Investment Funds in Canada 2024 PDF

INVESTMENT FUNDS IN CANADA Credentials that matter. ® THE CANADIAN SECURITIES INSTITUTE The Canadian Securities Institute (CSI) has been setting the standard for excellence in life-long education for financial professionals for 50 years. CSI is part of Moody’s Analytics Training and...

INVESTMENT FUNDS IN CANADA Credentials that matter. ® THE CANADIAN SECURITIES INSTITUTE The Canadian Securities Institute (CSI) has been setting the standard for excellence in life-long education for financial professionals for 50 years. CSI is part of Moody’s Analytics Training and Certification Services, which offers education programs and credentials throughout the world. Our experience training over one million global professionals makes us the preferred partner for individuals, financial institutions, and regulators internationally. Our expertise extends across the financial services spectrum to include securities and portfolio management, banking, trust, and insurance, financial planning and high-net-worth wealth management. CSI is a thought leader offering real world training that sets professionals apart in their chosen fields and helps them develop into leaders who excel in their careers. Our focus on exemplary education and high ethical standards ensures that they have met the highest level of proficiency and certification. CSI partners with industry regulators and practitioners to ensure that our programs meet the evolving needs of the marketplace. In Canada, we are the primary provider of regulatory courses and examinations for the Canadian Investment Regulatory Organization (CIRO). Our courses are also accredited by the securities and insurance regulators. CSI grants leading designations and certificates that are a true measure of expertise and professionalism. Our credentials enable financial services professionals to take charge of their careers and expand their skills beyond basic licensing requirements to take on new roles and offer broader services. CSI is valued for its expertise, not only in the development of courses and examinations, but also in their delivery. 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You can submit comments, suggestions, or concerns to [email protected] © CANADIAN SECURITIES INSTITUTE  INVESTMENT FUNDS IN CANADA PREPARED & PUBLISHED BY CSI 200 Wellington Street West, 15th Floor Toronto, Ontario M5V 3C7 625 René-Lévesque Blvd West, 4th Floor Montréal, Québec H3B 1R2 Website www.csi.ca Credentials that matter.® Copies of this publication are for the personal use Notices Regarding This Publication: of properly registered students whose names are This publication is strictly intended for information entered on the course records of the Canadian and educational use. Although this publication is Securities Institute (CSI)®. This publication may not designed to provide accurate and authoritative be lent, borrowed or resold. 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Identifiers:  ISBN 978-1-77176-785-9 (print) ISBN 978-1-77176-786-6 (ebook) First printing: 1997 Revised and reprinted: 2009, 2010, 2011, 2012, 2014, 2016, 2019, 2021, 2024 Copyright © 2024 by Canadian Securities Institute  INTRODUCTION i Introduction The information in the chapters to follow is designed to help you serve your clients in a professional, confident and knowledgeable manner. As you prepare by taking this course and become more confident, the role of the mutual fund sales representative becomes one of guidance. Helping clients through the maze and variety of investment products and choices in today’s financial marketplace is a valued service that many clients are seeking. Uncovering client needs and choosing the right product to meet those needs is the foundation of giving quality advice. By correctly understanding the financial objectives and impact of constraints on the client, you can build strong relationships with your clients. A mutual fund sales representative must also thoroughly know the investment products that are available for meeting clients’ needs. If either one of these key elements is weak or lacking, there is a risk that clients will feel poorly served and wrongly advised, and will look to take their business elsewhere. LEARNING OUTCOME Many financial services professionals advance their careers by acquiring a license to sell mutual funds, which is a $1.893 trillion industry in Canada as of November 2023. This course will give you the skills you need to work in this exciting investment area. After taking this course, you will be able to: guide clients in their selection of mutual funds and related investment products confidently describe and discuss with clients the risk/return characteristics of the different mutual fund classes ensure product suitability, the underlying principle of consumer protection regulations provide superior client service with respect to mutual fund investments LEARNING SECTIONS The course is organized around six learning sections: SECTION 1: INTRODUCTION TO THE MUTUAL FUND MARKETPLACE Clearly explains the role of the mutual fund sales representative within the context of client service. It also provides an overview of the financial marketplace, economy, and mutual fund industry. SECTION 2: THE KNOW YOUR CLIENT COMMUNICATION PROCESS Outlines and illustrates, through the use of examples, what information is required to know your clients and your products. We also address the process of analyzing this information to ensure investment suitability. SECTION 3: UNDERSTANDING INVESTMENT PRODUCTS AND PORTFOLIOS Details the features and risk/return characteristics of the various financial assets, as well as the process of creating and managing investment portfolios. SECTION 4: UNDERSTANDING MUTUAL FUNDS AND MANAGED PRODUCTS Thoroughly describes the nature of many mutual fund types, their portfolio risk/return characteristics, and their performance over time. The section also introduces the many types of alternative managed products available in the marketplace. © CANADIAN SECURITIES INSTITUTE ii INVESTMENT FUNDS IN CANADA SECTION 5: EVALUATING MUTUAL FUNDS Describes the techniques used to measure and evaluate mutual fund performance so that you can make better decisions when selecting a mutual fund for a client. SECTION 6: ETHICS, COMPLIANCE AND MUTUAL FUND REGULATIONS Lists and explains the rules and ethical principles you must adhere to as a mutual fund sales representative. The section also illustrates, via a series of case studies, how mutual fund sales persons integrate client and product knowledge to meet their legal, ethical and professional responsibilities. COURSE FEATURES This edition of the Investment Funds in Canada (IFC) textbook was prepared in early 2024. The IFC textbook is updated and revised on a regular basis to better reflect the rapidly changing financial services industry. The following learning features are included in this edition of the course: Chapter Outlines: The chapter outline lets you know what content will be covered in the chapter and will prepare you for the material you are about to read. Learning Objectives: The learning objectives help you to focus your studies on important topic areas. Be sure to read each objective before you begin a chapter; the objectives specify precisely what you are expected to know after reading the chapter and studying the material. To highlight their importance, we have linked each objective directly to the chapter’s major headings. Key Terms: A list of key terms is provided at the start of each chapter. Understanding the terminology and jargon of the mutual fund industry is an important part of your success in this course. Each key term is boldfaced in the chapter and appears in the glossary included at the end of the textbook. Real Life Case Studies: In almost every chapter a case study is presented that reflects different scenarios that mutual fund representatives may face during their career. Chapter Summaries: Each chapter closes with a concise summary of the material organized by learning objective. The summaries will help to reinforce the relationship between the material and the chapter learning objectives and may suggest areas of weakness that require further study. Online Exercises: Online Exercises are provided in each module of your online course. These exercises allow you to practice calculations or test your comprehension of the key concepts presented in the textbook. Every time there is an activity that is relevant to a section, there is an invitation in the textbook to complete the online activity. Also, at the end of each chapter you will be invited online to complete the end of Chapter Exercise and read the Chapter FAQs. HOW TO USE THIS TEXT This course package is designed on a self-study basis. The textbook includes examples, review questions and case studies that help you to practice key areas of the material. In terms of studying for the course, we suggest the following: Review the learning objectives prior to reading the chapter; the final exam will cover the information required in meeting these objectives. Make notes by summarizing the key points under each major heading and learning objective. Review the definitions of key terms found in the Glossary. After reading the chapter, complete all online exercises, and read the online FAQs to find answers to your questions. They are intended to reinforce your learning and develop your ability to explain and discuss the required knowledge and desired skills. © CANADIAN SECURITIES INSTITUTE  INTRODUCTION iii The course material is intentionally presented in a learning sequence to help you build on the knowledge from one chapter before moving onto the next. A clear understanding of each chapter is a required foundation for the next one. By completing the text reading, the review questions and case studies, it will prepare you to write the IFC exam. The term “mutual fund sales representative” has been used mostly through this text to represent the broad base of individuals that sell mutual funds. Depending on the firm or institution you work for, your job title might be different from that of “mutual funds sales representative.” THE CANADIAN SECURITIES INSTITUTE CSI has been setting the standard for world-class, life-long education for financial professionals for more than 50 years. Having trained over 800,000 global professionals, makes us the preferred partner for individual and corporate financial services education internationally. Our expertise extends from securities to mutual funds, from banking and trust to insurance, from portfolio management to financial planning and wealth management. CSI is a thought leader whose real-world training sets professionals apart in their field, by developing them into leaders who are able to excel in their chosen careers. Our focus on leading educational and ethical standards means that our graduates have met the highest level of proficiency and certification. 