Q: My father lost a large sum of money when the company holding his investments in his home country defrauded its clients. As a result, I worry whether it is safe to keep all our investments in one institution. What would happen to investors if these companies became insolvent? Should we diversify across fund providers and financial institutions the way we diversify our investments? — M.T.
Canadians have many legitimate gripes about their financial institutions, but compared with most other countries we’re pretty fortunate. Fund companies and brokerages may charge too much or provide lousy service, but they aren’t likely to defraud their clients. And in the extremely rare cases when they become insolvent, there are safeguards that should prevent investors from significant losses.
It may not be necessary to diversify your holdings across multiple fund providers or financial institutions. But every Canadian should understand how investor protection programs work and be aware of their limits.
Your online brokerage
Every major online brokerage is a member of the Canadian Investment Protection Fund (CIPF), which was established by agreement with the Investment Industry Regulatory Association of Canada. (IIROC is the self-regulatory organization that oversees investment dealers in Canada.)
The CIPF maintains a pool of money that can be used to compensate investors in the event of a member’s insolvency. Since 1971 there have been 20 of these: the most recent include the Canadian arm of MF Global in 2011, and two small firms in 2012.
If you’re a client of a CIPF member, you’re covered for up to $1 million per general account, but there is additional coverage for what they deem “separate accounts,” which include RRSPs, RESPs and certain trusts.
Your advisor’s firm
If you work with an advisor who uses ETFs, there’s an extra layer of coverage. For example, PWL Capital is a CIPF member, and its client accounts are held at National Bank Correspondent Network, which is also a member. Using a third-party custodian also means the advisors have no direct access to clients’ money.
Make sure any brokerage or investment dealer you work with is covered CIPF. And don’t just look for the logo on the firm’s website, since some have been known to falsely claim membership. Look for the firm’s name in the CIPF’s member directory.
Be aware that mutual fund dealers in Canada are not licensed by IIROC and are therefore are not covered by the CIPF. However, the Mutual Fund Dealers Association provides similar coverage through the MFDA Investor Protection Corporation.
Your index funds and ETFs
It’s important to understand that the CIPF and the MFDA Investor Protection Corporation only provide coverage in the event of a dealer’s insolvency. They don’t apply if the fund provider itself—such as iShares, Vanguard, or Tangerine Investment Funds—goes belly-up. In that case, would investors see the value of their holdings fall to zero?
No, they wouldn’t. In the legal jargon, fund providers are called “trustees,” and they are responsible for the day-to-day management of the portfolios. However, they are required to keep investors’ assets with a third-party custodian, which means if the fund provider becomes insolvent its creditors have no claim on your money.
iShares has produced a document that provides a good summary of the legal structure of ETFs. You can learn the name of the custodian of your specific fund by looking in the prospectus. (For example, State Street Trust Company is the custodian for both Vanguard and iShares in Canada.)
Your GICs and savings accounts
If your portfolio includes GICs or investment savings accounts, there’s one more safeguard to be aware of: the Canadian Deposit Insurance Corporation (CDIC). This crown corporation provides coverage for up to $100,000 per member institution, although registered accounts and trusts are considered separately, so your total coverage may be greater.
This is one area where it definitely makes sense to diversify to stay within CDIC limits. For example, if you’re planning to build a five-year ladder totalling $100,000, it would be wise to use two or three GIC issuers, even if it means accepting a slightly lower rate.
Remember, too, that the CDIC limit applies to both principal and interest. So if you’re buying a five-year GIC that yields 2.5% annually, you may want to keep the principal amount to about $88,000 so you’ll stay under the limit even after accounting for accrued interest.