Proceedings of the Standing Senate Committee on Banking, Trade and
Issue 19 - Evidence - May 14, 1998
OTTAWA, Thursday, May 14, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at
11:00 a.m. to consider the present state of the financial system in Canada (the
role of institutional investors).
Senator Michael Kirby (Chairman) in the Chair.
The Chairman: Senators, our first witness this morning is Ms Glorianne Stromberg
who, like members of the Senate, clearly understands that notoriety outlives
fame. We are delighted that you are with us.
As many of you will recall, in 1994, Ms Stromberg was asked by the Ontario
Securities Commission to provide advice with respect to what changes should be
made to the current regulatory framework, particularly governing mutual funds,
a report that she issued at the beginning of 1995 and which created quite a
storm of controversy. Subsequently, at the beginning of this year, she had been
asked by the Office of Consumer Affairs, which is part of the Department of
Industry, to look at a similar issue with respect to what protection should be
offered to consumers who are increasingly turning to mutual funds as a means of
protecting and generating a source of their retirement income. I believe that
report is due towards the end of June. Am I right?
Ms Glorianne Stromberg, Commissioner, Ontario Securities Commission: Yes, Mr.
Chairman, you are right.
The Chairman: I have no doubt that it will be received with the same degree of
attention and media focus as your last one. We welcome you to the strange world
of public policy, at the interface between business policy and public policy,
which can at times be quite controversial. I am delighted that you are with us.
I think you know the issues we are dealing with.
You have given us a paper, which my colleagues and I have read; it is a Canadian
perspective on the regulation and supervision of investment funds. You also
have been kind enough to draft a brief opening statement for today. We would
love you to go through the opening statement and then, on the basis of both
your statement and your report, there will be questions we want to ask you.
Thank you very much for taking the time to come down and be with us.
Ms Stromberg: Thank you, Mr. Chairman. Honourable senators, thank you for
inviting me to appear before you today in connection with your study of the
governance of institutional investors. I am delighted to know that you are
familiar with my report, Regulatory Strategies for the Mid-'90s --
Recommendations for Regulating Investment Funds in Canada, and that you have a
copy of the paper I prepared for the OECD last summer.
I have not prepared a formal submission today because I was not sure which
aspect of my work and thinking would be most helpful to you. The reason I say
this, because I do know you are looking into governance issues, is that I
believe that most of the observations and recommendations that I have made in
both papers are integral elements of effective corporate governance.
These observations and recommendations relate to regulatory structure,
organizational structure, competency, fair practices, adequate resources,
effective oversight, a legislative structure that supports fairness and
equality of opportunity, integrity of the people and firms who are authorized to
provide advice and investment services to others, integrity of the product and
services offered, effective oversight and monitoring of activities, and speedy
action to deal with problems and to keep them from reoccurring. These are all
essential elements of good governance. All of these elements need to be
present, integrated, and working effectively in order for there to be good
I will try to answer your questions today. I would be pleased to follow up on
any aspect that you would like. I should emphasize at the outset that anything
I say is said in my personal capacity and not as a Commissioner of the Ontario
Securities Commission. My views are my own, and are not necessarily shared by
the commission or anyone involved with the commission.
Let me highlight some matters that I believe are particularly relevant to your
study. First, I would like to talk about what I call the changing face of the
institutional investor. I think it is important to recognize this changing
face. It is important to recognize that the lines between so-called
institutional investors and the retail investor have blurred, as institutional
investors increasingly take on the management of money in a representational
capacity for individual investors rather than for their own account. In this
representational capacity, their authorization to continue to manage such money
may be terminated on relatively short notice or, in some cases, no notice.
The individual consumer investor who invests in a mutual fund or participates in
a defined contribution plan has a direct ownership interest in his or her
investments that fluctuates according to the market value thereof, as opposed
simply to having a contractual right to receive an agreed-upon payment at a
stipulated time. The individual consumer investor who holds his or her
investments either directly or through some sort of collective investment
vehicle is in direct competition with the institutional investor who invests
for its own account.
The secular shift in household savings that has occurred in the last ten years
from deposit-type instruments and life insurance to other types of investments,
with mutual funds being the investment vehicle of choice, has resulted in the
increasing revitilization of the marketplace. In other words, it is no longer
appropriate to think of the marketplace as being divided simply into the retail
market and the institutional market. The marketplace has become an individual
In this marketplace, it is important that the regulatory and supervisory
structure not favour the institutional investor over the individual consumer
investor, who is traditionally referred to as the retail investor. From the
regulatory and supervisory perspective, the fact of whether an individual holds
an investment interest in underlying securities directly or through some sort of
collective investment vehicle should make little difference. These themes are
developed in more detail in my OECD paper, and I have made several suggestions
for levelling the playing field.
I would like to talk briefly about the establishment and structure of investment
funds, particularly open-end investment funds, commonly known as mutual funds.
The current regulatory requirements contain few requirements respecting the
establishment and structuring of these funds. There is no requirement for the
investment fund manager to be registered with any securities authority in order
to establish and operate investment funds. In addition, there is no requirement
for the investment fund manager to have outside directors.
There are no requirements with respect to minimum regulatory capital, insurance
and bonding coverage, management resources, competency and proficiency of
personnel, adequacy of internal systems, controls and procedures, or procedures
for monitoring the same. In addition, there is no requirement in the case of
investment funds sponsored by the investment fund manager for the sponsored
investment funds to have independent boards.
It is important to keep in mind that the manager and trustee of the fund usually
are of the same entity, are affiliates of each other, and that the manager,
trustee, and its affiliates provide all requisite services to the mutual fund
on terms that, for the most part, are unilaterally imposed. Coupled with this
is the fact that most mutual funds in Canada are, for tax reasons, structured as
trusts and there is no constating legislative structure in Canada for trusts
that is comparable to the constating legislative structure that exists for
corporations. The terms of the trust are unilaterally set by the manager
One needs to consider the existence of prudential concerns in a structure that
permits all of the functions that are required to be carried out in respect of
an investment fund to be carried out by related parties on terms that, in
effect, are unilaterally imposed without there being some degree of review by
unrelated persons as to the manner in which the obligations are being carried
out. In the current structure, no one is considering the fairness aspects of
the structure and the transactions from the sole perspective of what is in the
best interests of the investment fund and its investors. It is no wonder that
there are questions about who is looking out for the interests of investors. I
have, therefore, made specific recommendations aimed at improving the
governance provisions in respect of investment funds. I am sure you will ask me
about them, but before you do, I would like to also talk about another issue,
which is the allocation of costs and expenses.
One of the concerns that has been raised about my recommendations is that they
will add costs and that these will be passed on to the consumer investor. In
the current environment, this is probably true. The fact that this is so might
well lead one to ask if enough scrutiny is being given to the allocation of
costs and expenses between the manager and the managed funds. It appears that
the tendency is simply to pass on costs rather than to take a good, hard look
at one's operations to see if it is appropriate to do so, or to see if there
are not more efficient ways of doing things for less cost.
On Monday of this week, the Investment Funds Institute of Canada released its
proposals for a model code of ethics for personal investing. Hand in hand with
this release came observations from a variety of sources that the manager's
cost of compliance would be passed on to the unit holders of the funds. No one
appears to have asked why the unit holders of the funds should have to pay extra
to ensure that the manager of their fund is fulfilling its fiduciary
obligations to them and is not appropriating investment opportunities that
belong to the funds for its own account. No one appears to be asking how much
of the manager's overhead expenses should be allowed to be passed on to the
unit holders of the funds. No one appears to be asking how much of the manager's
costs of distribution should be allowed to be passed on to the unit holders of
the funds. These amounts all appear in the management expense ratio of the
funds and reduce the amount of the investors' return. In earlier testimony, you
heard how much an investor's return is reduced over a period of years for each
additional 50 basis points that is charged. Therefore, these questions seem to
be legitimate ones to ask.
The answers impact on the ability of the investor to provide for his or her well
being and retirement income. They impact on the shortfall the government may
ultimately be called upon to provide.
