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Product approval criteria
Strict rules may miss the mark

On September 30, 2005, fund manager Larry Sarbit appeared on ROB-TV to discuss, in part, that he felt he was being targeted by an affiliate of his former employer. Berkshire, an affiliate of AIC Group of Funds, reportedly overhauled its product approval process, meaning Berkshire's advisors cannot sell Sarbit's new fund. Might its new rules be targeting Sarbit? More importantly, do its tighter criteria make sense?

The new criteria

According to a recent memo, product sponsors wishing to have access to Berkshire's network of financial advisors (through which to sell its products) must have at least $200 million in assets under management and an operating history of at least five years.

Sarbit, having left AIC in April 2005 to launch his new firm (officially in September) sees this new set of criteria as directly targeting his firm. Indeed, many (including yours truly) predicted that a string of redemptions would flow out of AIC American Focused and into whatever new firm or fund Sarbit would set up. So, it's not out of the realm of possibilities that AIC wants to do all it can to stem redemptions from one of its biggest funds - which is what makes the timing of the new rules a little suspicious.

Good reasons for tightening the rules

But nor is it surprising that, after the blow up of popular products like Portus (a hedge fund) and Crocus (a Manitoba labour fund), dealers across the country are (and should be) re-evaluating how they decide what their advisors can sell. Berkshire maintains that this is the driving force behind the changes, and surely that's at least a part of it. Indeed, we're told that Berkshire has undertaken a review of all existing relationships with providers of products that are not sold by prospectus (and hired additional resources to do so).

And Berkshire is not the only firm to tighten up its criteria. It's not uncommon for larger dealers to require a product sponsor to have at least $500 million in assets under management prior to signing a distribution agreement. There are two possible reasons for this. One is to make sure a company is big enough to be economically viable. The other is, for larger firms, to ensure that a company has a certain level of capacity to handle the flow of client money into its products.

Can't sell its own funds

The next question is: Does such criteria have merit? There's nothing inherently wrong with it. There are good reasons to require a certain level of operating history and size. But looking at Berkshire's new criteria brings up a couple of interesting questions.

First, if Trimark founder Bob Krembil re-entered the mutual fund business and launched his own fund; would companies like Berkshire flatly refuse him the "shelf space"? After all, it would be a new company with little in assets, so strictly applying the 5 years and $200 million filters would result in a polite "no thank you".

Second, would Adères Portfolio Management Ltd. have been able to sell its products at Berkshire had they applied today's criteria back in 1999? This seems like an odd question until you recall that Adères was a new fund company in 1999 with only a nominal amount of assets under management. (It's also where Sarbit landed after leaving Investors Group to manage Adères Focused American - later merged into AIC American Focused.)

Adères was a separate company, but owned by Berkshire. Turning back time and strictly applying its criteria to Adères would have prohibited Berkshire from selling its own funds.

People, not names, should count most

A business and its reputation are nothing more than the people behind it. Larry Sarbit is obviously a known entity at AIC and Berkshire. Is there a valid reason they don't want to sell his fund? Perhaps, but we'll probably never know for sure. In my opinion, a new company should not be treated as completely new if it's backed by people with a sound track record in both money management and operations.

Otherwise, strictly applying such criteria would preclude any new firm to get off the ground.

Plus, since many money managers often enjoy their greatest investment success with a relatively smaller asset base (when they have the greatest flexibility) waiting for a firm to get bigger may result in missing a fund's greatest years.

For better or worse, this is the tradeoff that more conservative firms - and their advisors - must accept in such situations. And dealers, understandably, are likely erring on the side of caution in the face of increased regulatory responsibilities.

So, I understand the criteria and its use but it's not the way I would go about screening products. If dealers want to play it safe, why not apply more common sense rules like "we won't approve a product sponsored by a firm that doesn't have an independent trustee"?

If compliance and the safety of client money are the real concerns, it seems silly to simply use criteria that have no relationship to governance and compliance. Why not zero in directly on the areas of concern?



Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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