By Lioninvestor (Martin Lee)

The term churning refers to the excessive buying and selling of securities by your stock broker to generate commissions. It can also mean the excessive purchase and sale of unit trusts by your financial advisor for the same purpose.

Yet another kind is the “cashing out” of investment linked policies (ILPs) to lock in profits and then buying a new one with another fund (incurring sales charge).

The same effect can be achieved with just a free switch.

As most (if not all) stock brokers are compensated based on commissions, they could have an inherent biasedness towards the client having more activity. If the client relies heavily on the recommendation of the stock broker or financial advisor but the latter has a less than honorable intention, it can be very detrimental to the health of the client’s portfolio.

The other day, I bumped into a ex-colleague (let’s call him Z) who wanted to liquidate his entire portfolio of unit trusts. His CPF investments of 80k+ had suffered a drop of more than twenty percent. His wife’s portfolio had suffered a similar fate and they were both advised by the same financial advisor.

I asked to take a look at his past transactions and this is what I saw.

• Z’s funds were invested in only the China and India market since last year.
• In March this year, he requested to switch all his funds to bond funds as a safe haven from the falling equity market. For this he was charged a 3% sales charge.
• In May, his so-called advisor “advised” him to switch his holdings back to equity to take advantage of the market rebound. All his holdings were switched back into two funds, one China and oneIndia fund. He was charged another 3% sales charge.
• As a result of the switch done in May, his portfolio suffered a further drop of 10k+.

I did not know whether to be angry or sad with what I saw. The CPF savings were Z’s lifelong savings.

There are two issues here. Incompetency and a lack of integrity.

Incompetency because

• No advisor in his right mind would tell his client to invest all his funds into only two regional equity funds.
• Trying to market time the rebound is a foolish thing to do.

Lack of integrity bacause

• The switching occured so soon after the initial sale with obvious tell tale signs of churning. If the advisor had wanted to actively manage the client’s portfolio, the funds should have been placed in a wrap account whereby fund switching is free. The client only needs to pay an annual warp account fee (typically 1%). If you do the maths, you will find that just one switch in three years will more or less make up for the wrap fees.
• According to Z, some (a couple of dozen) of his friend’s were in the same ship as him and have suffered heavy losses as a result of being served by that particular advisor. So, this is not just an isolated case.

Financially, the advisor is doing very well with all the commissions he has generated. Perhaps he is even given incentives for his performance. What an irony.

The sad thing is that the problem of churning in the industry goes even further than this.

Have you ever seen advertisements in the newspapers offering cash loans? One of the methods they employ is that they use your CPF monies to purchase unit trusts, charge you a sales fee of 3% and rebate you with some of the money.

Many cash straped people have no choice but to take up the offer. They can’t touch their CPF money and they would rather have cash on hand to meet their needs.

The goverment has taken certain measures that helps to reduce churning. One is the imposing of a 3% sales charge cap for funds purchased using unit trusts. Another is to disallow completely the use of the first 20k in our CPF OA and SA for investments.

While these measures might help to reduce churning, unfortunately, it can never be eradicated.

When the market goes on a bull run, many people don’t really scruntinize their transactions as they are making money.

The individual would do well to take a personal interest in his own investments and check how his portfolio is being managed, be it bull or bear.

Editor Note - Martin Lee is licensed by MAS to provide financial advice to individuals on collective investment schemes and life policies. He also writes regularly about investment and financial matters on his blog, the Den of the Lion Investor.

Website: http://www.lioninvestor.com