Another area that I would like to raise with you is that of voting rights -- an
area that has received little attention in Canada, and perhaps elsewhere -- and
that is the fact that by choosing to pool their investments in a collective
investment vehicle such as a mutual fund, individuals have given up one of the
fundamental rights that flow from the ownership of securities, namely, the right
to vote such securities. Individuals have unwittingly conveyed their voting
power and, by doing so, have placed enormous power in the hands of professional
money managers, some of whom are not independent of other financial and
The committee has already heard testimony about the economic value of the right
to vote. As concerns about concentration of power, shareholder activism, and
the impact of the short-term focus of money managers, corporate managers and
others grow, this is an area that can be expected to give rise to calls for
change. I think we need to be giving some thought about how to deal with voting
rights. At the very least, I think fund managers should clearly articulate their
policy with respect to voting, and if they deviate from this, explain why in
their annual and interim reports to investors. In any event, I think that the
economic value of the vote should unequivocally belong to the fund.
I hope that what I have said is relevant to your deliberations. I will be
pleased to answer your questions and to amplify anything that I have said.
The Chairman: Thank you very much for being your usual thorough and provocative
self. It is hard to know where to begin since you have raised many questions. I
will begin at the end of your presentation, and work backwards.
Leaving aside the voting issue for a minute, just so that I understand, the
mutual fund expense ratio business is essentially a cost-plus business. Is that
not essentially what happens, that as expenses go up, they all get passed on to
From a management standpoint, the drive for efficiency in the way the fund is
operated is effectively not there. Is that a fair characterization of the
Ms Stromberg: I think every manager will tell you that they are very sensitive
to the costs that are passed on.
The Chairman: They are not so sensitive that they do not pass them on.
Ms Stromberg: That is correct, they are not so sensitive that they do not pass
them on. There are critics of the structure who say that there really is not an
incentive to pay close attention to what is happening.
The Chairman: Do you agree with those critics?
Ms Stromberg: Yes. I have also been hearing many suggestions from people that we
should be looking to a structure where you have an all-in fee, so that you
declare right up front that, for 1 per cent of the net assets under
administration, the fund is provided with all investment advisory services and
other services that are required in order to operate. That used to be the way
many funds were structured. That changed probably back in the 1970s.
The Chairman: I would like to finish on the cost issue. The cost structure is
typically given as a percentage, as you put it a minute ago, of the funds under
management. Is that correct?
Ms Stromberg: Correct.
The Chairman: You have looked at this business much more than the rest of us
have. Is that a reasonable measure of the amount of effort involved? What I am
really asking is: If you have $1 million rather than $100,000 of someone's
money, does it really cost you ten times as much to manage, which is what the
formula would now imply, or is it the case of a business in which there is
basically kind of a fixed cost for managing anybody's money and then a
proportional cost beyond that but that the proportional cost is not uniform
over the whole range?
Ms Stromberg: Your statement is correct, senator. However, people with large
amounts of money are able to negotiate a lower percentage of their net assets
The Chairman: It is a linear function, but it is a different slope.
Ms Stromberg: That is right.
The Chairman: You said in your opening remarks that your paper contains have
suggestions for improving the governance. You said you had some specific ones.
I assume they are the ones that begin on page 8 of your European paper. Is that
Ms Stromberg: Yes, you are absolutely correct.
The Chairman: I know my colleagues will want to ask you a number of questions
about those. I have not had time yet to review in detail the IFIC guidelines
that were released earlier this week. Could you explain how their proposals and
your proposals differ or coincide?
Ms Stromberg: I am at a disadvantage in that I only received their code late
yesterday. I have not read it. In general terms, they were pretty close to the
recommendations that I have made. They made a serious effort to address the
My basic concern with the draft that was released about a year ago was the
proposal that fund managers who retained investment counsel from outside the
country would not make sure, as part of their due diligence process and a term
of their contract, that these outside portfolio managers were adhering to a
strong, comparable code of conduct. It seemed to me that by outsourcing your
investment advisory services to a portfolio manager that was not subject to the
IFIC guidelines, that you could perhaps avoid compliance.
The Chairman: Let us take it for the moment that you are fairly happy with the
IFIC guidelines, after you have had an opportunity to review the IFIC
guidelines -- which I assume you will as part of your work with the federal
government. It would be helpful to hear from you as to your assessment of them,
where they coincide with your proposals and where they do not, and if they do
not, to what extent -- whether it is a serious breach or just a marginal
Ms Stromberg: I will get back to you on that.
The Chairman: Let us make the assumption for the moment that, by and large, the
IFIC guidelines meet the objectives you have set out in your previous work. As
I understand it, the IFIC guidelines are to be guidelines in much the same way
that the corporate governance provisions of the Day report are guidelines. Is
Ms Stromberg: That is correct.
The Chairman: It is not proposed to legislate or impose a legally binding
regulatory scheme around the guidelines, is that right?
Ms Stromberg: IFIC has not requested that the securities authorities in Canada
make these into rules and regulations.
The Chairman: In your view, is that the right way to proceed or not? Let me give
you some background that has come up in the course of these hearings, as well
as the fact several people on the committee sit on corporate boards. The beauty
of the Day report was that the one regulation that was imposed was a regulation
that required that people report to the board on whether or not they were
sticking to the guidelines. The guidelines are not law. What is law is the
requirement that you report your performance or lack thereof in relation to the
The impact of that on the behaviour of directors has been quite profound. It
turns out that the fear of embarrassment, the fear of your peer group thinking
you are not living up to the spirit of the guidelines, has had a profound
effect in changing behaviour. In other words, behaviour changed not because
behaviour was forced to change but because of the fear of exposure that
behaviour was not changing.
With respect to the IFIC guidelines and your proposals, do you not need at least
the use of embarrassment as a regulatory tool, even if you do not go all the
way to formalizing all of the guidelines in regulatory form?
Ms Stromberg: I think embarrassment is a most effective regulatory tool in this
particular situation. There is nothing that will negatively impact a fund
manager more than suggestions that he or she has not adhered to that code.
The Chairman: What is the legislative or regulatory change that is required to
put the power of embarrassment in place? I ask you this question because you
are a lawyer and I am not.
Ms Stromberg: I am not exactly sure what is required, if anything. It would
probably be just a requirement that there be a report to unit holders and/or to
the commission, if we do proceed with the registration of investment fund
managers, as to their compliance with the code and if they have not complied,
what requirements, to be specific, and an explanation. This would be a
requirement similar to what was put in place in relation to the Day report.
The Chairman: We had fascinating testimony Tuesday night from the Governor of
the Central Bank of New Zealand on exactly the same kind of process, in the
sense of the regulations that are now required of financial institutions, banks
in particular, in New Zealand in terms of what directors must sign off on with
respect to risk profile and so on. My colleagues can correct me if this is an
unfair interpretation, but the governor's view seemed to be that the real
impact of the new regulatory scheme there was not so much that the public was
that much more informed but that it radically changed the behaviour of
management and members of the board. It was important to them that they look
good in relation to the information being published, and that, in turn, really
tightened up the management structure. In some sense, the by-product was, in
fact, far more valuable than the original designed intent, which was caveat
emptor public communication, consumer awareness.
Ms Stromberg: I am a strong supporter of that type of "regulation,"
The Chairman: Would it be an OSC regulation that would be required in order to
use what we are now referring to in shorthand as the power of embarrassment? Is
it a federally legislated change?
Ms Stromberg: It would be a matter of provincial law at this stage.
The Chairman: The entire investment fund industry is provincially regulated.
What happens with investment funds, mutual funds, if you like, that are owned
by federally incorporated insurance companies or banks?
Ms Stromberg: They have to comply with the provincial securities laws.
The Chairman: They have to comply, but if there were federal laws in that area,
they would have to comply with those as well; correct?
Ms Stromberg: They would have to comply with those laws as well.
The Chairman: Could one, at least in the federal jurisdiction, impose what we
are calling the "power of embarrassment" guideline on funds managed
by federally incorporated financial institutions, such as the big insurance
companies and the banks?
Ms Stromberg: I believe that the federal government could.
The Chairman: If it did, would that be likely to spread to provincial
jurisdictions or not?
Ms Stromberg: I would hope they would work in parallel. It would be important
that the provinces have comparable requirements because not all fund managers
are owned and operated by federal financial institutions, not yet, anyway.
Senator Tkachuk: I would like to have your help with the structure of the funds.
You bring this up on page 3 of your presentation. You mention that current
regulatory requirements contain few requirements respecting the establishment
and structuring of these funds. Would you explain that further? I think I know
what you mean, but I am not completely sure.
Ms Stromberg: Most mutual funds in Canada are structured as trusts. Trusts are
created by somebody. In the case of a mutual fund, it is the trustee making a
declaration of trust, which is just like a written document that sets out the
terms of the trust.