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CSI has established professional designations in growing specialties like financial derivatives and wealth management, adding to our respected and established courses and seminars. We’ve also pioneered the use of the Internet as a powerful tool for teaching and professional development, launching online courses and study aids. CSI – leaders in innovative, lifelong education for career-minded financial professionals. CSI courses are available on demand in a variety of formats anywhere and anytime to suit the needs of learners and their organizations. © CANADIAN SECURITIES INSTITUTE INVESTMENT FUNDS IN CANADA Content Overview 1 The Role of the Mutual Fund Sales Representative 2 Overview of the Canadian Financial Marketplace 3 Overview of Economics 4 Getting to Know the Client 5 Behavioural Finance 6 Tax and Retirement Planning 7 Types of Investment Products and How They Are Traded 8 Constructing Investment Portfolios 9 Understanding Financial Statements 10 The Modern Mutual Fund 11 Conservative Mutual Fund Products 12 Riskier Mutual Fund Products 13 Alternative Managed Products 14 Understanding Mutual Fund Performance 15 Selecting a Mutual Fund 16 Mutual Fund Fees and Services 17 Mutual Fund Dealer Regulation 18 Applying Ethical Standards to What You Have Learned © CANADIAN SECURITIES INSTITUTE  INVESTMENT FUNDS IN CANADA vii Table of Contents SECTION 1 | INTRODUCTION TO THE MUTUAL FUND MARKETPLACE 1 The Role of the Mutual Fund Sales Representative 1 5 INTRODUCTION 1 5 HOW HAS THE MUTUAL FUND INDUSTRY EVOLVED? 1 5 A Brief History of Mutual Funds 1 6 History of the Canadian Mutual Fund Industry 1 6 WHAT IS THE VALUE IN LICENSING? 1 6 How This Course Prepares You 1 7 WHY PROVIDE EXCELLENT CLIENT SERVICE? 1 7 Rewards for Providing Excellent Client Service 1 7 Why Client Service Is So Critical 1 7 WHY IS UNDERSTANDING YOUR CLIENTS AND PRODUCTS IMPORTANT? 1 8 Types of Responsibility 1 8 Personal Trust, Ethics and Compliance 1 9 KNOW YOUR CLIENT, KNOW YOUR PRODUCT AND SUITABILITY 1 11 WHAT IS THE ROLE OF A MUTUAL FUND SALES REPRESENTATIVE? 1 11 MUTUAL FUND SALES IN PRACTICE 1 15 SUMMARY 2 Overview of the Canadian Financial Marketplace 2 3 INTRODUCTION 2 3 WHAT IS INVESTMENT CAPITAL? 2 3 Characteristics of Capital 2 4 Sources and Users of Capital © CANADIAN SECURITIES INSTITUTE viii INVESTMENT FUNDS IN CANADA 2 6 WHAT ARE THE FINANCIAL INSTRUMENTS? 2 6 Financial Instruments 2 7 WHAT ARE THE FINANCIAL MARKETS? 2 7 Auction Markets in Canada 2 8 Dealer Markets 2 9 WHO ARE THE DIFFERENT FINANCIAL INTERMEDIARIES? 2 9 The Role of Investment Dealers 2 9 Other Intermediaries 2 11 WHAT IS THE CANADIAN SECURITIES REGULATORY FRAMEWORK? 2 11 Self-Regulatory Organization (SRO) 2 13 SUMMARY 3 Overview of Economics 3 3 INTRODUCTION 3 3 WHAT IS ECONOMICS? 3 3 Microeconomics and Macroeconomics 3 4 The Decision Makers 3 4 Demand and Supply 3 6 HOW IS ECONOMIC GROWTH MEASURED? 3 6 Measuring Gross Domestic Product 3 8 Productivity and Determinants of Economic Growth 3 8 WHAT ARE THE PHASES OF THE BUSINESS CYCLE? 3 9 Phases of the Business Cycle 3 11 Using Economic Indicators 3 12 Identifying Recessions 3 13 WHAT ARE THE KEY LABOUR MARKET INDICATORS? 3 13 Labour Market Indicators 3 15 Types of Unemployment 3 16 WHAT ROLE DO INTEREST RATES PLAY? 3 16 Determinants of Interest Rates 3 17 How Interest Rates Affect the Economy 3 17 Expectations and Interest Rates © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS ix 3 17 Negative Interest Rates 3 18 WHAT IS THE NATURE OF MONEY AND INFLATION? 3 18 The Nature of Money 3 18 Inflation 3 21 Disinflation 3 21 Deflation 3 22 HOW DO FISCAL AND MONETARY POLICIES AND INTERNATIONAL ECONOMICS IMPACT THE ECONOMY? 3 22 Monetary Policy 3 24 Fiscal Policy 3 24 How Fiscal Policy Affects the Economy 3 25 International Economics 3 27 SUMMARY SECTION 2 | THE KNOW YOUR CLIENT COMMUNICATION PROCESS 4 Getting to Know the Client 4 5 INTRODUCTION 4 5 WHY ARE CLIENT COMMUNICATION AND PLANNING IMPORTANT? 4 5 WHAT IS THE FINANCIAL PLANNING APPROACH? 4 6 WHAT ARE THE STEPS IN THE FINANCIAL PLANNING PROCESS? 4 6 Establishing the Client-Advisor Relationship 4 6 Collecting Data and Information 4 8 Analyzing Data and Information 4 17 Recommending Strategies to Meet Goals 4 17 Implementing Recommendations 4 17 Conducting a Periodic Review or Follow-Up 4 18 WHAT IS THE LIFE-CYCLE HYPOTHESIS? 4 18 The Stages in the Life Cycle 4 21 Summarizing the Life Cycle 4 23 The Planning Pyramid 4 25 SUMMARY © CANADIAN SECURITIES INSTITUTE x INVESTMENT FUNDS IN CANADA 5 Behavioural Finance 5 3 INTRODUCTION 5 3 INVESTOR BEHAVIOUR 5 3 Behavioural Finance 5 4 Behavioural Biases 5 8 HOW DO REPRESENTATIVES APPLY BIAS DIAGNOSES WHEN STRUCTURING ASSET ALLOCATIONS? 5 11 SUMMARY 6 Tax and Retirement Planning 6 3 INTRODUCTION 6 3 HOW DOES THE CANADIAN TAXATION SYSTEM WORK? 6 4 The Income Tax System in Canada 6 4 Types of Income 6 5 Calculating Income Tax Payable 6 5 Taxation of Investment Income 6 8 Tax-Deductible Items Related to Investment Income 6 9 WHAT ARE THE MAIN PENSION PLANS IN CANADA? 6 9 Government Pension Plans 6 10 Employer-Sponsored Plans 6 13 WHAT ARE TAX DEFERRAL PLANS? 6 13 Registered Retirement Savings Plans (RRSPs) 6 17 Registered Retirement Income Funds (RRIFs) 6 18 Locked-In Retirement Accounts 6 18 Tax-Free Savings Accounts (TFSA) 6 19 Registered Education Savings Plans (RESPs) 6 21 Pooled Registered Pension Plans (PRPPs) 6 22 SUMMARY © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS xi SECTION 3 | U  NDERSTANDING INVESTMENT PRODUCTS AND PORTFOLIOS 7 Types of Investment Products and How They Are Traded 7 5 INTRODUCTION 7 5 WHAT ARE FIXED-INCOME SECURITIES? 7 6 Government Bonds 7 7 Treasury Bills 7 7 Provincial and Municipal Government Securities 7 8 Corporate Bonds 7 9 Guaranteed Investment Certificates (GICs) 7 10 Commercial Paper 7 10 WHAT ARE THE FUNDAMENTALS OF BOND PRICING AND PROPERTIES? 7 11 The Inverse Relationship between Bond Prices and Interest Rates 7 11 The Impact of Maturity and Coupon on Price Volatility 7 12 Bond Yield Calculations 7 13 The Yield Curve 7 15 WHAT ARE EQUITY SECURITIES? 7 15 Common Shares 7 17 Preferred Shares 7 18 Preferred Share Features 7 20 Risks of Investing in Preferred Shares 7 20 HOW ARE NEW SECURITIES BROUGHT TO MARKET? 7 21 Trading Securities 7 21 Types of Market Transactions 7 22 WHAT ARE DERIVATIVE SECURITIES? 7 23 Use of Derivatives by Mutual Funds 7 24 SUMMARY 8 Constructing Investment Portfolios 8 3 INTRODUCTION 8 3 WHAT IS RISK AND RETURN? © CANADIAN SECURITIES INSTITUTE xii INVESTMENT FUNDS IN CANADA 8 4 Putting Risk and Return into Practice 8 7 WHAT ARE THE IMPACTS OF ECONOMIC CONDITIONS IN COMPARING RETURNS? 8 8 Inflation 8 8 Purchasing Power 8 8 Taxation 8 9 HOW TO CALCULATE A RETURN 8 9 Rate of Return on a Single Security 8 13 Rate of Return on a Portfolio 8 14 HOW TO MEASURE RISK 8 14 Measures of Price Volatility of Equities 8 16 Measures of Price Volatility of Bonds 8 18 WHAT IS PORTFOLIO ANALYSIS? 8 18 Diversification and Risk 8 18 Combining Securities in a Portfolio 8 21 HOW ARE PORTFOLIOS MANAGED? 8 22 Investment Objectives 8 22 Strategic Asset Allocation 8 23 WHAT ARE THE METHODS OF ANALYSIS? 8 23 Fundamental Analysis 8 23 Technical Analysis 8 24 SUMMARY 9 Understanding Financial Statements 9 3 INTRODUCTION 9 3 WHAT ARE THE FINANCIAL STATEMENTS? 9 4 WHAT IS THE STATEMENT OF FINANCIAL POSITION? 9 4 Assets 9 5 Liabilities 9 6 Shareholders’ Equity 9 6 WHAT IS THE STATEMENT OF COMPREHENSIVE INCOME? 9 7 WHAT IS THE STATEMENT OF CHANGES IN EQUITY? 9 8 The Auditor’s Report © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS xiii 9 8 WHAT IS FINANCIAL STATEMENT ANALYSIS? 9 8 Ratio Analysis 9 9 Liquidity Ratios 9 10 Financial Leverage (Risk Analysis Ratios) 9 12 Operating Performance Ratios 9 14 Value Ratios 9 17 Trend Analysis 9 18 External Comparisons 9 19 SUMMARY 9 21 APPENDIX A: XYZ INC. FINANCIAL STATEMENTS SECTION 4 | UNDERSTANDING MUTUAL FUNDS AND MANAGED PRODUCTS 10 The Modern Mutual Fund 10 5 INTRODUCTION 10 5 WHAT IS A MUTUAL FUND? 10 6 Advantages of Mutual Funds 10 7 Disadvantages of Mutual Funds Costs 10 8 The Structure of Mutual Funds 10 9 HOW ARE MUTUAL FUNDS ORGANIZED? 10 9 Directors and Trustees 10 9 The Fund Manager 10 10 Independent Review Committee 10 10 Mutual Fund Distribution 10 10 The Custodian 10 11 HOW ARE MUTUAL FUNDS REGULATED? 10 11 Self-Regulatory Organization (SRO) 10 12 National Instruments 81-101 and 81-102 10 12 General Mutual Fund Disclosure Requirements 10 12 The Fund Facts Document 10 15 The Simplified Prospectus 10 18 SUMMARY © CANADIAN SECURITIES INSTITUTE xiv INVESTMENT FUNDS IN CANADA 11 Conservative Mutual Fund Products 11 3 INTRODUCTION 11 3 WHAT ARE MONEY MARKET MUTUAL FUNDS? 11 3 Money Market Funds: Investment Objectives 11 4 The Returns on Money Market Funds 11 5 Reading Performance Tables: Money Market Funds 11 7 Sample Money Market Fund 11 9 WHAT ARE MORTGAGE MUTUAL FUNDS? 11 10 Introduction to Mortgages 11 11 Mortgage Funds: Investment Objectives 11 12 The Returns on Mortgage Mutual Funds 11 13 A Typical Mortgage Mutual Fund 11 14 WHAT ARE BOND AND OTHER FIXED-INCOME FUNDS? 