How much expertise is too much?

Wrap accounts offer layers and layers of management-but at a hefty cost

Kelly Rodgers, MoneySense June/July 2000

IF YOU HAVE $250,000 OR MORE in your RRSPs and investment account, your financial planner or stockbroker is likely to be extolling the virtues of wrap accounts. Should you listen? Well, that depends. In most cases, I think wrap accounts are the Ricky Martin of the investment world-superficially appealing but, in the end, much ado about nothing.

In a limited range of circumstances, you may find that wrap accounts actually do deliver value. If you're the director of a nonprofit organization, or if you're acting as the trustee for your great aunt's estate, a wrap account can give you peace of mind. But you have to know the right questions to ask.

Wrap accounts get their name because they "wrap" all the various aspects of investment management into a single package. You pay a single fee to have professionals evaluate mutual funds, pooled funds, stocks and bonds, then assemble all the building blocks into a suitable portfolio.

The idea is good, but the cost isn't. Clients in wrap programs usually wind up paying annual fees of 3% of their assets or more, and in my book, that's way too much to pay for money management. Anybody with more than $10,000 in assets can buy a good no-load, low-fee mutual fund for a third of what many wrap programs charge. If you have more than $500,000 in assets, you can go directly to an investment manager and invest in their low-cost pooled funds.

Wrap programs are not only expensive but confusing. For instance, these programs usually hire a consultant to evaluate investment managers in each of the different asset classes (domestic stocks, foreign stocks, bonds, etc.). The program then hires the top-rated managers-sometimes several in each asset class-to actually manage your money.

All these layers upon layers of management result in a structure of baffling complexity, and you wind up paying for it. Yet there's no evidence that all that professional management results in performance that's significantly better than a standard balanced mutual fund. Nor is there any evidence that consultants can pick money managers any better than the easily available ratings from Morningstar Canada.

So why would anybody ever buy a wrap account? Well, if you are in a position where you owe a "fiduciary duty" to an organization or an estate, you may actually want all those levels of management. They assure everybody that the money you're overseeing is invested in a manner that has been thoroughly vetted by teams of professionals.

Ultimately, it all comes down to your own objectives. But before investing in any wrap program, make sure you get answers to these questions:

HOW COMPLICATED IS THE PORTFOLIO GOING TO BE?

Some wrap programs use three, four or even more money managers for each asset class. The goal is to diversify your holdings by using managers with different investing styles. Problem is, by the time you employ three or more money managers in each asset class, your portfolio is so diversified that it will perform like the market index. It's a lot simpler-and cheaper-to simply buy an index mutual fund.

WHAT MANAGERS WILL THE WRAP PROGRAM BE USING?

If your wrap program is one that asks you to pick a management firm from a set menu, check to see if you can hire that manager on your own. Both McLean Budden and Bissett participate in a number of wrap programs. You can go to either of these firms directly to purchase their low-fee mutual funds or pooled funds. But don't count on your stockbroker or financial adviser to mention that option. If you go direct, his or her firm won't reap a commission from the deal.

HOW WILL MY TRADES BE EXECUTED?

Most, but not all, wrap programs include the cost of buying and selling stocks, funds, etc., within the program as part of the overall fee. That can be a good deal if you trade a lot, but you should ensure that you're not being nickeled and dimed to death. If a wrap program has to execute all its trades at the firm sponsoring the wrap program, you may be getting second-rate trade execution even though you are paying a premium price.

HOW WILL MY RESULTS BE REPORTED?

The investment profession has a professional body that sets ethical standards for its members. This group, the U.S.-based Association for Investment Management and Research, has set standards for how organizations should report the performance of investments in their marketing material. In the case of wrap programs, this standard requires that the performance of the account be reported after all the fees and expenses are deducted so that investors can see how much money is actually flowing through to them.

Much to my continuing amazement, none of the firms offering wrap programs in Canada do this. Their alibi? They don't have the necessary technology in place. When you are paying top dollar for an investment program, you should expect top quality. Deciding to ignore the ethical standards of the industry doesn't qualify as top quality.