Senator Tkachuk: It is saying that he is not going to take the money and go on a
holiday with it.
Ms Stromberg: It is saying that he is going to collect the money from investors,
hold it in trust, and use it to invest in a certain manner. The point I was
making on page 3 it is the manager who decides what goes into that trust
indenture and what does not. This is as opposed to, in the case of a
corporation, while you have a fair amount of freedom as to what provisions go
into your articles of incorporation, they are all structured under a
Corporations Act that has certain parameters in it.
The point I was trying to make is that there is no overall constating
legislative authority for the creation of what is often referred to as a
business trust. It would be advantageous if we did have that type of business
trust legislation for what, in effect, are business trusts as opposed to private
personal trusts that you establish under a will or to look after your family,
Senator Tkachuk: When a mutual fund wants to set up a new fund, if they want to
set up an international Far East fund that invests in Asia, for example, or
Europe, or whatever, and they set it up as a separate fund, is that separately
registered? How does that work? I have an account with a mutual fund. Take me
through my account. If I put money into one particular account, say a foreign
investing account, but it is all with Templeton, are there separate trusts for
each account or do they all operate under one trust?
Ms Stromberg: It varies; you have to look at each specific situation. It can be
done either way. In the case of Templeton, I understand they have separate
trusts for each separate fund. Other organizations have an umbrella-type trust
indenture that creates separate and distinct pools of assets that are used to
invest in a specific manner. For example, Far East funds or Canadian growth
funds are dead instruments but they legally are constituted as separate trusts.
They have to be, in order to get the benefit of the flow-through provisions
under the Income Tax Act for a trust; but they could be set up under a
umbrella-type trust instrument. That does not really matter.
I omitted to mention one thing about what does affect what goes into the trust
indenture, which is that National Policy 39 of the Canadian Securities
Administrators does have some parameters for the standards which must be met
for a mutual fund that is offered to the public.
The concern is that not all mutual funds are offered to the public, and National
Policy 39 does not purport to be a complete statutory legislative structure for
Senator Tkachuk: Does each of the individual funds within a mutual fund have a
separate board or is it one umbrella organization and then each manager manages
Ms Stromberg: Usually, the manager is the same person managing several funds and
there is no board of directors or board of trustees of the separate funds.
Senator Tkachuk: When they set up a new fund, management decides who will manage
Ms Stromberg: That is right.
Senator Tkachuk: The required expertise is hired, and then things proceed from
Ms Stromberg: Yes. The manager has a very high standard of care and legal
obligations in relation to the fund. The manager has what is referred to as a
fiduciary obligation to the fund. I do not want to leave you with the
impression that it is the Wild West. It is not. These funds are usually
unilaterally created -- it is not like a negotiated transaction -- so there is
not someone representing the fund separate and apart from somebody representing
Senator Tkachuk: You also say earlier on in the first part of the paragraph that
there are few requirements respecting the establishment and structuring of
these funds; in other words, that it is not that difficult a business to get
Ms Stromberg: That is correct.
Senator Tkachuk: A Bre-X situation should never have happened against all of
these regulatory requirements, but it did happen. My concern is that, sooner or
later, a similar situation will happen in the mutual funds. What is of concern
to me, and I am sure to other members of the committee, is that there is this
tremendous flow of money into mutual funds. I bet all of us here have an RRSP. I
do not have a clue what I pay in fees in each one of them <#0107>
frankly, I do not believe that most people know what their fees are. In a bank,
everybody knows what interest rate they are getting; everybody knows that if
they put in $2,000, they will make so much money. Most people look at what they
make in a mutual fund. There is a tremendous inflow of money coming in.
The Chairman: To support Senator Tkachuk's point of view, somewhere in the last
month I saw a public opinion poll of mutual fund investors. Somewhere in the
order of 60 per cent did not know that they had paid any fees at all. It was a
Canadian study; it was not a U.S. study. It reinforces exactly Senator
Senator Kenny: Mr. Chairman, I want the record to note that Senator Di Nino said
he knew what he was paying.
Senator Tkachuk: How are most of the organizations set up? For example, are
Templeton and Investors Group public corporations? You can buy stock in
Ms Stromberg: Yes, Investors Group is a public corporation. Templeton in Canada
is a subsidiary of a public corporation, but it is a private company here in
Senator Tkachuk: Is that a conflict? I remember that, at one time, if you bought
stock in Investors, you did much better than if you had mutual funds in
Investors; in other words, the more money you take off the top, the more money
you make for your corporation and the more profitable it is.
Ms Stromberg: Some financial analysts have suggested that you would be better
off buying the manager as opposed to the fund.
Senator Tkachuk: Exactly, which does not say a lot for people who have their
pension funds tied up in a mutual fund.
Ms Stromberg: I do not want to leave you with a completely negative picture of
it. I am talking about potential problems that can result from the lack of, for
want of another word, structural requirements. The fund industry in Canada has
enjoyed a good reputation and the people who have been around from the
beginning are very ethical, highly principled people. You should keep that in
mind. However, there is always the potential for problems. Problems occur when
you least expect them and where you least expect them.
My recommendations are aimed at trying to head off potential difficulties down
the road because people's money is at stake. The assets of the fund are held by
a custodian and they are held in trust and, presumably, that should offer a lot
Senator Tkachuk: I do not want to leave the wrong impression, either. I have
respect for what is, frankly, a fairly unregulated industry that has done very
well. The information they provide in their annual reports is really quite
detailed. They are on the market. You can always check. If you wanted to, you
could actually find out the value of your fund from a newspaper every day.
Everything is quite public and open, except for the mystery of how they run.
People know a lot about banks but they know little about mutual funds, and
there is a lot of money flowing in. I am asking these questions to try to get a
Ms Stromberg: These are good questions, and I understand the context in which
you are asking these questions. The record always sounds as if we are painting
such a gloomy picture.
Senator Di Nino: I want to continue on this line of questioning, but before I do
that, I want to ask you about the role that competition plays, particularly
competition with full disclosure, in making sure that the game is played on a
level playing field.
Ms Stromberg: I really do not know how to answer that question.
Senator Di Nino: Let me be more specific. The question was about a lack of drive
for efficiency. I think there was a comment made about fees being passed on, so
you do not really have to worry about what you are charging the client. I
suggest to you that there is a role that full disclosure in a competitive
manner plays in making sure that those fees are not exorbitant or that the
client at least has an opportunity to assess one opportunity versus another.
Ms Stromberg: Competition is a very important factor to the fund industry. If
you read the first chapter in this report, it will illustrate to you the
pressures that competition brings to bear on performance and on the pressure to
gather assets that leads to what I characterize as questionable sales
Competition also leads to pressures to make sure your performance stays up there
because that is reported on a daily, weekly, and monthly basis in all the
newspapers, with the best-performing fund of the hour and the worst-performing
fund of the hour. No manager wants to appear in a negative light. Sometimes
that leads to waiving fees, absorbing fees, if your problems can be handled that
way. Other times, it relates to buying what are really illiquid stocks and
trading them back and forth to create the appearance of a market value and to "juice
up" the returns. Competition is a very interesting factor in the fund
Senator Di Nino: Let me go back to my colleague's line of questioning. If I
understood your comments on page 3, you are telling us that entry into the
industry, the requirements, the rules and regulations, are not there to weed
out potential bad apples.
Ms Stromberg: That is right.
Senator Di Nino: Are you saying to us, in effect, that maybe some of the energy
and effort which is being expended in the creation of the regulations should be
directed towards creating an appropriate set of rules with the ability to
properly investigate the entrance into the industry?
Ms Stromberg: I think that people who want to enter the industry should have to
demonstrate their ability, competency, solvency, and resources to do so.
Senator Di Nino: You are saying that that is not the case these days.
Ms Stromberg: That is not the case these days.
Senator Di Nino: What are we doing about it?
Ms Stromberg: I will be indiscreet and say "not much."
Senator Di Nino: Are we wasting too much time on trying to close the barn door
after the horse is out in the field? Should we be directing some of our
energies towards earlier intervention, if you wish, in the process?
Ms Stromberg: Yes, senator, we should be, in my opinion, which I have been quite
vocal in expressing.
Senator Di Nino: I understand that. One of the reasons I am raising this is to
put it on the record, because I happen to agree with you. The problems are
generally created because there is not enough investigation and not enough
attention paid to the players involved. By the time the problems appear, an
enormous amount of energy has to be expended in trying to solve the problems; in
other words, in putting out the fires instead of creating an environment where
fires would not start. Am I correct in that assessment?