11 14 Interest Rate Risk and the Concept of Duration 11 15 Bond Mutual Funds: Investment Objectives 11 15 The Returns on Bond Funds 11 16 A Typical Canadian Bond Fund 11 17 Short-Term Bond Funds: Investment Objectives 11 18 Preferred Dividend Funds: Investment Objectives 11 21 SUMMARY 12 Riskier Mutual Fund Products 12 3 INTRODUCTION 12 3 WHAT ARE EQUITY MUTUAL FUNDS? 12 3 Standard Equity Funds 12 3 Equity Growth Funds 12 4 Equity Index Funds 12 5 Responsible Investment 12 6 Returns on Equity Mutual Funds 12 7 Hypothetical Examples of Equity Funds 12 10 WHAT ARE BALANCED MUTUAL FUNDS? 12 10 Investment Objectives of Balanced Mutual Funds © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS xv 12 11 Returns on Balanced Mutual Funds 12 12 Hypothetical Examples of Balanced Funds 12 12 Target-Date Funds 12 13 WHAT ARE GLOBAL MUTUAL FUNDS? 12 13 Investment Objectives of Global Mutual Funds 12 15 Returns on Global Equity Funds 12 16 Hypothetical Examples of Global Funds 12 18 WHAT ARE SPECIALTY MUTUAL FUNDS? 12 18 Risk Factors of Specialty Mutual Funds 12 18 Hypothetical Examples of Specialty Funds 12 22 Fund Wraps 12 23 SUMMARY 13 Alternative Managed Products 13 3 INTRODUCTION 13 3 WHAT ARE PRINCIPAL-PROTECTED NOTES? 13 3 Costs of Principal-Protected Notes 13 5 Advantages and Risks of Principal-Protected Notes 13 5 Before Investing in Principal-Protected Notes 13 6 WHAT ARE HEDGE FUNDS? 13 8 Investing in Hedge Funds 13 10 Hedge Fund Strategies 13 10 Costs of Hedge Funds 13 10 Advantages and Risks of Hedge Funds 13 12 Before Investing in Hedge Funds 13 12 WHAT ARE CLOSED-END FUNDS? 13 13 Advantages and Risks of Closed-End Funds 13 13 Before Investing in Closed-End Funds 13 13 WHAT ARE EXCHANGE-TRADED FUNDS? 13 14 Advantages and Risks of Exchange-Traded Funds 13 15 Costs of Exchange-Traded Funds 13 15 Before Investing in Exchange-Traded Funds 13 15 WHAT ARE SEGREGATED FUNDS? © CANADIAN SECURITIES INSTITUTE xvi INVESTMENT FUNDS IN CANADA 13 16 Advantages and Risks of Segregated Funds 13 17 Costs of Segregated Funds 13 18 Before Investing in Segregated Funds 13 20 SUMMARY SECTION 5 | EVALUATING MUTUAL FUNDS 14 Understanding Mutual Fund Performance 14 5 INTRODUCTION 14 5 HOW IS PORTFOLIO PERFORMANCE EVALUATED? 14 5 Measuring Mutual Fund Performance 14 6 Calculating the Risk-Adjusted Rate of Return 14 7 Other Factors in Performance Measurement 14 7 HOW IS PERFORMANCE ASSESSMENT CONDUCTED? 14 7 Benchmark Indexes 14 8 HOW IS A COMPARISON UNIVERSE USED? 14 9 Issues That Complicate Mutual Fund Performance 14 10 HOW IS QUARTILE RANKING USED? 14 13 SUMMARY 15 Selecting a Mutual Fund 15 3 INTRODUCTION 15 3 HOW DOES VOLATILITY IMPACT MUTUAL FUND RETURNS? 15 6 WHAT ARE THE STEPS IN SELECTING A MUTUAL FUND? 15 6 Research the Performance Data 15 6 Focus on Appropriate Investment Objectives 15 7 Focus on Best Long-Term Performance 15 7 Focus on Best Year-to-Year Performance 15 7 Focus on Good Performers with Lower Volatility 15 9 Focus on Funds with Successful Investment Managers 15 9 Compare Fund Facts Documents and Compare Prospectuses © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS xvii 15 9 Examine Fees and Charges 15 10 Analyze the Size of the Fund 15 10 Make the Decision 15 10 WHAT OTHER ELEMENTS SHOULD BE CONSIDERED WHEN ANALYZING AND SELECTING MUTUAL FUNDS? 15 11 People 15 12 Philosophy 15 13 Process 15 14 Performance 15 16 SUMMARY 16 Mutual Fund Fees and Services 16 3 INTRODUCTION 16 3 WHAT ARE THE FEES AND CHARGES OF MUTUAL FUNDS? 16 4 Fees Paid by Individual Mutual Fund Investors 16 5 Fees and Expenses Paid by Mutual Funds 16 6 Fees and Expenses Paid by Fund Managers 16 6 Mutual Fund Costs: Analysis and Implications 16 9 WHAT ARE ACCUMULATION PLANS? 16 9 Dollar Cost Averaging 16 11 WHAT ARE SYSTEMATIC WITHDRAWAL PLANS? 16 11 Fixed-Dollar (or Constant) Withdrawal Plan 16 12 Ratio Withdrawal Plan 16 13 Fixed-Period Withdrawal Plan 16 13 Life Withdrawal Plan 16 14 Annuities 16 14 HOW ARE MUTUAL FUNDS TAXED? 16 14 Tax Consequences 16 16 Reinvesting Distributions 16 18 SUMMARY © CANADIAN SECURITIES INSTITUTE xviii INVESTMENT FUNDS IN CANADA SECTION 6 | E THICS, COMPLIANCE AND MUTUAL FUND REGULATIONS 17 Mutual Fund Dealer Regulation 17 5 INTRODUCTION 17 5 WHAT ARE THE MANDATE AND SCOPE OF SECURITIES ADMINISTRATORS? 17 7 Regulatory Change You Should Know 17 7 WHAT ARE SELF-REGULATORY ORGANIZATIONS? 17 7 Objectives of CIRO 17 8 Autorité des marchés financiers 17 8 Compliance Supervision 17 9 WHAT ARE THE REGISTRATION REQUIREMENTS? 17 9 Educational Qualifications 17 10 The Registration Process 17 11 The National Registration Database 17 11 Dual Employment 17 12 Transfer and Termination of Registration 17 13 HOW DO REPRESENTATIVES AND DEALERS MEET THE KNOW YOUR CLIENT RULES? 17 14 Conflicts of Interest 17 15 Know Your Client 17 16 Suitability 17 18 Know Your Product Rule 17 18 Vulnerable Clients 17 19 The Role of KYC Information in Opening an Account 17 20 WHAT ARE THE STEPS IN OPENING A MUTUAL FUND ACCOUNT? 17 20 Relationship Disclosure 17 21 New Accounts 17 22 The New Account Application Form (NAAF) 17 24 Types of Accounts 17 26 Intermediaries, Transfers, and Referrals 17 27 WHAT ARE THE PROHIBITED SELLING PRACTICES? 17 29 WHAT ARE THE RULES FOR COMMUNICATIONS WITH CLIENTS? 17 29 Sales Communications 17 29 Handling Complaints © CANADIAN SECURITIES INSTITUTE  TABLE OF CONTENTS xix 17 30 WHAT ARE YOUR OTHER LEGAL RESPONSIBILITIES? 17 30 Privacy Law 17 32 Anti-Money Laundering and Terrorist Financing 17 36 SUMMARY 18 Applying Ethical Standards to What You Have Learned 18 3 INTRODUCTION 18 3 WHAT ARE ETHICS AND THE STANDARD OF CONDUCT? 18 3 Ethical Decision-Making 18 4 The Standard of Conduct and Ethical Guidelines 18 5 Duty of Care 18 5 Integrity 18 7 Professionalism 18 8 Compliance 18 8 Confidentiality 18 9 HOW TO APPLY WHAT YOU’VE LEARNED TO CASE STUDIES 18 9 Case 1: Roger Black 18 10 Analysis — Case 1: Roger Black 18 12 Case 2: Janet Chen 18 13 Analysis — Case 2: Janet Chen 18 15 SUMMARY G Glossary © CANADIAN SECURITIES INSTITUTE  SECTION 1 INTRODUCTION TO THE MUTUAL FUND MARKETPLACE 1 The Role of the Mutual Fund Sales Representative 2 Overview of the Canadian Financial Marketplace 3 Overview of Economics © CANADIAN SECURITIES INSTITUTE 1 2 INVESTMENT FUNDS IN CANADA SECTION 1 | INTRODUCTION TO THE MUTUAL FUND MARKETPLACE Section 1 introduces the role of the mutual fund sales representative and the products that make up the financial marketplace. This first section consists of three chapters. Chapter 1 covers the role of the mutual fund sales representative. We define this role, explain why it exists and gives an example of what the job involves. The chapter also provides you with an overview of the mutual funds industry from a historical perspective. Chapter 2 covers an overview of the Canadian financial marketplace. We include an introduction to financial markets and review the market participants that make up those markets. The current regulatory framework is also introduced in this chapter. Chapter 3 introduces the concepts of economics. We provide an overview of the laws that govern microeconomics and discuss the elements of macroeconomics, including national income, gross domestic product, interest rates and inflation, among others. These three chapters provide you with the foundation to work from as you study the material presented in this course. © CANADIAN SECURITIES INSTITUTE  The Role of the Mutual Fund Sales Representative 1 CONTENT AREAS How Has the Mutual Fund Industry Evolved? What Is the Value in Licensing? Why Provide Excellent Client Service? Why Is Understanding your Clients and Products Important? Know Your Client, Know Your Product and Suitability What Is the Role of a Mutual Fund Sales Representative? Mutual Fund Sales in Practice LEARNING OBJECTIVES 1 | Describe the evolution of the mutual fund industry and the impact mutual funds have had on the financial services marketplace. 2 | Explain the value of becoming a licensed mutual fund sales representative and how it prepares you to deal more confidently with clients to protect their interests and provide quality advice. 3 | Discuss the importance of providing excellent client service. 4 | Identify the legal, ethical and professional responsibilities of a mutual fund sales representative. 5 | List and describe the six components of knowing your client. 6 | Describe the important role a mutual fund sales representative plays in the client relationship, and explain how this role differs from that of a financial planner. © CANADIAN SECURITIES INSTITUTE 1 4 INVESTMENT FUNDS IN CANADA KEY TERMS Key terms are defined in the Glossary and appear in bold text in the chapter. client service Know Your Product compliance legal responsibility disclosure mutual fund ethical conduct mutual fund sales representative ethical responsibility net worth ethics professional responsibility financial planner prospectus fund facts suitability investment fund volatility Know Your Client © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 5 INTRODUCTION A mutual fund is an investment vehicle that pools contributions from investors and invests these proceeds into a variety of securities, including stocks, bonds and money market instruments. Individuals who contribute money become share or unit holders in the fund and share in the income, gains, losses and expenses the fund incurs in proportion to the number of units or shares that they own. Professional money managers manage the fund’s assets by investing the proceeds according to the fund’s policies and objectives and based on a particular investing style. The mutual fund industry in Canada has experienced tremendous growth over the past several decades, both in choice of products available to investors and in the dollar value of assets under management. Accordingly, the industry offers mutual fund sales representatives and investors many opportunities and challenges. Are mutual funds ideal for all investors? As we will learn in this chapter and throughout the course, there is no one perfect investment that suits all investors; however, it is worthwhile to point out that mutual funds have become important investment products for many investors. Although they may seem simple and nearly universally available, mutual