Are Exempt Market Products Good, Bad, Ugly, or is This the Wrong Question?
In my experience, too many investors have a “black or white, good or bad” attitude towards all investments, including exempt market products. Having been in the financial industry for so long, in so many capacities, one develops a sense of generally accepted truths that can be detrimental to your success as an investor. I believe strongly there is one such myth that needs to be exposed: The “one-size fits-all” myth.
As an individual investor, you need to understand how the industry works. By and large, this is a sales industry, where individual salespeople are paid to sell you as much product as possible. The more you buy, the more a salesperson is paid. This applies to banks, brokerage firms, insurance companies, mutual funds, GIC providers, and the exempt market industry. For most firms, their success is a result of capturing as close to 100% of your investment wallet as possible.
This general structure of the industry can run counter to the most important issues of proper qualification and suitability. A higher commission cheque can cloud the judgement of determining if an investment product should be in your portfolio. In addition, companies reward those who sell the most, sending top salespeople on trips and lauding them with awards. Of course, as a company relying on profit for financial success and growth, those who contribute should be rewarded. That is what capitalism is all about. My point is this: There is most likely zero correlation between a “corner office” advisor and investment returns or value that you will receive when you examine your portfolio statement.
To illustrate this point I can tap into personal experience. I have worked for:
- A boutique mutual fund/ insurance dealer
- The largest brokerage firm in Canada
- A bank-owned mutual fund firm
- The largest insurance company owned brokerage firm in Canada
Very rarely has there been discussion focusing on situations where a company’s product shelf is inappropriate. In addition, there is a certain portfolio size where almost no firm will tell you they cannot help you, hence, the potentially dangerous “one-size-fits-all” myth. The truth is that none of the company types listed above have something for every investor.
This non-ideal structure can, to a great extent, contribute to costly investing mistakes.
Now that you have some real information to chew on, let’s take this a step further. In my opinion, exempt market products are certainly not for everyone. While there are examples where private exempt products are an ideal fit, here are some examples where either I recommended an investor not purchase exempt market products, or could not legally provide them:
Recently Laid Off– A 30 yr-old mutual fund investor, with a wife and small child, came to the office. He had a $120,000 RRSP and a few thousand in the bank. He expressed frustration with mutual fund returns and wanted his money to work harder. He had also recently lost his job, and was expecting a severance until new employment was found. This family needed emergency funds as well as liquidity. With exempt products you are generally locked-in for a number of years. Based on the size of the family portfolio, illiquidity, and the fact that he may have to access RRSP funds at some point, the recommendation was to stay away from the exempt markets.
Extremely Risk Averse– A very nice lady, in her 70’s, called me after listening to a recent radio broadcast. She mentioned having $800,000 in the bank. Most of it was in GICs, and some in mutual funds, both were disappointing. She had heard about the great returns available through mortgages and energy investments. I asked her how long she could lock her funds in for. She wanted them to be accessible any time. I asked her about risk tolerance. She said she wanted guarantees, and did not want any risk at this stage of her life. I asked her about investments that she is familiar with. She indicated knowing almost nothing except for GICs at the bank. She also had no idea how her bank mutual funds work. I let her know that, most certainly, exempt market products are inappropriate, and that I cannot provide these products to her. Mutual funds are not even suitable for this type of investor.
Doesn’t Qualify Under Provincial Securities’ Regulations-I have had many calls from investors in Ontario. Many are interested in benefitting from Western Canadian farmland investing, for example. Before we discuss product features, etc, the first items to cover are qualification and suitability. Qualification levels are set by provincial securities regulators, and vary by province. In Ontario I have to find out if they earn at least 200K/yr consistently, or have $1Million net financial assets, or $5 Million total net worth. If not, unfortunately the discussion ends there, the OSC says they cannot buy an exempt market product. Even if you have $999,999 in net financial assets, and you want to make a purchase as low as $5000 for example, you cannot legally make the purchase. Qualification rules are expected to change in the near future, however, but these are the rules as they stand today.
Concentration Issues– Quite frequently I will have a conversation with a farmer who wants more farmland investments, energy executive who wants an energy fund, business owner who wants private equity, etc. We all understand and are comfortable with certain areas. However, many of these investors are already saturated with investments in these areas, and could use some diversification. I have personally witnessed more money being lost through concentration into a single investment, or investment category, than anything else (I have a story about a Bell Canada employee with 5000 Nortel shares who refused to sell, but that’s a story for another day!). When I explain the reasoning behind diversification, and that it makes so much financial sense to spread the portfolio over a number of asset classes (both public and private), most get it. Some investors are sophisticated enough, and have the means, to occasionally concentrate investments, however they always understand the increased level of risk. Others simply do not believe in diversifying, are expecting a successful outcome, and don’t fully appreciate the risks involved. Greed puts the blinders on. These investors are a train wreck waiting to happen. I do not want to be a part of these types of situations, so we part company prior to investing.
How You Can Tell the Difference
As an individual investor, you need to pay attention to the types of statements made, and questions asked, by any financial product salesperson you meet. Do they try and find out about your background, investment experience, overall financial situation, in order to assess qualification and suitability? Or, do they simply tout the great features of their products, or portfolio “system”, with the assumption that what they are selling is good for you? Are they willing to provide examples where their products were not able to meet certain situations, or is every attempt made to fit a product into your situation?
I hope this article has provided you with some additional education and perspective regarding the exempt market. It is a huge and extremely vital part of Canada’s economy, but must be understood adequately, or mistakes can easily occur. If you have any questions, please feel free to ask using this confidential form. The Guide to Q&A is here.
For more education and perspective regarding the exempt markets, download the free e-book “Guide to Understanding Real Assets and if They Are right For You”, located to your right.