Ms Stromberg: You are correct in that assessment. The whole thrust of my
recommendations is aimed at doing what you can do to prevent the problems from
occurring in the first place.
Senator Di Nino: Do you have an opinion on the creation of a national regulatory
Ms Stromberg: I am a very strong advocate of a strong, centralized, single
regulator. That is one of the core recommendations in this report. Perhaps
naively, I saw it as coming about through provincial co-operation. I was trying
to find a way to avoid becoming involved in a constitutional issue if we could
do it without a constitutional change. I still have hopes that we will
ultimately come to this. I think it is very important, and not only in Canada;
I think we have to look at linking internationally with other regulators and
find a way to have, in effect, an international securities regulator.
Senator Di Nino: Do you think we should have a national body, at least to the
degree that we can, even if not all the provinces or territories would agree?
Ms Stromberg: Yes. There are many different elements of agreements. Even if you
cannot get everybody to say they are agreeing, often their actions are
coordinated so that you have effective agreement.
Senator Stewart: We have had various questions concerning the fact that costs
are not adequately restrained because they are simply passed on to the
investor. Then it has been said that there is a great deal of competition in
this field, and that information is available regularly as to how the various
funds are doing. My question is not a very profound one, but one I want to ask
anyway. How much churning takes place in the area of investment? We see a whole
page in the paper devoted to the daily standing of funds. This might lead the
person from Mars to assume that, the next morning, there would be a great deal
of movement of money. How much, in fact, does take place?
Ms Stromberg: I do not know, senator. I am not sure that anybody has done any
survey or compiled any statistics on this. Anecdotally, you hear of people who
look in the paper and decide a certain fund has done so well that they should
be in it, so they will sell another fund and chase after the star of the
moment. How much of that happens, I do not know.
Senator Stewart: The fact that you do not know suggests that competition and
information may not be all that important in the field; that someone buys into
a fund, puts the documents away and forgets about them for several months
because they have other things on their minds.
I want to come to quite another area. This is the one that Senator Di Nino was
exploring. I will read you a sentence or two just to tie my question back to
your original statement. You said that there is no requirement for the
investment fund manager to be registered with any securities authority in order
to establish and operate investment funds. Then you go on to additional
considerations that are related to that.
The question that I put down when I read that comment was "Why?" I
want to compose an answer and see if you agree. This particular industry got
under way and has flourished in a period of peace and prosperity. Let us say we
were to revert to conditions comparable to those of the early 1930s, when there
presumably would be disasters, at least as perceived by the investors. Is it not
the case that there has not been a perceived need for the registration and then
the various other requirements to which you refer on page 3 of your written
statement and that, given the belief in the adage "if it ain't broke,
don't fix it," politicians are not very likely to move?
Ms Stromberg: That phrase has often been used in relation to the investment fund
industry. I hope that the people who use it are right. I am concerned that they
may not be right and that, at some point, something is going to happen that
will prove the vulnerability of the fund industry to the absence of an
effective structural framework.
I am not a great advocate of detailed, minute regulation, but I think we should
be addressing what I call the structural issues. We should have an investment
fund statute that will, among other things, recognize the validity of the
business trust and have appropriate constituting requirements. I think we need
to have requirements for the registration of managers which take into account
having adequate capital, insurance and bonding coverage, et cetera, the points
I mentioned there.
I should clarify that, for anybody who is going to provide investment
counselling and portfolio management advice to the fund or to any other entity,
the person does have to be registered. Many of the mutual fund managers, who
also act as portfolio managers, are registered in that capacity with the
various securities commissions. However, the capital requirements and the
insurance and bonding coverage, and things of that nature, are very minimal. I
think we are talking about $5,000 as a minimum capital requirement. There is a
formula, but it bears no relationship to the magnitude of assets under
Senator Stewart: Am I correct in believing that you are talking about the
Canadian industry? You are not talking about the North American industry.
Ms Stromberg: You are correct, senator.
Senator Stewart: Is the situation better in the United States?
Ms Stromberg: Yes, I think it is, in some respects.
Senator Stewart: Mr. Chairman, I am going to ask a variation of a question I
asked last night. We know that Europe is moving toward the establishment of a
monetary union, and we were told that this is likely to lead to a great deal of
rationalization in financial services in Europe. You mentioned a strong, single
regulator just a moment ago. You talked about linking in with other regulators
-- that there will not be one regulator, but several.
Given the increasing economic integration of Canada with the United States both
in trade and investment, how close are we to the point when knowledgeable
people are going to suggest that there should be a single, strong regulator for
North America in this area?
Ms Stromberg: I think that suggestion has already been made. As a practical
matter, we have negotiated agreements with the SEC.
Senator Stewart: You say "we", meaning Ontario?
Ms Stromberg: "We" is probably the wrong word. The Canadian Securities
Administrators and the SEC have entered into memoranda of understanding with
respect to certain types of securities transactions, so that an issuer that
files in one jurisdiction will be able to offer its securities in another
jurisdiction with minimal requirements. I think that is a good development. It
is the way we are going right now in Canada with the efforts to address the
so-called "virtual commission", which is based on mutual reliance. It
presupposes that people are comfortable with the standards that each separate
jurisdiction has in place and, that they are prepared to rely on the work done
in that jurisdiction.
Senator Stewart: While recognizing the merits of that kind of arrangement, would
you still say that, in Canada, we need a strong, single regulator?
Ms Stromberg: Yes.
The Chairman: I would like to ask a follow-up question to Senator Stewart's
question. When he asked you whether things were better in the United States
than in Canada with respect to the regulatory system, your response was "in
some respects". Then you stopped. I was waiting for you to go on and tell
me in what respects they are better.
Ms Stromberg: Their structure under the Investment Company Act of 1940 is a good
structure. They have business trust statutes. In that sense, I am attracted to
some of the structures that they have in place. However, in Canada, we have
some pretty good regulation in relation to what we require investment funds to
do or not to do. We can improve it, but I would not wholesale want to say we
should opt for the American standard.
The Chairman: Have you listed anywhere in your writings what those improvements
Ms Stromberg: Not that I can recall offhand.
Senator Kelleher: I would congratulate you for what I would call your "ground-breaking"
report. I think it is fair to say that it was not greeted with open arms and
you were certainly not given achievement awards for it. As a matter of fact,
you had to suffer many darts and arrows. However, I think it is a very valuable
report. It was not an easy report to bring forward. Following that report, I am
sure you have suffered a few sleepless nights.
Following up with what Senators Stewart and Di Nino said in connection with the
need for some sort of a national securities commission, it is widely known that
there is a great deal of competition for investment in this area today.
Everybody is competing for investment dollars. That is, of course, one of the
reasons we entered into our trade agreements with the United States, so that all
of the investment would not be attracted to the States, leaving us hanging.
Given the competition out there today for investment dollars, from your studies,
would it be fair to say that a lack of some form of national securities
commission is hurting investment here in Canada or causing problems?
Ms Stromberg: I think the answer to your question is yes, but that is a gut
Senator Kelleher: Is that your short answer: that it probably is having some
Ms Stromberg: Yes.
Senator Kelleher: That is mine, too. It is another reason we need a national
Ms Stromberg: Senators, there is one aspect in what I said to you that feel I
have not brought home. To the extent you give some deliberation to regulatory
structure, there is another point I would to draw to your attention. Today, in
Canada, we have a segmented regulatory structure that is based on the old four
pillars that supposedly disappeared with financial services de-regulation which
started in 1987.
We should be giving some thought to having the regulatory structure match the
integration of the financial services industry instead of having separate
securities regulators, bank regulators, insurance regulators, and trust
regulators, to the extent we still have trust companies. I say this because,
when you filter down to the bottom line, you reach the consumer investor -- each
and every one of us around the table. We all have integrated financial needs. I
think we would benefit if the regulatory and supervisory structure reflected
our integrated needs and just did not piecemeal off into different camps the
different things we need.
Senator Kelleher: We are aware of that because earlier this year OSFI asked our
committee to go to London and take a look at the FSA, where, as you know, they
split those functions off from the Bank of England, gathered in other
regulatory bodies, and they now come under the FSA. They asked us to take a
look at that to see what we thought of their system and whether there was
something there that might be helpful and applicable to Canada.