funds are in fact a complex investment vehicle. Available in a variety of different forms and through a variety of different distribution channels, they may be one of the most visible vehicles for many investors. The funds themselves are subject to a range of unique provisions and regulations; thus, it is important to ensure a full understanding of this particular investment vehicle. This first chapter provides you with a brief history of mutual funds and explores the role of the mutual fund sales representative. NOTE As of January 1, 2023, the former Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) were amalgamated to form the Canadian Investment Regulatory Organization (CIRO). HOW HAS THE MUTUAL FUND INDUSTRY EVOLVED? Investment products vary over time with changing economic and social conditions. Among the investment products known as investment funds that offer investors access to a portfolio of securities, mutual funds represent a fairly recent development. They have evolved from earlier types of investment funds with which they still compete for investment dollars. Overall, the evolution of the mutual fund industry has been characterized by significant growth in the number of funds available, the popularity of those funds with small investors, and the dollar value of fund assets under management. A BRIEF HISTORY OF MUTUAL FUNDS Financial historians generally agree that mutual funds are more than two centuries old. Some believe they had their start in the Netherlands in 1774, while others point to the modern mutual fund having its start in England in the mid-1800s. Regardless of where mutual funds started out, their popularity grew steadily, primarily because of their design. For many investors, building a portfolio of individual stocks can be a costly venture. There are the fees associated with buying stocks, not to mention the time involved in researching individual companies. Mutual funds solved this problem by giving investors who have minimal funds to invest access to a product that offered a professionally managed and diversified portfolio of securities at a relatively low cost. © CANADIAN SECURITIES INSTITUTE 1 6 INVESTMENT FUNDS IN CANADA HISTORY OF THE CANADIAN MUTUAL FUND INDUSTRY The number of mutual funds in Canada grew slowly until after the Second World War. During the 1950s and 1960s, the number of mutual funds grew dramatically. The 1970s, however, was a difficult period for stock market investors, and the mutual fund industry did not experience the same level of rapid growth. A better market climate in the 1980s and 1990s, in combination with other factors, resulted once again in a period of strong growth in mutual funds. Canada’s financial services landscape also played an important role in contributing to this strong growth. The chartered banks aggressively entered the mutual fund market in the early 1980s and this helped to lay the groundwork and distribution channels for the strong growth that was to follow. The following timeline gives you an idea of the evolution of the mutual fund industry in Canada. 1930s Three mutual funds open for business in Canada. 1960s 30 mutual funds and total assets under management of about $560 million. Total assets double to almost $1 billion by the middle of the decade. 1980s Chartered banks enter the industry. Number of funds grows from about 80 to 400 by the end of the decade. 2000s Assets under management reached about $400 billion. 2020s Assets under management approached $2 trillion. Source: IFIC Industry Overview, November 2023 – https://www.ific.ca WHAT IS THE VALUE IN LICENSING? In Canada, individuals who sell financial products, such as mutual funds, insurance, stocks, or who have specific duties within a financial services company, such as portfolio management or supervisory responsibilities, are required to meet educational, employment and work experience criteria in order to be licensed. Once the licensing requirements have been met, the application for registration is handled either by your employer or, if you are working independently, by a sponsoring financial services firm. After you are licensed, you may also be required to take further educational courses to maintain your license. Your license has clear value to you and your clients in establishing investor relationships and participating in the mutual fund industry. Acquiring your license to deal with clients as a mutual fund sales representative has value because it demonstrates: You are committed to your professional development, which shows your clients that you understand the features, characteristics, and types of mutual funds in the market. You have achieved a level of competence in understanding the importance of making recommendations that are suitable based on knowing your client. You understand the importance of your fiduciary responsibility of care to always deal with clients in an ethical manner. You understand the responsibility regulators play in protecting the integrity of the industry. HOW THIS COURSE PREPARES YOU This course covers a wide range of topics related to understanding mutual funds from a product, client, and regulatory perspective. Meeting client needs is the focal point of any relationship and the better informed you are, the greater the likelihood of successful client relationships. These relationships are built on trust—the trust clients put in you to help them fulfill their financial needs and the confidence you show by knowing your client and the products you are recommending. © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 7 Keep in mind however, that this course is just the beginning. As you progress and begin to deal with more sophisticated clients, your education and training will also need to change, becoming more specialized to meet the changing needs of your clients. Additionally, you may need to satisfy continuing education requirements throughout your career, depending on the industry licenses you acquire. This can only be viewed positively from a client’s perspective, because it shows your commitment to staying current and keeping your skills sharp. WHY PROVIDE EXCELLENT CLIENT SERVICE? In virtually every type of business, providing excellent client service has become the business differentiator. But what does client service mean? Generally, it means: Fully understanding client needs, and then Identifying the “right” solutions to satisfy those needs The mutual funds business is no exception; every client is unique. Providing excellent client service has important rewards and is perhaps the most critical aspect of your job. REWARDS FOR PROVIDING EXCELLENT CLIENT SERVICE The rewards for providing excellent client service are substantial. Happy clients: Come back for repeat business. They bring more business to your institution because they tell their friends and families about you. They buy other related products and services because they are satisfied when they deal with you. WHY CLIENT SERVICE IS SO CRITICAL This course is about mutual funds and investing in and recommending mutual funds to clients. On another level, however, the course is really about providing first‑rate client service as an employee or independent representative of a mutual fund dealer. It might seem strange to begin with client service, especially when you might already be providing excellent client service for your organization. There are, however, two important reasons why client service is a central issue here: Mutual funds are subject to sales regulations and disclosure requirements, and this demands a specialized client service approach. The rapidly changing financial services environment requires you to understand the characteristics and purpose of many products. We deal with client service early in the course because it is imperative that client service be thought of first and mutual fund strategizing second. This concept is one of the core considerations contemplated by regulators when the rules that govern mutual funds are enhanced. Two of these enhancements are the Client Focused Reforms and the guiding principle to always put client interests first. These enhancements will be explained in more detail as you progress through the course. WHY IS UNDERSTANDING YOUR CLIENTS AND PRODUCTS IMPORTANT? For many clients, the purchase of mutual funds can be a new experience. Some clients wanting to buy mutual funds know little about the nature of the funds offered. Often, they are not sure which fund they should buy. Not all © CANADIAN SECURITIES INSTITUTE 1 8 INVESTMENT FUNDS IN CANADA clients have the skill or knowledge to judge whether a particular mutual fund investment is suitable. Many of them will look to you for guidance. This means that you have special responsibilities for understanding your industry, its products, and the clients who come to you for help. TYPES OF RESPONSIBILITY When dealing with clients, you have legal, ethical and professional responsibilities: Legal Responsibility You must ensure any investment you recommend or client order that you accept is suitable for the client. An investment is suitable if it fits the client’s investment needs and objectives, personal and financial circumstances, investment knowledge, risk profile and investment time horizon. All provincial securities acts make this legal responsibility clear. Ethical Responsibility You must place your client’s needs before your own needs (such as reaching a sales target) or those of your dealer. You should be aware that sales incentives that encourage promotion of one product over another are prohibited and are subject to regulatory scrutiny. As such, you should always be prepared to justify your recommendations by maintaining adequate evidence of your suitability discussions in your client summary meeting notes. Professional Responsibility You must provide the best client service possible. You can meet all these responsibilities if you know your client, know your products, and know that you have the obligation to refuse to sell an unsuitable product to the client. To develop successful client relationships, you must earn a client’s