‘Separate account portfolios’ differ from most common in­vestment accounts with a stockbroker in that it is rare for bro­kers to be qualified or licensed to manage accounts on a discretionary basis. According to securities regulations, brokers must ask for and receive consent on every transaction in a cli­ent’s account before executing that transaction. Failure to do so is the practice of ‘discretionary trading’ by stockbrokers and can lead to not only serious penalties, but also, in extreme cases, the removal of their license to practice.

Over the long term, research has not shown any significant difference in performance between professionally managed separate account portfolios and mutual fund portfolios. Both can be used to implement an investment strategy effec­tively. However, some major differences between the two approaches should be considered when deciding between them.

Some of the differences between separately managed portfolios and mutual (or pooled) fund portfolios are outlined below.

Availability to the individual investor: Until recently, inves­tors with smaller portfolios were unable to access the services of professional money managers and were often limited to pur­chasing mutual funds. Professional money managers typically establish minimum account size restrictions; these restrictions have been beyond the scope of all but the most affluent individ­ual investors. On the other hand, the minimum amount re­quired for an initial mutual fund purchase has decreased as the popularity of mutual fund investing has grown over the years, and some funds now require as little as $500 to buy in.

Separate account managers have traditionally focused on providing services to institutional investors, managing the size­able portfolios of defined benefit pension funds and large en­dowments. Most accomplished managers have an account size minimum of $1 million or more. As their reputation and track record improve, a manager may continue to increase their ac­count minimum. Some separate account managers may com­mand minimums as high as $50 million – far beyond the reach of the majority of investors.

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The Europe Australia Far East (EAFE) index is the most widely used benchmark for evaluating the performance of for­eign equity money managers. It is interesting to note that inter­national managers have performed much better than their Canadian counterparts compared with passive forms of money management (Figure 2). Some argue that there are more oppor­tunities to capitalize on market inefficiencies in some of these less developed markets and that it is, therefore, easier to exploit over-reactions to market activities.

The advantages of indexing are as follows.

• An index mutual fund buys securities across all the sectors of the market represented by that index. This provides built-in diversification and avoids money manager risk because managers’ areas of specialization tend to be more sector specific.
• For smaller investors, indexing may cost less to implement because purchases can be executed with mutual or pooled funds, and transaction and administrative costs are shared among all investors in the fund.
• Indexing allows for a great degree of certainty when matching the risk/reward profile of the investor to the performance measurement standards established in their written IPS.

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For most investors, implementation consists of simply ‘biting the bullet’ and putting real money into action. However, we can learn from people with successful pension plans who first complete a due diligence process, and then implement their IPS by proceeding with the investment options and strategies pro­posed by an investment management consultant.

This is an appropriate time to address, debate and resolve some remaining theoretical issues including passive versus ac­tive money management approaches; pooled versus separate ac­count portfolios; dollar-cost averaging versus lump sum investing; and market timing versus strategic asset allocation. Passive versus active investment strategies: Passive investing is also referred to as ‘indexing’. It involves buying an invest­ment product that contains the entire basket of securities that make up a particular index, such as the Standard and Poor’s (S&P) 500 or the Toronto Stock Exchange (TSE) 300. For ex­ample, if after a thorough assessment, the asset allocation calcu­lated as optimal for a particular investor consists of 40% in Canadian equities, and the TSE 300 is selected as the appropri­ate benchmark against which to compare the performance of that portion of the portfolio, then a purely passive strategy would be to invest 40% of the portfolio in a TSE 300 index mu­tual fund.

This is in contrast with active management, where a money manager sorts through the universe of stocks and bonds, and se­lects only those that are appropriate for the investor’s invest­ment objectives as well as consistent with their own particular management style or investment specialty.

Indexing, or passive management, has been around for a long time but gained significant popularity in the late 1980s. Reviews of performance results of equity money managers through the 1980s suggested that some 60% of those managers ‘underperformed the indexes’. This underperformance, coupled with higher fees and transaction costs for active manage­ment, convinced many institutional investors to switch from active to passive management strategies.

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When asked recently what I am writing about in this se­ries of articles, I explained that each of the last few arti­cles has outlined how the individual investor can apply one step of the six-step investment management consulting (IMC) process in their own portfolio. My colleague was surprised be­cause it is typically affluent institutional or pension fund cli­ents, known to be methodical – almost clinical – in their approach toward money management, who make use of the IMC process.

He laughed and asked why an individual investor would want to read a bunch of industry-specific rhetoric on an invest­ment process developed for pension plans. “Why don’t you write on current events and more topical issues of interest? Be­sides, if they learn these steps and procedures, your readers might not come to us for any further investment advice and counsel.” In retrospect, I must concede that these are good questions, and ones that you may be asking yourself as you read this last article in the series.

In my first article in this series, I introduced the notion that “the most effective way to circumvent the common mis­takes made by an affluent investor…is first to establish a pru­dent process or strategy and then stick with it.”

Even the most sophisticated and experienced investors fall prey to common, needless mistakes, but many of these mistakes can be avoided for a more desirable outcome when clearly de­fined objectives are laid out and a proven process is put into ac­tion. Well aware that any investor must navigate through a myriad of decisions to reap the rewards of investing, I intro­duced the six steps of the IMC process as a framework and theo­retical foundation that any investor can use for this purpose.

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