Ms Stromberg: Did you do it?
Senator Kelleher: We had a nice trip to London, yes.
Ms Stromberg: What is going on there is very interesting. Australia is in the
process of realigning its regulatory structure along that line.
Senator Kelleher: We will be having a teleconference with them within the next
week or so on this subject. Earlier this week, we had a teleconference with the
Governor of the Bank of New Zealand and his people. They are exact opposites:
New Zealand has basic, minimum regulation; and Australia has maximum
Ms Stromberg: I think those are at the leading edge.
Senator Tkachuk:. Are you advocating a centralized structure such as the one
they are promoting in Britain?
Ms Stromberg: Yes.
Senator Kelleher: One of the practices that seems to be becoming more prevalent,
from the evidence that we have been hearing, is both pension fund and mutual
fund representatives approaching the individual companies where they have made
investments and asking for information. In the old days, if you did not like
your investment, you just sold it. That is really not very practical in Canada
today, particularly given the rather thin float we have, partly because of the
20-per-cent rule. That is another area of discussion.
The pension funds and mutual funds told us they are doing this. It seems to some
of us that they are getting information that is not available to individual
investors and shareholders. The companies are religiously telling us they do
not give them anything more than is allowed, that they do not get any inside
information, and there is nothing they would be told that is not available to
the individual shareholder. Quite frankly, I have a little trouble buying that.
If I were the president of a company and the head of OMERS or the Ontario
Teachers' Pension Plan or some of these very large funds asked me for
information, human nature is such I would be a little more open with them than
I would be with, say, Senator Stewart, who comes from the Maritimes and asks a
question about a company in which he has 100 shares. This appears to be a
growing problem. Has it grown to the extent where we should be considering
Ms Stromberg: Yes, it is a problem and, yes, it has grown to the extent that you
should be considering doing something. I would urge you to think in terms of
trying to create a regulatory system that really focused on -- forgive me for
falling into legal jargon -- a continuous disclosure system, where you have a
system that requires, to the extent you could ever require things of this nature
to happen, all of the information that is material to be in the marketplace on
a current basis so that everyone has access to it.
In the OECD paper I talk about this need to equalize the information flow and
point out how we are able, probably for the first time in history, to actually
do something about this with the advances that have been made in technology and
communications. An example is the B.C. annual meeting which was held last week.
Anybody, whether a shareholder or not, could tune into that meeting on the
Internet and watch and hear the proceedings in the same way that they could if
they were physically present.
Companies that talk to analysts are now giving advance notice that there will be
an analyst's call at ten o'clock on a certain day, and if you want to listen in
to this call, you can do it. We have the resources. It is crucial to remember
that information is a major equalizing force. Access to it in an open and
timely manner is the absolute, fundamental ingredient to levelling your playing
Senator Kelleher: I have one final question, Mr. Chairman, on a different topic.
We were discussing fees earlier this morning. As I recall, the evidence we have
heard indicates that the costs of running a pension fund are much less than the
costs of running a mutual fund. If that information is correct, why would there
be such a difference? There seems to be quite a difference in costs between
running a mutual fund and running a pension fund. Am I correct in my assumption
there is a difference?
Ms Stromberg: Yes. They are two different types of investment vehicles but the
amount charged to a pension fund for money management is substantially less
than the amount that is charged to a mutual fund.
Senator Tkachuk: They operate through a tax. Employees send a cheque every month
to the pension fund, while a mutual fund has to go out and get the cash.
Ms Stromberg: I would have called that a "contribution".
Senator Tkachuk: We can call it a contribution, but it is a forced contribution.
They know they are getting the money from so many employees. They do not have
to actually acquire the cash. There is a lot of expense involved in acquiring
Ms Stromberg: You are right, there are not the distribution costs and marketing
costs. I am probably one of the few people left who is concerned about fund
managers charging costs of distribution to the mutual fund itself. They will
say we do not charge costs of distribution; we just have a management fee.
However, the management fee includes at least 1 per cent that is aimed at
Senator Callbeck: I have one question, and it may have been covered because I
was late coming in. I read in Maclean's that the industry had agreed to 80 per
cent of your recommendations. Could you briefly tell me what are the other 20
per cent? Maybe you have covered those.
Ms Stromberg: I did not cover that. I do not know where that 80-per-cent number
came from. The industry is generally supportive of the recommendations but it
is sort of "not now" or "not yet". A lot has not happened
but a lot has happened. That is not really helpful. I never knew where that 80
per cent number came from.
Senator Callbeck: That is true, it has not happened, but I take it from this
that they have agreed, in other words, 80 per cent feel the recommendations
should be carried out. To which ones do they have strong objections?
Ms Stromberg: Nothing occurs to me. At one point, there were objections to
having an independent board. Interestingly enough, in recent meetings with
industry participants, they have been quite supportive. Those that have put
independent boards in place have found them extremely useful.
The Chairman: The fees charged by mutual funds in the United States compared to
Canada are dramatically lower. I presume the costs of doing business are
effectively the same. My question is why is that so? Should we be encouraging
U.S. funds to come into Canada precisely for the purpose of lowering costs?
My other cost-related question would be if the bank mergers go ahead as
proposed, what impact, if any, is that likely to have on the cost structure or
the costs as charged to retail consumers by the industry as a whole, not just
the bank-owned mutual funds? In a nutshell, I am wondering the extent to which
mergers, on the one hand, or U.S. competition on the other, can drive down fees
to levels comparable to those in the United States.
Ms Stromberg: The absolute numbers between Canada and the United States are
misleading in that, in the United States, they tend to unbundle their fees and
so they sound as if they are lower than what they, in fact, are.
The Chairman: I am not comparing apples and apples.
Ms Stromberg: That is right. In the United States, until recently, it was not
common to sell funds on a deferred-sales-charge basis, whereas in Canada that
has become the most common way of selling mutual funds. That raises the cost of
our funds significantly because the manager has to, in effect, pay 5-per-cent
sales commission up front and then pays a trailer fee as well. That adds
substantially to the cost. I am told that the Americans are following our good
example and we are seeing a convergence of the cost of American funds and the
cost of Canadian funds.
As to your second question, yes, I would be in favour of increasing competition.
Costs are only going to come down in Canada if there are low-cost providers
with high-service performance. I would be receptive to opening our marketplace.
To answer your last question about the impact of the bank mergers, I do not
know. Right now, some of the banks have declared that they are going to be the
leaders in lowering the cost of their funds and have announced plans of a
period of time over which they are going to do it. Again, the increasing
knowledge and awareness of the consumer will make a big difference in how much
fees do come down and what the time frame will be.
The Chairman: Thank you very much for taking the time to be with us and for
agreeing to look in some detail at the IFIC guidelines and telling us where
they differ from yours.
I think I have asked you to consider the following question, and if I did not, I
meant to: Recognizing that federal jurisdiction in this area is somewhat
limited, do you think that federal leadership in the area of using the
embarrassment power the IFIC guidelines, or an amended version thereof, in
relation to federally chartered institutions could be a useful first step in
ultimately leading to the spread of that regulatory technique across all mutual
Ms Stromberg: I would be glad to do that. If I can assist you in any other way,
I would be glad to do that as well.
The Chairman: Thank you. We appreciate your being here.
Senators, our second and last witness this morning is Mr. Doug Grant, who is the
Chairman of Sceptre Investments.
Mr. Grant, I notice you have been taking quite detailed notes. I do not know
whether you are going to make a presentation or a presentation-in-rebuttal. In
any event, we are delighted to have you with us. We appreciate you taking the
time to come from Toronto to be with us today. I understand you have a short
opening statement. As you see, after the presentation, we proceed in a
relatively informal way to some quite interesting questions and discussions.
Mr. Douglas Grant, Chairman, Sceptre Investments: Thank you for inviting me. I
do have a short opening statement.
At the outset, I will tell you about Sceptre so that you will be familiar with
my background. Then, I will briefly cover the following points: the
20-per-cent-limit rule; Sceptre's approach to its fiduciary responsibilities;
the private meetings issue`; and the MERs, management expense ratios.
Sceptre is the fifth largest pension fund manager in Canada and the tenth
largest investor manager overall. As near as I can tell, it is about the 320th
biggest in the world. That means there are at least 300 bigger money-management
organizations in the world. We manage $19.3 billion, of which $14.4 billion is
in pension funds, estates, foundations and trusts; $1 billion in mutual funds;
and $1.2 billion in high net-worth individuals. Those start at $250,000 and up.