respect and trust. You can accomplish this through good business practices as well as through ethical behaviour that reflects well on the profession and its practitioners. PERSONAL TRUST, ETHICS AND COMPLIANCE The mutual fund industry is based on trust and confidence. As a consequence, even though the industry already has many rules and regulations, mutual fund professionals must conduct themselves in an ethical manner. Every year, your organization likely requires that you sign a “code of conduct” outlining the important aspects of protecting client information, maintaining client confidentiality, and following best practices. In addition to expectations of ethical conduct, the mutual fund industry also sets out rules and regulations that cover the compliance aspects of the sale of mutual funds. Compliance means following the rules, whether those rules are legal requirements or dealer policies. If you are not in compliance, you may be held liable and subject to dismissal. Ethical conduct involves complying not only with the letter of the law but also with the spirit of the law. Ethics are moral principles that go beyond prescribed behaviour and addresses situations where rules are unclear or contradictory. It is possible to behave unethically even when complying with the rules. As a mutual fund sales representative, you may have a fiduciary responsibility to your clients (i.e., a responsibility to always put the client’s interests first). Criteria that may be used to determine whether a fiduciary duty is present in a mutual fund sales representative-client relationship include a high degree of reliance by the client on the representative’s advice and the vulnerability of the client. To ensure that the client’s needs are met, you must gather specific information from the client. The Know Your Client (KYC) rule imposes a higher standard of care on you than if you were merely executing the client’s orders. The mutual fund sales representative-client relationship requires that you act carefully, honestly, and in good faith when dealing with the client, and do not take advantage of the trust the client has placed in you. © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 9 EXAMPLE A retired couple with little investment experience told an advisor that they required a secure monthly income from their investments to maintain their current standard of living. Following the advisor’s advice, the couple invested the bulk of their money in equity mutual funds on the assurance that such investments were safe. The couple eventually suffered large losses on their investments after a sudden and severe market downturn. The court found liability on several grounds, including negligence for the firm’s failure to follow the KYC rule and choose suitable investments for the couple. When disputes between mutual fund sales representatives and clients are resolved through civil litigation, the courts generally hold that the mutual fund sales representative owes a fiduciary duty to the client. The existence of such a duty imposes a high standard of care upon the representative. An example of an area for compliance is the disclosure rule. Full, true, and plain disclosure of facts is necessary to make reasonable investment decisions. The fund facts document issued by mutual funds must disclose enough detail for the client to make an informed investment decision. The fund facts document is designed to be no more than four pages in length and gives investors key information that is relevant to their investment decisions, including facts about the fund itself, performance history, investments, and the costs of investing in the fund. The client can also request the mutual fund’s prospectus, which provides greater detail than the fund facts document and is much greater in length. The subject of fund facts documents and mutual fund prospectuses are covered in more detail later in the text. KNOW YOUR CLIENT, KNOW YOUR PRODUCT AND SUITABILITY On October 3, 2019, the Canadian Securities Administrators (CSA) released its final amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. This initiative, known as the Client Focused Reforms (the CFRs), made changes to the representative conduct requirements with the following intent: To better align the interests of securities advisers, dealers, and representatives (registrants) with the interests of their clients To improve outcomes for clients To clarify for clients the nature and terms of their relationship with registrants The CFR initiative is based on the concept that client’s best interests must come first in the client-registrant relationship. CIRO has aligned its rules with the CSA CFR amendments. ABOUT THE CFRs Over the past few decades, the securities industry has changed from a transactional, trading focused environment to one where advice and guidance exemplify the role and expectations of mutual fund sales representatives. Ensuring that each investment recommendation is suitable has become a fundamental obligation of all representatives. You must appreciate, apply, and document the components of suitability, a requirement at the intersection of the Know Your Product (KYP) and Know Your Client (KYC) rules (which we discuss later in the course). The CFRs cover enhanced expectations regarding KYC determination and KYP research, along with rules on conflicts of interest and implementation of a trusted contact person requirement. The CFRs are aimed at enhancing the standards of conduct in the securities industry and better aligning the expectations of customers with their firms. These new regulations became effective on December 31, 2021, and CIRO-regulated firms were mandated to comply with them. These regulatory reforms will translate into stronger processes to further support a winning team approach and demonstrate an ongoing commitment to putting customers first. © CANADIAN SECURITIES INSTITUTE 1 10 INVESTMENT FUNDS IN CANADA The three pillars of registrant expectations are suitability, KYC, and KYP. While these pillars, along with other rules and regulations, are affected by the CFRs, what follows is a brief introduction to these important cornerstones of the industry. A more detailed discussion of these concepts and the CFRs can be found in Chapter 17. One way of integrating ethics into rules compliance is through ensuring the suitability of investment recommendations for a particular client. Suitability means ensuring that all recommendations: take into account the client’s unique situation and investment objectives; are based on the sales representative’s understanding of the client’s personal and financial situation; and are based on the sales representative’s knowledge of the investment products being recommended. The KYC rule states that you must take reasonable steps to learn the essential facts relevant to every client and every order. Information concerning the client’s financial status (both income and net worth), family and other commitments, as well as financial goals, is required to make an appropriate investment recommendation. What if the client refuses to provide the information that you need to make a decision? The client may say, “Take my order or I’m leaving!” If you cannot determine investment suitability, but go ahead and accept the client’s order, then you will have violated securities law. You will have exposed your dealer and yourself to legal action should the client sue. You will have done a disservice to yourself, your employer and the client. No one likes to turn away a client, but your legal, ethical and professional responsibilities might require you to do so in some cases. Clients who do not believe they will benefit from providing you with detailed information may be right. In some cases, clients may have more investment knowledge than you. There may be little you can do to improve on their decisions. In other cases, clients may think they know more than they actually do. In any case, you must rely on the legal requirement to assess and interpret a client’s KYC to ensure suitability. If you cannot determine investment suitability, then you should not accept the order. Knowing your clients means knowing their: 1. personal circumstances 2. financial circumstances 3. investment needs and objectives 4. investment knowledge 5. risk profile (in terms of risk capacity and tolerance) 6. investment time horizon (in terms of the client age and time available to invest) We cover these six interrelated components more fully in Chapter 4 in the discussion on analyzing client data and information. Related to knowing your client is the notion of knowing your product. In the case of mutual funds, KYP is a question of understanding all the characteristics of the funds you are recommending to clients. You must understand the investment’s structure, features, risks, initial and ongoing costs and the impact of those costs. You must also document your KYP research efforts and maintain such notes in the client file. In addition, the representative must only consider those investments that have been approved by the Member. If the representative’s Member firm has not approved an investment, the representative cannot make the investment available to the client. Once you know your client and your product, you can assess and demonstrate why an investment product is right or wrong for your client. Product knowledge is a key element in determining suitability. The question of suitability ultimately comes down to whether the investment’s risk and return characteristics fit the client’s KYC characteristics. If you know your clients and your products, then you can make sure your clients avoid inappropriate investments. That is what it takes to fulfill your legal, ethical, and professional responsibilities. © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 11 WHAT IS THE ROLE OF A MUTUAL FUND SALES REPRESENTATIVE? As a mutual fund sales representative, you play the important role of ensuring that clients’ purchases are suitable given their predetermined financial goals, financial circumstances, personal circumstances, investment knowledge, risk