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Quebec unitholders may be out of luck in recouping losses

Scandals in funds sector show assets sometimes not protected by industry, KEITH DAMSELL says


A trio of scandals in Quebec's mutual fund sector exposes the myth that assets held by retail investors are protected by the industry.

In late August, police raided the offices of Norbourg Asset Management Inc., a Montreal financial services firm that allegedly embezzled $130-million from its clients. Then on Sept. 13, the Autorité des marchés financiers, Quebec's financial regulator, began an investigation into the disappearance of $3.4-million at Zenith Management and Research Corp. One week later, the AMF froze the assets of Argentum Management and Research Corp., citing a "substantial decrease" in the value of the fund company's net assets.

A look at the mandates of Canada's investor protection funds suggests Quebec unitholders may be out of luck when it comes to recouping losses.

The $225-million Canadian Investor Protection Fund provides coverage for members of the Investment Dealers Association of Canada (IDA) in the event of insolvency. The fund acts as a custodian of assets and does not protect their market value.

And the Mutual Fund Dealers Association of Canada's $30-million Investor Protection Fund covers the losses of fund dealers only, again, in the event of insolvency. The MFDA has no regulatory status in Quebec.

None of the three troubled Quebec firms is a member of the IDA or the MFDA, nor are any insolvent.

Quebec's AMF, meanwhile, administers two protection funds covering, firstly, fraud in connection with investment dealers and, secondly, deposits of insolvent financial service firms. The Norbourg and Zenith funds are not covered by either pool, and there is too little information to date regarding Argentum, the AMF said. Ironically, the Quebec regulator's protection funds are unique in Canada and receive much praise for their mandate.

Investor protection is sore point for Larry Waite, the MFDA's president and chief executive officer. "There should be a fund for the whole industry," he said, noting that "a very small part" of invested assets in this country is covered.

The CIPF, meanwhile, argues that the potential cost of a fraud-specific fund makes it unworkable. "You couldn't have a sum large enough to protect against that kind of risk," said fund president and CEO Rozanne Reszel.

It's an issue the industry will be wrestling with. Last week, Brenda Vince, the new chairwoman of the Investment Funds Institute of Canada, rejected calls for an investor protection fund, arguing a system of better checks and balances for fund managers and increased capital requirements for the funds may be the best means to cover losses from a fraud.

"Managers are not regulated today," Ms. Vince said. "I had to jump through more hoops to become an officer of a [fund] dealer than I did to be an officer of a [fund] manager. I find that quite bizarre."

Backlash against AGF portfolio

A new product portfolio from AGF Management Ltd. that promises a performance-linked, money-back guarantee has sparked a firestorm of criticism within the industry.

The AGF Elements portfolio -- five so-called "wraps" with five different mandates: conservative, balanced, growth, global and yield -- pledge to waive a portion of the management fee if returns fall short of a benchmark return over a three-year period. The management fee refund is capped at 90 basis points. (A basis point is 1/100th of a percentage point.)

Fees and performance are the focus of attention. AGF is regarded as a high-cost fund manager and many industry rivals believe Elements will be expensive.

The total management expense ratio (MER) of the Elements funds will be determined after the first year of operations so it's hard to get a sense of fixed costs. However, AGF has pegged annual management fees for the five offerings at 1.7 per cent to 2.1 per cent. The company expects additional operating expenses per wrap will be a further 20 to 30 basis points; industry sources, however, suggest a better range for a start-up product is 30 to 40 basis points.

In other words, Elements' MER costs will range from a low of 1.9 per cent to a high of 2.5 per cent, within spitting distance of wrap fees of Franklin Templeton Investments Corp., AIM Funds Management Inc., and others.

It's harder to pin down the impact of AGF's customized benchmark. While much of the industry uses a fixed benchmark for wraps, AGF will use a blended benchmark that will shift each quarter, taking into account the returns of the group of funds in each wrap. The company claims its method provides the most accurate means of judging returns; critics argue it is an ever-changing target. "The benchmark we have selected will be much harder to beat," said AGF vice-president Larry Herscu.

So why not market a lower-cost wrap instead of an arguably harder to understand performance guarantee wrap?

"Once you buy quality, you expect quality. If it falls apart, you expect your money back," he said.

SRI fund companies join forces

Ethical Funds Co. and Guardian Capital Ltd. are joining forces, a partnership that illustrates the challenges faced by so-called social responsible investment (SRI) funds.

The newly created Guardian Ethical Management Inc. will market a new suite of ethical funds to institutional investors. Guardian brings its client list to the table; the Toronto firm manages more than $15-billion in assets for institutions. Vancouver-based Ethical, meanwhile, is this country's largest retail SRI fund manager.

On paper, the deal looks like a merger of equals. Each firm will appoint three members to the board and the role of chairman will rotate every two years.

Nevertheless, Guardian may have the upper hand. Guardian already manages Ethical's largest fund, the $432-million Ethical Growth Fund, and will be adding further Ethical names to its mandate. Ethical's management costs will fall but competitors question whether the Guardian team has the best SRI skill set.

And while Guardian has continued to rack up growth, Ethical has struggled of late and is no doubt eager for new business.

© 2007 The Globe and Mail. All rights reserved.

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