We manage $2 billion for other organizations, and about $600,000 for insurance
companies. We invest about 97 per cent on behalf of retail investors. For
example, in the pension fund business, we probably manage the savings or part
of the savings of 400,000 or 500,000 Canadians.
The Chairman: Is this through their pension funds?
Mr. Grant: Yes.
We are a public company and have been since 1986. We are the largest Canadian
manager of equities outside of North America. We started in that about 15 or 20
years ago. We are one of the few Canadian companies who have our own capability
in-house. Most Canadian companies did not do that because of the 10-per-cent
foreign content rule, which was then raised to 20 per cent. We did it because
we wanted to understand what was going on in the rest of the world in order to
be good Canadian managers.
The Chairman: Given the fact that you are the largest outside North America, can
you give us some sense of what percentage of your non-North American assets
are, for example, in Europe, in Asia? Just give ballpark numbers.
Mr. Grant: Yes. This is money outside of North America. It would be
approximately 60 per cent in Europe, 10 per cent in Japan, 10 per cent in
Singapore, Hong Kong and Australia, New Zealand.
The Chairman: They are together as a package.
Mr. Grant: Approximately 12 per cent is in emerging markets, of which half would
be in Asian emerging markets and half would be in Latin America.
The Chairman: Thank you. I wanted to get some feel as to whether you were
entirely in Europe or entirely in Asia.
Mr. Grant: We have capabilities in about 40 different countries, and we do it
all from here.
The 20-per-cent rule was originally introduced and still defended, I believe,
because Canada was an importer of capital and there was a feeling, and it was
in the development model of 30 years ago, that these retirement funds should be
kept in Canada and that would produce jobs here. This was never good theory. It
has been discarded in almost every model in the world. The facts have changed,
as you know. Ten years ago, the governments in Canada were raising, that is,
borrowing, $50 billion a year. They are now or will shortly not be raising any.
In fact, they will be refunding.
The Canada Pension Plan will be going into the market for almost $100 billion in
equities over the next five years. This limitation rule can be circumvented by
the use of derivatives, and that is being done. In fact, I was told that the
largest fund in Canada, which is the Ontario Teachers' Pension Fund, is 45 per
cent outside of Canada through the use of derivatives.
The Chairman: That is approximately the number they gave us on this point.
Mr. Grant: This was sanctioned, apparently, by the Department of Revenue. There
are costs involved in this. It can be risky. It is sophisticated, and it is a
technique which is not generally available to the public.
The costs of this rule have been enormous. You have heard testimony that every
1-per-cent-increase in return varies the final retirement package by 20 per
cent. The cost of not being in foreign markets has been enormous in that sense
to Canadian retirees.
It also means that we have not generally developed a community of international
investing expertise in Canada and so, increasingly, Canadian retirement foreign
assets are being managed out of New York, London, Switzerland, and other
countries. I would guess that the fees going to those managers is some $200
million or $300 million annually.
Finally, in my view, Canada should have been, and still could be, an
international financial management centre. We have the basics here. We have the
infrastructure. We have the rule of law. We have the respect of the
international community and we have the defence umbrella of the United States.
We have not developed that community, in part, because of this rule and, in
part, because when the Government of Canada has acted, if anything, it has
discouraged the legitimate centre, which was and still is Toronto because that
is where the critical mass is located. The Government of Canada designated our
international financial centres to be Montreal and Vancouver, which was crazy.
I would recommend that rule be eliminated altogether. A sensible way of doing
that is to repeat what we did the last time, which was increase it by 2 per
cent a year up to 30 per cent, and then remove it altogether.
I would like to turn to Sceptre's approach to its fiduciary responsibilities.
Sceptre has no money of its own. Our entire revenue stream is fees from
managing money for other people. We must invest on behalf of our clients so
that we achieve the highest return possible judged in relationship to the risk
and without regard to our personal views on moral, social or political matters.
That is a legal fiduciary responsibility.
We act for approximately 200 pension funds. We vote all proxies, with the
exception of about five institutions which have reserved that right for
themselves. We employ Fairvest, who I know testified before you. We employ
their proxy service to advise us on any controversial matters.
All portfolio managers with that designation have to be registered, and there
are fairly strict requirements in that regard. All of our portfolio managers
must sign off on every proxy solicitation.
We vote with management, except if there is an issue, and we always vote against
"poison pills" or shareholder protection rights, which we never asked
for. As a matter of rule, we vote against any request for an increase in
options beyond 15 per cent of outstanding shares.
At Sceptre we control $7.5 billion in Canadian equities, which is about 1.2 per
cent of the float of the Toronto Stock Exchange. We hold significant positions
in several companies, and more so because of this 20-per-cent regulation.
We spend all of our waking hours trying to be the best investor we can on behalf
of our customers. We employ the best people we can. We pay among the highest in
the industry. We spend all our time trying to create the right environment for
good investment decisions to be made. In that environment, or at least in that
effort, we are part of an efficient market. By that I mean our efforts help to
make the capital system operate more effectively because we are part of the
process whereby people's savings are directed to profitable investments.
In that process, we have private meetings with companies in which we invest.
These meetings are valuable to us, in part, because we control the agenda and,
in part, because it is important to us to know the character of the people
managing the companies that we invest in. It is important to the companies, and
they agreed to do it because they need to stay in touch with their shareholders
and we are, typically, a big shareholder.
This is a valuable tool to us. We do it not only in Canada, but throughout the
world. These private meetings are very important to us in just the same way as
I am sure private meetings are important to you. Public meetings are also
important, as are financial statements and quantitative analyses. It is one of
the ways in which we try to be a good investor.
I believe you are a bit concerned that in these meetings we get information that
other people do not get. You recognize, of course, that there are legal
requirements on insider information, so that is out of the question. We are
always trying to get information that other people do not get or put it together
in a way that makes more sense. This is part of the market.
I urge you, though, as you think about this issue and think about what to do in
terms of regulation, to think of the benefits that result from these meetings
and also the costs of attempting to regulate them. I urge you not to try to
stop the private meetings. Do not effectively stop them by somehow saying that
if we agree to meet with representatives of a certain company, we have to
advertise that beforehand and agree to meet in a hall that is big enough to
accommodate everybody. It would mean that those meetings would be held in a
different forum. Canada would be out of step with the rest of the world if we
tried to do this.
I would urge you, before you try to protect the retail investor, you try to
understand exactly who that retail investor is. Every retail investor now has
access to a mutual fund or to a money manager. My guess is that somebody who
owns 100 shares is being advised by an investment dealer, and the investment
dealer employs analysts who have private meetings. Also, people have other
reasons for owning shares. Maybe they work for the company or they know
somebody in the company or they are convinced of the success of the industry.
Sceptre has been a public company since 1986. I have been the chairman since
that time and responsible for all investor relations. I try very hard in our
annual report to tell shareholders how we conduct our business and to supply
the information I would want if I were trying to understand our business. We
also have public annual meetings which are announced in the financial press in
advance, and all shareholders are invited to attend. We held the last one about
a month ago, and one question was asked. I pleaded for more questions. There
were no more questions. We then had drinks and food afterwards and I was not
approached for questions.
I think you should encourage formats in which information is made available. I
think you should encourage disclosure. I know that the OSC will shortly be
introducing a rule whereby everyone who has clients who, in total, control 10
per cent or more of a stock has to disclose that, and if there are movements of
2 per cent either side of that, that also has to be disclosed. There is a
growing tendency now for people to have quarterly phone conferences. Glorianne
Stromberg mentioned that. BCE did an Internet show on their annual meeting. I
am sure those kinds of things will grow. I would urge you not to try to stop
these private meetings, but rather to encourage the access to information.
Finally, I will address the subject of fees charged for mutual funds. We went
into the mutual fund business in 1986. Our objective was to charge fees that
were in the bottom 25 percentile of fees charged, and to achieve rates of
return which were above average. We have done both of those things. In fact,
two years ago, we were named the mutual fund company of the year.
I would call our mutual funds an artistic success and a commercial failure. The
reason I say that is because we do charge lower fees. In fact, two of our
biggest funds are in the 85th percentile of fees and we have $1 billion, and
yet Trimark, which started about the same time, has about $28 billion and they
charge quite a bit more than we do. For example, in our balanced fund, our total
management expense ratio which includes our fees and all other fees, is 1.43
per cent. I think the average for balanced funds is about 2.5 per cent.
