Eavesdropping on the wealthy

Ever wonder how the rich get richer? By demanding value for their investment dollar

BY KELLY RODGERS

WHAT ARE THE INVESTING SECRETS of the rich? Do they know something we don't know?

In some ways, yes. For the past six years I have earned my living by advising people worth $1 million to $5 million. My job is to help these rich clients search for investment managers who meet their needs.

As far as I can tell, the rich don't necessarily have any special insights into what stocks are going to soar. But what they do have is the confidence to apply a systematic, commonsense approach to managing their money. The good news? You can apply many of the same techniques to your own portfolio, no matter how big or small.

The first investing secret of the rich is that they demand value for their money. (How do you think they got to be rich in the first place?) The're not willing to pay more for investment services simply because they find a particular adviser to be charming or personable. Nor do they chase after the hottest manager or the most publicized fund. Instead, they go shopping for the best combination of low fees and consistently good performance. Many rich clients flock to no-load fund companies such as Phillips Hager & North Investment Management Ltd. in Vancouver or Bissett & Associates Investment Management Ltd. in Calgary. Both firms have excellent longterm results and lower-than-average fees.

Those savings in fees can be very significant. Small investors typically pay 2% or so of their mutual fund assets every year for management expenses. People who choose mutual fund VIW programs, which bundle together many services for a single fee, pay more than 3%. But at firms like Philips Hager & North, people who have $500,000 or more can get a managed portfolio of funds for less than I%. Over several years, the savings in management fees are enough to pay for a new Mercedes.

While you may not have a $500,000 portfolio, you and your spouse may have more than you think in combined household registered and non-registered assets. You may be surprised at how much you can save by applying a bargain-hunting approach to your own search for investment expertise. Take a close look at what a mutual fund or investment program is charging you, both in up-front fees and in deferred charges, as well as in ongoing expenses (you can check on the ongoing expenses by asking for the fund's MER, or management expense ratio). Compare that total with what other funds or programs are charging. In many cases, cheaper is better. Especially with bond or money market funds, there's little scope for one manager to radically outperform another. The less you're paying in fees, the better.

Of course, low costs are just part of the picture. The second investing secret of the rich is that they approach investing like a business. They set up a business plan, establish annual targets, then analyze the results. They treat their advisers like employees, not friends.

When clients come to me, the first thing I do is help them draw up an investment policy statement. This document clearly states who they are, their objectives and their tolerance for risk. It also states what they are hiring an investment manager to do, and what constraints will be placed on the manager.

In addition, this document clearly outlines how the manager will be judged. This is the third investing secret of the rich: they have reasonable expectations, and they regularly judge managers based on bow they measure up to those expectations.

The key to measuring performance is setting relevant benchmarks. Let's say, for instance, that one of my clients wants a balanced portfolio with a bias toward foreign equities. We might set up a theoretical benchmark portfolio composed of, say, 35% flxed-income investments, 40% foreian stocks and 25% Canadian stocks.

We then monitor how this benchmark portfolio would perform if it simply matched the overall performance of the markets as tracked by such indicators as the ScotiaMcLeod Bond index, the Toronto Stock Exchange composite 300, the Standard and Poor's 500 and the Morgan Stanley EAFE indices. You can think of this benchmark portfolio as the idiot's portfolio: it represents what would happen if the manager simply bought all the stocks or bonds in a market index and never made an asset-mix or security-selection decision.

If a money manager caift beat the performance of the benchmark portfolio over a reasonable period of time, that manager isn't adding any value. Pretty soon, my client is growing uncomfortable. And pretty soon after that, the manager is no longer looking after my client's money.

Small investors can use benchmarks to help guide their own investment decisions. I'm always surprised by the number of people who buy into funds based upon a quick scan of some seemingly impressive results. Instead, they should ask how the fund has done in comparison with the appropriate market index over the same period. Sometimes funds that look like super buys are actually average or below- average performers when you compare them with the index.

Benchmarks are also useful in establishing what long-term gains you can expect from your entire portfolio. The median performer among balanced pension portfolios returned almost 7% in i998 and just over 11% annualized during the previous five years. That suggests that a 10% rate of return is a realistic long- term target for most balanced portfolios. If you're falling short of that figure, it's time to reconsider your approach. You may want to seek expert advice or simply reassess how your assets are allocated. Conversely, if your portfolio is returning much better than 10%, you should also think twice. High returns usually mean high risk. While it may sound strange to criticize double-digit gains, those who achieve stellar results are often embracing more risk than they realize. If you've been riding a wave of big returns, you should ask yourself if you're comfortable with the prospect of a highly volatile portfolio. If not, you may want to consider a more conservative asset mix.

Most investing secrets of the rich are nothing more than a combination of basic common sense and knowledge. The difference between the rich and the rest of us is that they have the self-confidence to stick to the basics and to find out what they need to know. They don't get caught up in the theory of the week or the trend of the month. It's an approach that's easy to articulate but difficult to follow.