The Globe and Mail, Report on Business
Published July 23, 2011

By Tom Bradley

I recently spoke at a conference about the future of the wealth management industry. It was a good audience, but a bad gig. No matter what I said, I was sure to be wrong about some things. As Yogi Berra said, "It's tough to make predictions, especially about the future." So I took a defensive tack, and used my allotted time to focus on the factors that I believe will shape the industry.

I picked five, starting with the most important one – investment returns. With interest rates where they are, we're bound to have lower portfolio returns in the coming years. At most we're looking at 3-per-cent per year from government bonds, the foundation of a balanced portfolio. If interest rates start rising, that number could be closer to zero in the medium term. And as I've pointed out in this space numerous times, artificially low rates inflate all asset prices, including stocks and real estate.

Out of returns flows factor two – asset allocation and portfolio construction. Rock-bottom yields will eventually translate into clients holding fewer bonds and guaranteed investment certificates (GICs), which means income will increasingly come from equities and structured products. On the equity front, investors will hold fewer Canadian stocks and more foreign. (This was the easiest non-prediction I made, because after a decade of world-beating returns, our home-market bias can't go much higher).

On the topic of building portfolios, I did find myself proffering some forecasts. The trend toward indexing and exchanged-traded funds (ETFs) will continue. Despite the recent attention from the industry and news media, the penetration of passive investing is still low in Canada. I also suggested (somewhat hopefully) that there would be a clearer separation between market-related returns (beta), which should be cheap to acquire, and added-value from active managers (alpha), which is more expensive. Closet index funds, which are the worst of both worlds (expensive beta), will become extinct.

Real estate has to be factored into any forecast about money. If house prices go stagnant or decline owing to interest-rate sensitivity, mortgage payments may compete more vigorously for investment dollars.

The third factor to shape the wealth management industry will be the need to lower the cost of distribution. Progress has been made on bringing down fees, with investors now able to trade cheaply and take advantage of low-cost mutual funds and ETFs. But the progress has been uneven. Overall, Canadians' total cost of investing has gone up with the growth of structured products, hedge funds and the re-emergence of closed-end funds.

What gains we've had so far have come from the buy side (money managers), who are being pressured to reduce their fees. The distribution channels (advisers, agents, investment bankers, bank branches) have not yet taken a hit, but their time is coming. Lower returns and legislated transparency around commissions and advisory charges will change the game. The good players may not be affected much, but the "one-call-a-year" asset gatherers will increasingly be shaken out. Fewer Canadians will pay advisory fees for no advice.

I called factor four the "shadow pension crisis." There’s been much said about the sorry state of pension plans in Canada, but also troubling are the 60 per cent of Canadians who don't have workplace pensions at all. They're underfunded, too. Soon-to-retire baby boomers have been buffeted by the same perfect storm that hit defined-benefit workplace pension plans, namely low interest rates and poor foreign-equity returns.

This means Canadians will be saving more, paying increasing attention to their investments, and likely using some kind of government-sponsored supplementary plan for part of their portfolio.

The last factor I highlighted was the state of the customer. I wasn't around in the 1930s, or even mid-1970s, but I would suggest that investors' faith in the investment industry is as low as it's ever been. The professionals have been wrong too many times (client returns reflect it), have proven untrustworthy on occasion, and are too rich (where are the clients' yachts?).

This lack of trust will increasingly define how clients invest. Baby boomers will take more interest in their portfolio and push their providers harder. Gen X and Yers will do it online with the help of bloggers and peer networks.

Where do these five factors point? Oh darn, I've run out of space. No for room for predictions today. I'll leave that up to you.