I think the reason these fees are there is because the buyers do not care. The
reason they do not care is because the rates of return have been so high for so
long. This is abnormal. I have been in the business for 35 years. I want to
tell you I do not trust investment forecasts but I do trust structure, and I can
guarantee you that, in the next 10 or 15 years, rates of return will revert to
more normal kinds of 8 or 9 per cent. Under those circumstances, I think people
will pay more attention.
It is my impression that fees in the mutual fund business are a good deal lower
in the United States. I know for a fact that fees in the pension business are
lower in Canada by as much as 50 per cent. I do not understand that, which is
why we went into the mutual fund business the way we did. The only thing I can
think of is that Canadians like to be advised, because most of these fees go to
the advice or selling function. If you have to pay an advisor a trailer of 1
per cent a year, you have to charge 1 per cent to recover that. We did not pay
anybody anything because we thought that the intelligent public would come and
beat a path to our door. I still have that hope, but it did not happen.
There is complete disclosure of the management expense ratios. Every month they
are listed in the financial press alongside the rates of return, the assets,
the phone numbers, and so forth. When very highly intelligent Canadians tell me
they did not know what the management expense ratio in their fund is, I gasp. I
think some day this will come. I know that many people do not know that they pay
a front-end load or a back-end load, but they should know because it is
disclosed and they are paying it. These are big purchases that people make, and
it is their retirement. I do not think you need to regulate intelligent people
where there is disclosure. Obviously, they have other reasons for doing what
they are doing.
I am surprised that people can charge whatever they want to the fund holders.
Our auditors tell us what we can charge. What we do is we fix the
management-expense ratio and we say we will not go over that. We have
frequently gone over that, in fact, and we pick up the difference.
That concludes my opening remarks.
The Chairman: In talking about your fourth point which was your plea to us that
we should not put a stop to private meetings, you used the word "encourage"
two or three different times in the context of we should "encourage"
disclosure, and "encourage" access to information. Do you have any
idea how we can do that?
Mr. Grant: No, I do not know how you would do it. I think companies are starting
to do it in these phone conferences. I think they will progressively do it over
the Internet. The legislation requires us to have an annual meeting, to report
quarterly, to report material events. I think that those disclosure
requirements are adequate.
The Chairman: My second question relates to the IFIC guidelines. Are you or some
of your employees members of IFIC?
Mr. Grant: I believe we are a member. The reason I say that is because I do not
know how other people operate, but I have an idea of how I would like to be
treated if I were a client. That is how I treat our clients. At every annual
meeting of the shareholders of Sceptre, I say our number one consideration is
our clients. Our number two consideration is our employees. If we treat those
two groups right, then our shareholders will benefit.
Our lawyers tell us if we are anywhere near breaking any law and, hopefully, we
are not anywhere near breaking a law. I have not looked at the IFIC guidelines
which came out earlier this week.
The Chairman: I thought you might not have.
Mr. Grant: I did look at some of those when Glorianne Stromberg came out with
her report. We were generally in agreement with all of them, and felt that we
complied with them. I had a disagreement on one issue.
The Chairman: Was it on a minor issue?
Mr. Grant: Yes. We did not pay trailer fees to anybody. I wanted to start paying
trailer fees to just a few people because I wanted to select who was going to
sell our funds. Also, it is much more efficient to have a relationship with,
say, 12 or 30 people. I believe the Stromberg report recommended, and the
institute picked it up, that if you paid a trailer fee to one person, you had to
pay it to everybody, so we pay it to everybody.
The Chairman: I am quite intrigued by your comment that the charges to pension
funds for managing their funds are some 50-per-cent lower in Canada than in the
U.S. Why is this the case? It is really intriguing when we hear that, even
taking into account Ms Stromberg's observation that a direct comparison on the
mutual fund industry is not apples-to-apples. She said that, in spite of that,
it seems that the U.S. funds are lower than Canadian funds but, on the other
hand, pensions are the exact reverse. Do you know what the logic is there, what
Mr. Grant: I do not know why they pay as much as they do in the United States. I
think they do much more specialty management.
The Chairman: What do you mean by "specialty management"?
Mr. Grant: It means they will hire somebody to run their domestic equities and
someone to run their international equities and someone to run their bonds.
They have many more managers. We are starting into that increasingly in Canada.
It used to be that you had one fee and you ran the whole fund and every part of
it. When you get into specialty management, the fees go up. I think that was the
reason for it in the United States.
Senator Di Nino: You are in business to make money, is that right?
Mr. Grant: Right.
Senator Di Nino: You are trying to create a successful business which delivers a
fair and equitable return to the investors. That is basically your game.
Mr. Grant: Yes. As I said to you, though, and I have written it in the 12 annual
reports and said it at every meeting of shareholders, our first responsibility
is to our clients because, if we did not have clients, we would not have a
business. I think the current terminology is "various constituencies".
You have to make a profit to be in business.
Senator Di Nino: Precisely. One of the matters we looked at this morning is the
regulatory issue as it relates to your industry. How do you distinguish
yourself from your competitors? How do you place yourself? How do you tell the
people out there that Sceptre is a good place to come and put their money in
for the short-term, the long-term, or whatever particular area you want to
emphasize at any one time?
Mr. Grant: There are a variety of markets. In the pension business, it is a
strictly numbers-business and you have to convince about six actuarial firms in
Senator Di Nino: Numbers being returned?
Mr. Grant: Absolutely, rate of return, consistency over four-year periods.
Senator Di Nino: Am I correct that fees really do not play a major role, it is
the bottom line?
Mr. Grant: No, we think fees have to be competitive. You have to charge what
other people charge.
Senator Di Nino: At the end of the day, that is all added to the final figure.
The investor's line is: I will give you $1 million and you give me "x"
Mr. Grant:That is not so in the pension business. I noticed Glorianne Stromberg
said that there is good negotiating power in the pension business. You are
dealing with about six actuarial firms in Canada who place the business, that
is, if you have a pension fund, they will search for the manager, come down to
the three that they think will suit you best and then you make a presentation in
front of the trustees. They are going to consider the fee, and they want the
fee to be competitive.
The more important aspect is the rate of return, and since that is going to come
and go, they want it to be consistent over time, and they want to carefully
consider the chemistry and so forth of your organization.
Senator DiNino: As a trustee of at least three pension funds, or funds that are
invested in that manner, when we put it together at the end, we look at the
return, we add the fee on to the cost, or we deduct a fee or whatever. That is
a component of the total return. How do you get your message across to the
retail investors? Maybe my friend Senator Tkachuk, who does not know what he
pays, should come and talk to you. He told me $250,000 is too high for him.
Maybe you can make a special deal and lower it.
Mr. Grant: As I say, I think we were an artistic success and a commercial
failure. I may not be the right one to ask. Our particular approach was to say
that we would charge lower fees and give better performance. We have done that.
We earned $1 billion. I am not complaining.
You asked how we tried to differentiate ourselves. That is how we tried to
differentiate ourselves. We will stick to that because, over time, a growing
proportion of the market is intelligent and informed and will seek you out.
There is a legitimate role for advice given by financial planners, investment
dealers, and so on. We are now paying those people who sell our funds 0.25 per
cent per year as a trailer fee. The average in the industry is something like
0.5 to 1 per cent. If you had the choice and you were trying to make a living
as an investment dealer, you would sell someone else's fund.
We will stick with the approach of trying to differentiate ourselves by charging
Senator Di Nino: Am I right in assuming, as I tried to suggest to Ms Stromberg,
that competitive forces, together with proper disclosure, are a strong element
of control, if you wish, in the market?
Mr. Grant: Yes, that is perfectly right. The reason the fees have not come down
the way we thought they would must be a combination of the unusually high rates
of return that have been experienced and perhaps people feeling that paying the
higher fees, to the extent they know about it, is worth it because they have
someone that they trust looking after their interests, and perhaps that person
is are an investment dealer or financial planner.
Senator Di Nino: Do you need more or less regulation, or do you need a different
kind of regulation?
Mr. Grant: Do you mean with respect to the management-expense ratio?
Senator Di Nino: With respect to the whole industry, not just related to the
Mr. Grant: The industry has come from $25 billion in 1990 to $325 billion in
March, and there has not been a major catastrophe. I do not think you need
regulation with respect to MERs.
The funds should have directors who look after the interests of the unit holders
in the funds. That is one of the recommendations Ms Stromberg made.
