US$325 million a year from Thomson Reuters for 30 years for its news and editorial comment.

New York-based Tradeweb, which was formed in 1998, builds and operates electronic over-the-counter marketplaces, with a focus on the fixed income and derivatives markets, according to its website.

Bloomberg LP, the parent company of Bloomberg News, competes with Thomson Reuters in providing news, data and information to the financial industry. It also competes with Tradeweb in offering trading in bonds and derivatives to its subscribers.