SUITABLE PERFORMANCE COMPARISON CASE STUDIES

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1 SUITABLE PERFORMANCE COMPARISON CASE STUDIES Case Study #1: Equity mutual fund investments compared to index performance benchmark A mutual fund investor had a medium risk tolerance, a growth investment objective, and a long-term investment time horizon. The investor held his account at Firm ABC from May 2007 to June We assessed the risk profile and characteristics of the mutual funds using the simplified prospectuses in effect at the time of the purchases in May 2007 (see Table 1). We found that there were no changes to the mutual fund risk ratings during the relevant period. Our assessment showed that all of the mutual funds were growth-oriented, in keeping with the investor s growth objective, but 30% of the account was invested in an unsuitable high-risk precious metals mutual fund (see Table 2). Table 1: Excerpt from precious metals mutual fund prospectus Table 2: OBSI risk and asset allocation analysis * In all tables figures are rounded to two decimal places. Where possible, we focus our loss calculation on the unsuitable portion of the client s portfolio. Advisors are responsible to recommend suitable investments, but they cannot guarantee the performance of any investment that involves risk. While suitable investments may gain or lose money, we are not concerned either way and our objective is to interfere with them as little as 1

2 possible. In this case, we calculated the performance of the unsuitable high-risk precious metals fund and found a loss of $1, (see Table 3). Table 3: Actual performance of unsuitable high-risk precious metals fund The unsuitable high-risk investment was a Canadian precious metals mutual fund. Since Canadian exposure was suitable for the investor, and further to our objective to interfere with the suitable parts of the advisor s recommendation as little as possible, we selected the S&P TSX Composite Index as the suitable performance benchmark to represent medium-risk growth-oriented Canadian investments. We compared the suitable performance benchmark to the performance of the high-risk mutual fund, accounting for the timing of the trades (grouped by date) and reducing the S&P TSX Composite Index performance to account for the annual MER cost an equity mutual fund investor would typically incur (see Table 4). 2

3 Table 4: OBSI comparative performance analysis * Rate of return after MER = [( %) x (1-2.31%) 1.07 ] - 1 = 2.49% Based on our calculations, the investor incurred $2, ($33, $31,134.93) in financial harm by holding high-risk rather than medium-risk investments. To assess the compensable loss (how much of the financial harm we believe the firm should compensate the investor), we evaluated the investor s responsibility, considering his limited investment knowledge and inexperience with mutual funds, and that the advisor did not disclose to the investor that the precious metals mutual fund was high-risk. In this case, we found the firm was responsible for compensating the investor for all of the $2, of financial harm. 3

4 Case Study #2: Common stock investments compared to index performance benchmark A stock investor also had a medium risk tolerance, a growth investment objective, and a longterm investment time horizon. The investor held his accounts at Firm XYZ from October 2009 to August We assessed the risk profile and characteristics of the stocks and their issuers using historical data from Bloomberg at the time of the purchases (see Table 5). Table 5: Example of OBSI s Equity Analysis Our assessment showed that all of the common stocks were growth oriented in keeping with the investor s growth objective, but a large percentage was high-risk. Specifically, in October 4

5 2009, 24% of the account was invested in unsuitable high-risk stocks, increasing to 28% when one high-risk stock was sold and two additional high-risk stocks were purchased in December 2010 (see Table 6). Table 6: OBSI risk and asset allocation analysis Where possible, we focus our loss calculation on the unsuitable portion of the client s portfolio. Advisors are responsible to recommend suitable investments, but they cannot guarantee the performance of any investment that involves risk. While suitable investments may gain or lose money, we are not concerned either way and our objective is to interfere with them as little as possible. In this case, we focused our loss calculations on the unsuitable stocks. We calculated the performance of the unsuitable stocks and found a gain of $11, As shown in Table 7, while several of the stocks had gains, two had losses. OBSI always nets the losses and gains on unsuitable investments to determine the overall loss or gain on the unsuitable portion of an investor s account. 5

6 Table7: Actual performance of unsuitable high-risk U.S. stocks All the unsuitable high-risk stocks were U.S. stocks. Since U.S. exposure was suitable for the investor, and further to our objective to interfere with the suitable parts of the advisor s recommendation as little as possible, we selected the S&P 500 index as the suitable performance benchmark to represent medium-risk growth-oriented U.S. investments. We compared the performance of the S&P 500 to the performance of the high-risk stocks, accounting for the timing of the trades (grouped by date) and reducing the index performance to account for actual commissions the investor incurred (see Table 8). 6

7 Table 8: OBSI comparative performance analysis Based on our calculations, the investor s actual unsuitable investments outperformed the suitable benchmark by $ ($73, $72,168.85). Therefore, despite being unsuitably invested in high-risk stocks, the investor did not incur financial harm and we did not recommend that the firm compensate the investor. 7

8 Case Study #3: Mutual fund investments compared to index performance benchmarks A balanced investor had objectives for 40% lower-risk income and 60% medium-risk growth. The investor held her accounts at Firm RST from June 2008 to June We used historical data from the simplified prospectuses at the time of the purchases in June 2008 to assess the risk profile and characteristics of her account. We found there were no material changes to the profile of the account from 2008 to Our assessment showed the investor held entirely equity mutual funds, of which 10% were medium risk and 90% were high risk, thereby exceeding her risk tolerance (See Table 9). There were no lower-risk income investments in her account. We concluded the account was unsuitable overall. Table 9: OBSI risk and asset allocation analysis Where possible, we focus our loss calculation on the unsuitable portion of the client s portfolio. Advisors are responsible to recommend suitable investments, but they cannot guarantee the performance of any investment that involves risk. While suitable investments may gain or lose money, we are not concerned either way and our objective is to interfere with them as little as possible. However, in this case, because the portfolio was almost entirely unsuitable, we calculated the performance of the entire portfolio and found a loss of $13, As shown in Table 10, while most of the mutual funds had losses, two precious metals funds had large gains. OBSI always nets the losses and gains on unsuitable investments to determine the overall loss or gain on the unsuitable portion of an investor s account. 8

9 Table 10: Actual performance of the account The entire account was invested in Canadian equity mutual funds. Since Canadian exposure was not inappropriate for the investor, and further to our objective to interfere with the suitable parts of the advisor s recommendation as little as possible, we weighted the suitable performance benchmark 40% to the DEX Universe bond index representing lower-risk income investments and 60% to the S&P TSX Composite index representing medium-risk growthoriented investments. We compared the combined performance benchmark to the actual account performance, accounting for the timing of the trades (grouped by date) and reducing the index performance to account for MERs the investor was likely to have incurred. In our assessment, we found that the investor had limited investment knowledge and relied on her advisor s recommendations, believing they suited her needs. However, she was alarmed at the decline in the value of her account in late 2008 and early She met with her advisor in February and May Given the discussions at these meetings, we found that by May 31, 2009 the investor knew she did not have any income investments and that the risk of her holdings was too high. We found she took reasonable steps once she became aware of the problem by selling all of her investments on June 30, Therefore, we compared her actual investment performance to a suitable performance benchmark for the entire period from June 2008 to June 2009 (See Table 11). 9

10 Table 11: OBSI comparative performance analysis The calculations show that even if the investor had been suitably invested, she would have incurred losses ($6,833.36), but her losses would have been smaller by $6, ($13, $6,833.36). We recommended she be compensated for this excess loss amount. 10