profile, and investment time horizon. You and your client will work together to obtain the necessary information and then judge whether the client’s characteristics fit the characteristics of any investment products the client might have in mind. When the fit is poor, you must explain to your client why the product is unsuitable and, where feasible, suggest suitable alternatives. In some cases, the role of the mutual fund sales representative is very simple. For example, many clients will quickly be able to provide reasons for their purchase (their goals) and will indicate that they have considered their financial condition and are aware of the investment risks that a mutual fund might present. Some clients are highly sophisticated investors. In these cases, it is easy to ensure suitability. In other cases, with less sophisticated clients, you must carefully document the client’s goals and circumstances and carefully explain the nature of the products the client has in mind. In many cases, you will play the role of an educator – and that just makes good business sense. At the same time, there are limits to your role. Clients generally are looking for solutions to attain financial goals through mutual fund offerings. However, your role does not extend to helping clients with developing a financial plan through establishing household budgets, for example. This would be the role of a financial planner. In situations where clients require planning to attain their goals, your role is to refer the client to persons qualified to give advice in the appropriate specialist area. A mutual fund sales representative may only provide guidance on mutual funds and only after obtaining a mutual funds license. If you think that a particular client would be interested in individual stocks, then he or she must be directed to a salesperson who is registered to sell those securities. Your mutual fund registration restricts you to speak only about mutual fund products. MUTUAL FUND SALES IN PRACTICE You will examine all the elements of providing guidance in detail as you move through the text. At this point, however, you might be curious about the actual job of a mutual fund sales representative. Following is an example of investment guidance in action. In the example, some basic knowledge of mutual funds is assumed, so don’t worry if some aspects are unclear. The case is meant only to provide you with a sense of the mutual fund professional’s role. Exhibit 1.1 | Investment Guidance in Action (for information purposes only) Background You are a registered mutual fund sales representative meeting with a new client for the first time. In situations like this, you begin by filling out your dealer’s mutual fund application form. These forms typically have sections for: The applicant’s name, address, and birth date. The amount of money the client wishes to invest. Investment needs and objectives, investment knowledge, annual income, and net worth. Net worth is the value of all of the client’s assets after subtracting outstanding liabilities such as loan and mortgage balances. An evaluation of the client’s risk profile. There are other areas to be filled out on the form as well. The section for client information is there to help you ensure that you know your client, as the law requires. If a client refuses to provide this information, then you cannot legally sell him or her a mutual fund investment. © CANADIAN SECURITIES INSTITUTE 1 12 INVESTMENT FUNDS IN CANADA Exhibit 1.1 | Investment Guidance in Action (for information purposes only) In our example, assume that you have obtained the client’s name, address, and birth date. His name is Dave Wills, he is single, lives in London, Ontario, and is 29 years old. The Interview You start off with a few client-related questions you are legally obligated to ask to ensure that Mr. Wills invests only in suitable funds. You work toward understanding his personal and financial circumstances. Your questions also deal with his investment needs and objectives. Mr. Wills is starting to save for a down payment on a house and needs to have that money in about two or three years. This information is important because the short length of Mr. Wills’ investment horizon makes some mutual funds unsuitable. In your own mind, you have already limited him to a money market fund, or perhaps a bond fund. Equity funds would not work with a short investment horizon. Together with Mr. Wills, you complete a questionnaire, being careful to define each KYC option and any industry terms. You know that working through the KYC determination process thoroughly will go a long way toward accurately identifying the most appropriate investor profile for your client. Mr. Wills has a moderate willingness to accept risk and a moderate ability to endure a financial loss. This is critical information since mutual funds are not suitable for highly risk averse investors. The only exception to this rule might be money market funds, but even that is questionable. Highly risk tolerant investors are suitable mutual fund clients, but you would tend to see few of them, because this type of investment does not usually interest them. Given Mr. Wills’ risk profile, he continues to be a candidate for mutual funds. You complete your meeting and document all discussed details in your advisor notes, so that you have a record of your compliance with your ongoing fiduciary regulatory duties. Mr. Wills has a net worth of about $40,000, made up of the balances of two savings accounts, and an annual income of $42,000. Based on the information you have so far, you would be surprised if Mr. Wills said that he had excellent or even moderate investment knowledge, because a moderately knowledgeable, moderately risk tolerant client with a net worth of $40,000 would probably already have some type of mutual fund or other investment besides savings accounts. In response to your question, Mr. Wills describes his investment knowledge as poor. Investment Guidance By this point, you know enough about Mr. Wills to provide some guidance. You have ruled out equity mutual funds. You believe that he could probably tolerate some investment risk. You also know that he is not a knowledgeable investor. With this information in mind, you ask Mr. Wills if he has selected a type of mutual fund of the three that you offer. He answers that he would like to invest $10,000 in the equity fund. A relative told him that he could get the best returns with equity funds. You must now clearly explain that, while it is true that equity funds should provide a better return than either bond or money market funds over the longer term, they are among the riskiest of all mutual funds. That means that over shorter periods, equity funds might fall and then not rise again until well after the investor needs the money. In Mr. Wills’ case, in the first year, the equity fund might do very well, but in the second year, it might do very poorly. If Mr. Wills needs the money at the end of the second year, he might find that his capital has declined. For this reason, given Mr. Wills’ short investment time horizon, equity funds are not suitable. You next explain that this problem of fluctuating value (known as volatility) is not as pronounced with most bond funds and hardly exists at all with money market funds. In cases like this, when the client does not have much investment knowledge, it is particularly important to explain as much as you can about the risk characteristics of suitable and unsuitable funds. Documents, known as the fund facts and the prospectus, describe these characteristics for each fund. You will give a copy of the fund facts document (and prospectus upon request) to the client, but it would be helpful to point out, and even read through, key areas of concern, such as the fund’s investment objectives. In Mr. Wills’ case, you could read the warning about equity fund volatility contained in the fund facts or prospectus and contrast this with the objectives of the money market and bond funds. © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 13 Exhibit 1.1 | Investment Guidance in Action (for information purposes only) The Decision Mr. Wills asks whether you think the bond fund is the more suitable choice of the remaining two funds. In response, you ask Mr. Wills to fill out a special questionnaire designed by your firm that will lead to a recommended mutual fund portfolio made up of some of the funds offered. Mr. Wills fills out the questionnaire and the resulting suggested portfolio is 5% equity mutual fund, 10% bond fund and 85% money market fund. Mr. Wills decides to invest the $10,000 in the suggested mutual fund portfolio. Legal, ethical and professional responsibilities — notice how you have successfully taken them in charge. First, you respected legal requirements by the care you took in making sure that the investments made by the client were suitable given his objectives, financial and personal circumstances, investment knowledge, risk profile, and investment time horizon. Second, you fulfilled your ethical responsibility by looking after the client’s needs rather than your own or your dealer’s needs. In this case, you have recommended that most of the client’s capital be invested in a money market mutual fund. Money market mutual funds generate lower fees for the financial institution’s mutual fund dealer-subsidiary than other types of mutual funds. Finally, by carefully obtaining critical client information and using it to guide and inform, you have acted professionally. Because you have provided excellent client service, you have increased the likelihood that Mr. Wills will continue to invest with your institution. Case Study | A Day in the Life of a Mutual Fund Representative: Mary Gets Set for Success (for information purposes only) Mary, a mutual fund sales representative at a major Canadian financial institution, begins her working day watching business channels to get up to date on the previous day’s news and any overnight developments, setting her up to be well-prepared to address questions from clients and colleagues. Upon