The buzz of the last few years around the dinner table at family functions with my ageing aunts and uncles has revolved around investments, performance of funds and their retirement nest eggs. I handle a few inquiries, have a considerate peek at their portfolios and give general opinions on the markets or what their advisors have suggested for the upcoming year. Whether they take my advice or that of others is their choice, but when asked I’ve never had a problem at pointing out important considerations for their lifestyle and investing needs. What I’ve been seeing more and more frequently within their portfolios is what the mutual fund industry now terms as “wraps”.
A Wrap Account (or often termed managed account) is a portfolio designed to include broad diversification of assets & geography in a number of mutual fund that hold the promise to steadily perform in all varieties of market environments. It provides the “sensible solution” as it helps take out the specific selection of mutual funds by clients and places their assets into one large pool of capital that is a managed fund of funds. For someone without the time or knowledge to make choices on their own with an advisor it provides a “hands off” approach that benefits both sides of the equation – in theory. The benefits to clients are often touted as low maintenance, stable and professionally managed with advisors pushing these products as exposure to successful net worth managers they might not otherwise gain access to due to their own net worth.
A wrap account mutual fund is essentially a pre-packaged portfolio of mutual funds that target different styles of investing (income, growth, balanced, index) which help clients to hold and advisors to sell. Which segment of the portfolios you best qualify for depends on your risk tolerance, investor profile and time horizon. A client answers questions asked by a computer and the asset mix, risk tolerance and other factors can be immediately determined by an advisor at the push of a button. The portfolios offer simplicity as they are re-balanced out of the hands of clients and you can receive a single quarterly and annual report to read through versus multiple reports for each individual mutual fund you might otherwise own.
The clear benefit of a wrap account or fund for many investors is they now don’t need to follow an abundance of mutual funds or stocks in their portfolio and have access to one single investment that proposes to do the exact same as they were doing before. The clear cost for many investors is well…cost.
Let’s examine one such wrap account: TD Managed Income Portfolio
My sixty-one year old uncle and aunt own this fund within their RRSP and had questions over its worth to them versus other strategies. The wrap manages $1.75B in assets, charges an MER of 2.08% and its benchmark is the Morningstar Balanced Canadian Conservative Index. Within this wrap are the following funds with percentage allocations:
In contrast a portfolio constructed of purely index funds offered by TD (E-Series) with comparable allocations would charge an average MER of 0.45% with an annual drag of only $2056.50.
Noted the wrap account has only been around since late 2004, but the three year comparison is still as startling. If my relatives had invested into the E-series of four funds in similar allocations (TD CDN Bond, CDN Index, US Index & INT Index) to date they would have cumulatively returned (without rebalancing) 15.11%. The wrap account over the exact same period (which is rebalanced) would have returned 7.55%. The difference between both portfolios (including fees) amounts to over $34,000 in just a short three year period. Not only is the wrap portfolio lagging due to a higher cost (fees), but also in the performance of the managed funds. The fund has outperformed its peers (Canadian Fixed Income Balanced) but severely lagged the earlier stated benchmark.
This example clearly isn’t perfect since certain assumptions are made due to rebalancing in the indexed portfolio. I would also have to point out the relative strong performance of the indexes in question over the past three years might skew the results in my arguments favour and not be representative of other time periods. Regardless, what is stunning is the sheer underperformance due to fees that my relatives have endured since signing up for this wrap program over the past few years.
Past performance is certainly no indication of future returns, but one could make the case that the savings in fees alone (~$7500/yr) should be enough to help investors become more aware of the underperformance associated with some of these products. The adoption of a much more simplistic approach to protecting your nest egg, while adding some capital appreciation is certainly within the reach of many investors if they constructed a portfolio with similar objectives and focused instead on cost-effective investments that maximize performance. When you examine the overlap of funds within this wrap account it becomes clear how unneccesary some of this active management is.
Any investor should take the time to understand what they’re investing in and the impact those options have on fees, performance and risk. Finding the right advisor at times that will provide you with unbiased opinions can be more worthwhile than simply trusting your banking institution and investing in these often appealing wrap account programs.
Just something to put into context and consideration as RRSP season starts to draw to an end.