We are a public company. We already have independent directors. Our mutual funds
fall under the umbrella of our corporation. We have that, and think other
companies should have that as well.
I think there should be one regulatory body in Canada. If we want to sell our
funds in various provinces, we must file in the provinces, and we regard it as
a provincial fund-raising measure. It would be much more efficient if we just
sent them a cheque. When we do our annual filings, the lawyer comes in and
literally lines up five papers for each province across the table. We had to get
a new table. Then we sign 50 documents. That is not efficient. It is
mind-boggling. We would prefer to send the province a cheque and sign five
copies with one commission.
Senator Di Nino: Having been involved in that, I have a great deal of sympathy
Are those in the field, those who have entered the field in the last few years,
and those who are entering the field now, qualified to be there? There was some
question in Ms Stromberg's mind. Are we doing an appropriate job of ensuring
that the people coming into your industry have the ability, the qualifications,
and the financial wherewithal to be able to manage other people's money to the
degree that we have seen happen in the last few years?
Mr. Grant:I should know the answer to that question. I know that, in order to be
a portfolio manager in Canada, there are certain stiff regulatory requirements.
You must have completed year one of a chartered financial analyst course, with
five years experience in the field. That part of it is in order.
I am a little surprised to hear that any company can start up with $5,000 in
capital and minimal bonding. That does not sound good to me.
Senator Di Nino: I do not want to put words in your mouth, but I am getting the
impression from talking to different people, including Ms Stromberg today, that
perhaps we should be looking closer at how we qualify people to enter into that
market. Do you have an opinion on that?
Mr. Grant: If she says that is something we should do, then I would agree.
Senator Di Nino: You like her.
Mr. Grant: I have known her for 30 years, and I think she is terrific.
Senator Di Nino: Not everyone in the industry agrees with you.
Mr. Grant: If you want to be an investment dealer, you must be registered. I
would think that, if you want to manage mutual funds, you should be registered
as a company.
Senator Di Nino: I went through a particularly unpleasant experience not too
many years ago where this situation arose. I do not think the rules are strong
enough to exclude people who are not competent, but that is a personal thing.
I do have other questions on the foreign content rule, but I will pass to other
senators and perhaps come back later.
Senator Stewart: Mr. Chairman, my questions are not at the centre of our focus.
If Senator Di Nino has questions which are, I think you should see him.
The Chairman: Senator Stewart, I would like you to go ahead. Time is passing. On
the foreign property rule, Mr. Grant was very clear. He would like to have what
this committee has recommended for a decade, which is that we move the foreign
property rule up at 2 per cent a year for five years.
Mr. Grant: I know you recommended it.
The Chairman: We recommended it. It is not a partisan question. This committee
has unanimously recommended it to both Conservative and Liberal Ministers of
Finance, with the same lack of success. That does not mean we are not right,
just that sometimes we do not get our own way.
Senator Stewart: Mr. Chairman, last night a witness commented on the effect of a
fund manager's concern for short-term results on a particular industry. It
happened to be the oil and gas industry. The impact of those short-term goals
was deleterious as far as that industry was concerned, in his view.
Given the new importance of institutional investors, and given the emphasis
which inevitably they put on getting a good return, have you any concerns for
the long-term impact of this form of investment for the economy in general? Are
we building flimsy houses rather than economic structures that will be good for
Mr. Grant: I recognize that some institutional investors are just interested in
short-term results. However, one of the questions you are considering is the
power of institutional investors and that power being exercised through their
holdings of significant blocks of stocks of any one company. The flip side to
that is that, if you hold a significant block of stock in a company, you cannot
trade it easily. The implication is that you better try to ensure that the
company does well in the long term.
If you are a worthwhile corporate executive and a fund or an institution comes
to you and tries to make you do something which is not in the long-term
interests of the company, you should resist. To the extent that institutional
investors are becoming bigger and more powerful, I would think the weight of
the total structure of the industry, if anything, would lead to longer-term
Senator Stewart: I could ask more questions on that issue, but I think we have
the thrust of your thinking.
If I understood you correctly, insofar as your investments outside North America
are concerned, 60 per cent, or the greater part, are in Europe.
Mr. Grant: Right.
Senator Stewart: Would it be indiscreet for you to tell us how much of that is
in the United Kingdom and how much in Ireland?
Mr. Grant: It would not be indiscreet. I cannot remember. At least, I do not
have that information. It is in the report to our unit-holders. I do know that
it is not an undue weighting. We have investments in Switzerland, France and
Senator Stewart: I ask that because in the Standing Senate Committee on Foreign
Affairs, we were told by a man from the Bank of Canada that Canadian investment
in Europe was, to a very great extent, in the U.K. and in Ireland. We were
particularly interested in Ireland because it exports a great deal to the U.K.
Yet, the U.K., unlike Ireland, will not be in the monetary union. I was trying
to get information at this public meeting.
Mr. Grant: I cannot speak for other people, but I can tell you categorically
that we are not concentrated in the United Kingdom and Ireland.
Senator Stewart: That being the case, has the percentage of your investment in
Europe changed to any extent by reason of the forthcoming realization of the
Mr. Grant: Yes, it has increased.
Senator Stewart: You think it will be good for business in the member states.
Mr. Grant: Absolutely.
Senator Stewart: Would you tell us why? I know it is a very complicated answer,
but can you give us one or two points?
Mr. Grant: I will give you a simple one. If you started off with $1 in France a
year ago and changed your currency 11 times, you would come back with 50 cents.
Senator Stewart: Should we apply the same model in North America?
Mr. Grant: I think to a large extent we have that model in North America. I wish
we had it more in Canada, in the sense that I would like to see barriers
removed between provinces. However, I think Europe is trying to move to where
Senator Di Nino: That is interesting.
Mr. Grant: This increase in European investment is not just because we think the
EMU will work. Companies in Europe are already beginning to restructure and
become more shareholder conscious, and do the things that American companies
have been doing for 10 years. That is the reason we are investing in large,
international companies, generally headquartered in Europe.
The Chairman: Do you think the so-called "efficiency mergers"
happening elsewhere in the world will now start to happen in Europe?
Mr. Grant: I think they happened first in the United States. They are already
happening in Europe, and hopefully they will then move into Japan.
The other day someone said that the Japanese do not have a word in their
language for "shareholder orientation", but they are developing one.
Senator Callbeck: You mentioned your use of proxy voting, and that you sometimes
meet with the management of companies in which you invest. Do you believe that
you have a lot of influence on the corporate governance of these companies? If
the answer is yes, could you give us an example, without using names, of where
you feel you have had an influence?
Mr. Grant: I am not sure how much influence we have had. The classic case was
Canadian Tire. What happened there was that Fairvest -- or before Fairvest,
Bill Allan -- organized a group of shareholders. We were very active in that.
Not a meeting goes by where our portfolio managers do not make a suggestion. We
are opinionated, and we ask questions and make suggestions. I do not know how
many of these are accepted. However, we will tell a company that we think they
are doing a good job in one area and a bad job in another. We will also fill
them in on any information that we have heard about their company. Sometimes we
have influence, but most of the time we do not.
Senator Callbeck: The other question I have relates to fees. Obviously you have
the lowest fees. There seems to be a great deal of difference between your fees
and your competitions' fees. Why is there such a gap?
I take from what you say that you believe that, eventually, Canadians will
become educated and realize what they are paying in fees. That, I think, is
quite a piece down the road. Meanwhile, you are losing a lot of money. Why are
you not more concerned about the bottom line?
Mr. Grant: How should I answer that?
The Chairman: Carefully.
Mr. Grant: I do think these fees will come down. We have been waiting for 12
years. Some of the banks say they will lower their fees. I think there is more
and more press about this, and more people are talking about fees. It certainly
is in the public domain. It is in the financial papers every month.
I think the rates of return achieved by funds will be more normal, which means
quite a bit lower than they have been. When that is the case, people will look
more carefully at the fees.
For example, we have had a management-expense ratio on our bond fund of 1.25 per
cent for the last 10 years. Ten years ago, bonds yielded 18 per cent. They now
yield 6 per cent. At our last annual meeting, we reduced our MER from 1.25 per
cent to 0.95 per cent, and we announced it to all our shareholders. We think
that when investors realize they will not get the big returns on bond funds
they will pay more attention to the fees. I expect that to happen.
The Chairman: Thank you for taking the time to be with us. We appreciate your