her arrival at the office, Mary reviews her schedule for that day’s meetings. She notices that she has two meetings booked, one with a brand-new client to investing and one where she will be reviewing a client’s existing portfolio. For the first meeting, Mary prepares the necessary documents to set up a new account. She reviews to ensure that she is well prepared to discuss the fundamental principles of investing to help her new-to-investing client establish a solid foundation of investment knowledge. Her primary goal will be to help her client articulate their investment goals. Also, she wants to establish a clear understanding of the client’s risk tolerance and their time horizon. All of this information will help ensure that Mary provides the right investment solutions to set the client on the right path for their investment journey. For her second meeting, Mary reviews her client’s investment profile and existing mutual fund holdings, checking that the client’s portfolio is properly aligned to their KYC profile and reflecting their stated goals. Mary notices that the client’s portfolio has drifted from the strategic asset allocation since their last review six-months ago, so she prepares appropriate recommendations to re-align the client’s portfolio. She also prepares some recommendations for the client to consider replacing existing mutual funds with funds that are providing similar gross returns but with lower fees – thereby enhancing the client’s potential returns. Now, Mary is set-up for success and ready to provide excellent client service to her clients. © CANADIAN SECURITIES INSTITUTE 1 14 INVESTMENT FUNDS IN CANADA TERMINOLOGY REVIEW How familiar are you with the terminology you have been introduced to in this chapter? Complete the online learning activity to assess your knowledge. Note: To access the online components of your course, login to your Student Profile at www.csi.ca and, once logged in, click on the ‘Access Online Courses’ button. YOUR RESPONSIBILITIES AND YOUR CLIENT How well do you know the different responsibilities of a mutual fund representative, and how well do you know your client? Complete the online learning activity to assess your knowledge. © CANADIAN SECURITIES INSTITUTE  CHAPTER 1      THE ROLE OF THE MUTUAL FUND SALES REPRESENTATIVE 1 15 SUMMARY After reading this chapter, you should be able to: 1. Describe the evolution of the mutual fund industry and the impact mutual funds have had on the financial services marketplace. The growth in the demand for mutual funds can be tied to their design: investors who have minimal funds to invest have access to a product that offers a professionally managed and diversified portfolio of securities at a relatively low cost. The mutual fund industry in Canada grew dramatically in the 1980s and 1990s, spurred by a declining interest rate market, the chartered banks entering the fund industry, and a proliferation of choice in the number of funds available. 2. Explain the value of becoming a licensed mutual fund sales representative and how it prepares you to deal more confidently with clients to protect their interests and provide quality advice. Individuals who sell financial products such as mutual funds are required to meet educational, employment and work experience criteria in order to be licensed. Meeting client needs is the focal point of any relationship and the better informed you are the greater the likelihood of successful client relationships. 3. Discuss the importance of providing excellent client service. Client service means fully understanding client needs and identifying the right solutions to satisfy those needs. The rewards for providing excellent client service include repeat business and the potential for expanding your client base. 4. Identify the legal, ethical and professional responsibilities of a mutual fund sales representative. Your legal responsibility ensures that any investment you recommend is suitable for the client. Your ethical responsibility ensures that client interests are placed ahead of your own needs and those of your dealer. Your professional responsibility is to provide the best client service possible. 5. List and describe the six components of knowing your client. Knowing clients means knowing their personal and financial circumstances, investment needs and objectives, investment knowledge, risk profile, and time horizon. Knowing your product is a question of understanding all the characteristics of the funds you are recommending to clients. 6. Describe the important role a mutual fund sales representative plays in the client relationship, and explain how this role differs from that of a financial planner. The mutual fund sales representative plays the important role of ensuring that client mutual fund purchases are suitable. Depending on the investing experience of clients, you will also play the role of educator. It is also important to recognize what services you cannot provide, for example financial planning. In situations where clients require planning to attain those goals, your role is to refer the client to persons qualified to give advice in the appropriate specialist area. © CANADIAN SECURITIES INSTITUTE 1 16 INVESTMENT FUNDS IN CANADA REVIEW QUESTIONS Now that you have completed this chapter, you should be ready to answer the Chapter 1 Review Questions. FREQUENTLY ASKED QUESTIONS If you have any questions about this chapter, you may find answers in the online Chapter 1 FAQs. © CANADIAN SECURITIES INSTITUTE  Overview of the Canadian Financial Marketplace 2 CONTENT AREAS What Is Investment Capital? What Are the Financial Instruments? What Are the Financial Markets? Who Are the Different Financial Intermediaries? What Is the Canadian Securities Regulatory Framework? LEARNING OBJECTIVES 1 | Define investment capital and describe the role played by suppliers and users of capital in the economy. 2 | Describe and differentiate among the types of financial instruments used in financial market transactions. 3 | Describe the roles and distinguish among the different types of financial markets and define primary and secondary markets. 4 | Describe the roles of the financial intermediaries in the Canadian financial services industry. 5 | List the industry regulators and their main functions and requirements affecting mutual fund sales representatives. © CANADIAN SECURITIES INSTITUTE 2 2 INVESTMENT FUNDS IN CANADA KEY TERMS Key terms are defined in the Glossary and appear in bold text in the chapter. ask price institutional investors auction market investment fund Autorité des marchés financiers (AMF) liquidity bid price mutual fund Canadian Investment Regulatory open-end fund Organization (CIRO) over-the-counter (OTC) capital primary market Chambre de la sécurité financière retail investors dealer market secondary market derivatives securities equities self-regulatory organization financial intermediaries source of capital financial market stock exchange fixed-income securities underwriting foreign investors users of capital initial public offering © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      OVERVIEW OF THE CANADIAN FINANCIAL MARKETPLACE 2 3 INTRODUCTION The Canadian financial services industry plays a significant role in sustaining and expanding the Canadian economy. The industry grows and evolves to meet the ever-changing needs of Canadian investors, both from domestic and international perspectives. In some way, we are all affected by the financial services industry. The vital economic function the industry plays is based on a simple process: the transfer of money from those who have it (savers) to those who need it (users). This capital transfer process is made possible through the use of a variety of financial instruments: stocks, bonds, mutual funds and derivatives. Financial intermediaries, such as banks, trust companies, and investment and mutual fund dealers, have evolved to make the transfer process efficient. This chapter introduces the Canadian financial system and its participants: investment markets, products, intermediaries, and the regulatory environment. For those new to this material, we offer a suggestion: stay informed about the markets and the industry because it will help you better understand the material presented in this textbook. There are countless sources of financial market information, including newspapers, the Internet, books and magazines. The course material will be easier to grasp if you can relate it to the activity that unfolds each day in the financial markets. Ultimately, this will help you achieve your goal of becoming an informed and effective participant in the mutual fund industry. WHAT IS INVESTMENT CAPITAL? In general terms, capital is wealth – both real, material things such as land and buildings, and representational items such as money, stocks and bonds. All of these items have economic value. Capital represents the invested savings of individuals, corporations, governments and many other organizations and associations. It is in short supply and is arguably the world’s most important commodity. Capital savings are useless by themselves. Only when they are harnessed productively do they gain economic significance. Such utilization may take the form of either direct or indirect investment. Capital savings can be used directly by, for example, a couple investing their savings in a home; a government investing in a new highway or hospital; or a domestic or foreign company paying start-up costs for a plant to produce a new product. Capital savings can also be harnessed indirectly through the purchase of such representational items as stocks, bonds or mutual funds or through the deposit of savings in a financial institution. Indirect investment occurs when the saver buys the securities issued by governments and corporations, who in turn use the funds for direct productive investment – equipment, supplies, etc. Such investment is normally made with the assistance of the retail or institutional sales department of investment firms. CHARACTERISTICS OF CAPITAL Capital has three important characteristics. It