What the NHL, Bernie Madoff, ETFs, the Internet, and Hedge Funds all mean for the NEW Exempt Market
By: Justin G. Charbonneau
So what do the NHL, Bernie Madoff, Exchange Traded Funds (ETFs), the Internet, and Hedge Funds all mean for the NEW Exempt Market? Simply put, each of these have, and continue to, effect on the Exempt Market without you likely even knowing it.
Because many analogies can be transcended from sports to business, I find sports can tell us a lot about how to run a business effectively and which strategies work best under which set of rules. With the NHL Stanley Cup playoffs having just passed, I am quickly reminded about how the merits of skills, work ethic, coaching strategy, and the game’s rules all affect a team’s ability to win. The key here, related to the Exempt Market, has been the transformation of the NHL rules over the past decade with more and more restrictions on stick infractions, and malicious hits to the head causing concussions. Similarly, the Exempt Market, under NI 31-103, has gone through its own rule changes in an attempt to better protect both investors and the industry through better transparency and more disclosure. Although more rules or tighter regulations typically mean more headaches for most players in the short-run, over the long-run, these new regulations should help both investors and players win with hopefully fewer clubs nearing the fate of the Phoenix Coyotes (last year). Those teams who can adapt to the new rules of the game and plan a winning strategy accordingly will be able to make the playoffs year after year, potentially even win the cup! Just look at the two teams who battled in the final round for the cup – these two teams were not necessarily the best skilled or the top teams (LA finished 8th; NJ finished 6th in conference play), but have in one year found a way to strategize, and win, using the rules optimizing the NEW NHL.
Bernie Madoff, or “Madoff,” the new term meaning ‘Ponzi’ scheme, is how investors alike will probably refer to fraud for generations to come. Why would Bernie Madoff’s actions affect your business given no ties to Exempt Market investors? The simple truth is that all investors, since the “Madoff” scheme, have become much more discerning about who they give their hard earned money to regardless of apparent track record, or being a ‘who’s who’ in the investment business. All regulators, whether that is the provincial regulators in Canada or the SEC in the United States, have increased the due diligence requirements of both prospectus and prospectus exempt issued investments. The SEC has gone so far as to create a Whistleblowing Fund thereby rewarding those discerning members of the public who spot and whistle blow on potential fraudulent investment schemes. If provincial securities regulators in Canada ever collaborate in an effort to protect investors in a more coordinated manner, I wouldn’t doubt if they took a play out of the SEC’s playbook with respect to the Whistleblowing Fund incentive. The bottom line is that more regulation is here to stay. By educating your clients about their rights, and inherently going deeper with them about the true risks of potential investments, you have the opportunity to win more of their trust, and best of all, a larger share of their portfolios!
The advent of ETFs as a core asset class product has begun to materially change the industry in which our firm mainly operates in – the Mutual Fund industry. So why would ETFs affect the Exempt Market? Combined with sixty year low record interest rates, fees and disclosure of Advisor compensation now matter more than ever. ETFs have helped bring investment management fees, and as a byproduct, industry compensation, to the forefront. Historically, fees paid by clients have been swept under the rug through net performance disclosure by the Mutual Fund industry. The game changer, however, has undoubtedly been the rise of low cost ETFs in concert with more widely accessible internet access which is affording investors a plethora of disclosure on all things fee related. By no means am I suggesting fees will ever get as low in the Exempt Market as they are today with ETFs, but I think the key here is that fee disclosure and Advisor compensation are being included more and more in the conversations with investors. Furthermore, I’m not suggesting Advisors should not be paid for their invaluable financial planning, risk mitigation, and investment management services, but taking a proactive approaching in talking about fees and commission rates will go a very long way in building more trust and understanding with your clients.
The Hedge Fund (HF) industry continues to grow as investors demand more downside protection and strong absolute returns no matter what happens with the ups and downs of the stock market. So why would HFs matter to your business, which is less affected by the public capital markets? Well, the reality is the HF industry continues to grow and attract assets under management despite having the worst couple years in its history1, thereby they are proving to be real competition to the Exempt Market. Something the Exempt Market can learn from the shortcomings of the HF industry is that no single product works in all kinds of market environments, nor do HF models work the same in a laboratory as they do in the real market. As a result, as an Advisor serving your clients’ interests, one has to think more holistically and truly uncover the asset class correlations and risk associated with various investment products when building a client portfolio. In simple terms, diversification typically means spreading out one’s capital amongst various investment products, however, as the financial crisis demonstrated, true diversification only works on an asset correlation basis. I believe with the increased regulations in the Exempt Market, a higher standard of due diligence is demanded by regulators and investors alike. Advisors have a great opportunity to truly understand asset class and correlation diversification using both private and public investment vehicles. Thereby affording themselves the opportunity to win a larger share of clients’ wallets by truly becoming their client’s coach when it comes to their investment portfolios.
The investment business as we knew it five to ten years ago has changed dramatically with the lower than average stock markets returns, growing public awareness of Madoff schemes, and the reality that each and every one of us – Advisor or Investor – has access to an inordinate amount of information at our finger tips – via the Internet – making us all ‘experts’ alike. What’s more disturbing is investor time horizons have shrunk dramatically along with lackluster investor returns, which says something about the ability of humans to predict the future and time the stock markets. Instead of spending an inordinate amount of resources to try to the win Stanley Cup every year, why not make the realization that spreading around portfolio risk through true asset class diversification, creating a more engaging dialogue about fees and compensation with clients, and truly serving their long term needs of your clients is the best sustainable and most sensible approach in the sport called “the investment management business”. In the words of the Great One - Wayne Gretzky, “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.” All investment industries, whether that be the Mutual Fund business, HFs, or the Exempt Market is truly undergoing changes akin to that of what the NEW NHL did many years ago.