is mobile, sensitive to its environment and scarce. Therefore capital is extremely selective. It attempts to settle in countries or locations where government is stable, economic activity is not over-regulated, the investment climate is hospitable and profitable investment opportunities exist. © CANADIAN SECURITIES INSTITUTE 2 4 INVESTMENT FUNDS IN CANADA The decision as to where capital will flow is guided by country risk evaluation, which analyzes such things as: The political whether the country is involved or likely to be involved in internal or external conflict. environment: Economic trends: growth in gross domestic product, inflation rate, levels of economic activity, etc. Fiscal policy: levels of taxes and government spending and the degree to which it encourages savings and investment. Monetary policy: the sound management of the growth of the nation’s money supply and the extent to which it promotes price and foreign exchange stability. Investment opportunities for investment and satisfactory returns on investment when considering opportunities: the risks. Characteristics of whether it is skilled and productive. the labour force: Because of its mobility and sensitivity, capital moves in or out of countries or localities in anticipation of changes in taxation, exchange policy, trade barriers, regulations, government attitudes, etc. It moves to where the best use can be made of it and attempts to avoid areas where the above factors are not positive. Thus, capital moves to uses and users that reliably offer the highest returns. Capital is scarce worldwide and is in great demand everywhere. SOURCES AND USERS OF CAPITAL The only source of capital is savings. When revenues of non-financial corporations, individuals, governments and non­-residents exceed their expenditures, they have savings to invest. Non-financial corporations, such as steel makers, food distributors and machinery manufacturers, have historically generated the largest part of total savings mainly in the form of earnings, which they retain in their businesses. These internally generated funds are usually available only for internal use by the corporation and are not normally invested in other companies’ stocks and bonds. Thus, corporations are not important providers of permanent funds to others in the capital market. Individuals may decide, especially if given incentives to do so, to postpone consumption now in order to save so that they can consume in the future. Governments that are able to operate at a surplus are “savers” and able to invest their surpluses. Other governments are “dis-savers” and must borrow in capital markets to fund their deficits. Non-residents, both corporations and private investors, have long regarded Canada as a good place to invest. Canada has traditionally relied on savings for both direct plant and equipment investment in Canada and portfolio investment in Canadian securities. SOURCES OF CAPITAL Retail, institutional, and foreign investors are a significant source of investment capital. Retail investors Retail investors are individual investors who buy and sell securities for their own personal accounts, and not for another company or organization. Institutional investors Institutional investors are organizations, such as a pension fund or mutual fund company, that trade large volumes of securities and typically have a steady flow of money to invest. Retail investors generally buy in smaller quantities than larger, institutional investors. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      OVERVIEW OF THE CANADIAN FINANCIAL MARKETPLACE 2 5 Foreign investors Foreign investors also are a significant source of investment capital. Historically, Canada has depended upon large inflows of foreign investment for continued growth. Foreign direct investment in Canada has tended to concentrate in particular industries: manufacturing, petroleum and natural gas, and mining and smelting. Some industries also have restrictions with respect to foreign investment. USERS OF CAPITAL Based on the simplest categorization, the users of capital are individuals, businesses and governments. These can be both Canadian and foreign users. The ways in which these groups use capital are described below. INDIVIDUALS Individuals may require capital to finance housing, consumer durables (e.g., automobiles, appliances) or other types of consumption. They usually obtain it through incurring indebtedness in the form of personal loans, mortgage loans or charge accounts. Since individuals do not issue securities to the public and the focus of this text is on securities, individual capital users are not discussed further. Just as foreign individuals, businesses or governments can supply capital to Canada, capital can flow in the other direction. Foreign users (mainly businesses and governments) may access Canadian capital by borrowing from Canadian banks or by making their securities available to the Canadian market. Foreign users will want Canadian capital if they feel that they can access this capital at a less expensive rate than their own currency. Access to foreign securities benefits Canadian investors, who are thus provided with more choice and an opportunity to further diversify their investments. BUSINESSES Canadian businesses require massive sums of capital to finance day-to-day operations, to renew and maintain plant and equipment as well as to expand and diversify activities. A substantial part of these requirements is generated internally (e.g., profits retained in the business), while some is borrowed from financial intermediaries (principally the chartered banks). The remainder is raised in securities markets through the issuance of short-term money market paper, medium- and long-term debt, and preferred and common shares. GOVERNMENTS Governments in Canada are major issuers of securities in public markets, either directly or through guaranteeing the debt of their Crown corporations. Federal When revenues fail to meet expenditures and/or when large capital projects are Government planned, the federal government must borrow. The government makes use of two main instruments: treasury bills (T-bills) and marketable bonds. Provincial Like the federal government, the provinces issue debt directly themselves. Governments When revenues fail to meet expenditures and/or when large capital projects are planned, provinces must borrow. They may issue bonds to the federal government or borrow funds from Canada Pension Plan (CPP) assets (or the Québec Pension Plan in the case of Québec). Alternatively, a province may issue debt domestically through a syndicate of investment dealers who sell the issue to financial institutions or to retail investors. In addition to conventional debt issues, some provinces issue their own short-term treasury bills and, in some cases, their own savings bonds. © CANADIAN SECURITIES INSTITUTE 2 6 INVESTMENT FUNDS IN CANADA Municipal Municipalities are responsible for the provision of streets, sewers, waterworks, police Governments and fire protection, welfare, transportation, distribution of electricity and other services for individual communities. Since many of the assets used to provide these services are expected to last for twenty or more years, municipalities attempt to spread their cost over a period of years through the issuance of instalment debentures (or serial debentures). SOURCES AND USERS OF CAPITAL Who are the typical sources of capital and users of capital? Complete the online learning activity to assess your knowledge. WHAT ARE THE FINANCIAL INSTRUMENTS? Transferring money from one person to another may seem relatively straightforward. Why, then, do we need formal financial instruments called securities? As a way of distributing capital in a large, sophisticated economy, securities have many advantages. Securities are formal, legal documents that set out the rights and obligations of the buyers and sellers. Securities tend to have standard features, which facilitates their trading. Furthermore, there are many types of securities, enabling both investors (buyers) and users (sellers) of capital to meet their particular needs. FINANCIAL INSTRUMENTS Much of this text deals with the characteristics of different financial instruments – primarily stocks, bonds, and mutual funds. The brief discussion included here introduces you to the different types of financial instruments discussed throughout this text. Financial instruments are divided into broad classes: debt instruments, equity instruments, investment funds, derivatives and other financial instruments. Debt Instruments Debt instruments formalize a relationship in which the issuer promises to repay the loan at maturity and in the interim makes interest payments to the investor. The term of the loan ranges from very short to very long, depending on the type of instrument. Bonds, debentures, mortgages, treasury bills and commercial paper are all examples of debt instruments (also referred to as fixed-income securities). Equity Instruments Equities are usually referred to as stocks or shares because the investor actually buys a “share” of the company, thus gaining an ownership stake in the company. As an owner, the investor participates in the corporation’s fortunes. If the company does well, the value of the company may increase, giving the investor a capital gain when the shares are sold. In addition, the company may distribute part of its profit to shareowners in the form of dividends. Unlike interest on a debt instrument, however, dividends are not obligatory. Different types of shares have different characteristics and confer different rights on the owners. In general, there are two main types of stock: common and preferred. © CANADIAN SECURITIES INSTITUTE  CHAPTER 2      OVERVIEW OF THE CANADIAN FINANCIAL MARKETPLACE 2 7 Investment Funds An investment fund is a company or trust that manages investments for its clients. The most common form is the open-end fund, also known as a mutual fund. The fund raises capital by selling shares or units to investors, and then invests that capital. As unitholders, the in