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david berman

Globe and Mail columnist David Berman.The Globe and Mail

Asset management stocks tantalize investors with big dividends, low valuations and an impressive two-month rebound, but that's not enough to offset the sector's formidable long-term challenges.

Companies such as AGF Management Ltd., CI Financial Corp. and IGM Financial Inc. are facing stiff competition from major banks, the popularity of low-cost exchange-traded funds and emerging robo-advisers, in addition to new regulations that are driving down fees associated with lucrative mutual funds.

The worst part: The sector is showing a stunning lack of imagination in confronting these challenges, which has been weighing on share prices.

Over the past three years, CI Financial has fallen 18 per cent, IGM (formerly Investors Group Inc.) has fallen 32 per cent and AGF has fallen more than 50 per cent.

These companies used to have it good: Investors were willing to pay hefty fees for mutual funds, in the form of management expense ratios (MERs), because there were few alternatives if they wanted a large basket of stocks or bonds managed by professionals.

Assets under management surged in the 1990s. According to the Investment Funds Institute of Canada (IFIC), assets rose from $25-billion in 1990 to $440-billion by the end of the decade – nearly an 18-fold increase that made the likes of AGF Management and CI Financial among the hottest stocks on the S&P/TSX composite index.

Between 1996 and 2000, CI Financial shares rose 730 per cent, or nine times the gain for the S&P/TSX over the same period.

These glory days are over, though. Worldwide, competitors have seen the rich fees, fat profit margins and opaque pricing on mutual funds, and have moved in with sensible alternatives, such as passive ETFs that outperform most actively managed mutual funds over time at a fraction of the cost.

At the same time, regulators have begun to demand greater transparency. In Canada, home to some of the highest mutual fees in the world, the Canadian Securities Administrators released a report this week arguing that commissions paid by investment fund managers are at odds with the interests of investors, implying changes ahead.

In November, global consultancy McKinsey & Co. concluded that success for North American asset managers "will become increasingly difficult for firms that continue to rely solely on the traditional approaches to growth and profitability."

The current environment is hardly a disaster. In Canada, IFIC reported that total assets under management rose to nearly $1.3-trillion in November, up 7.4 per cent year over year.

But the details aren't pretty: Globally, investors have shown a clear preference for lower-cost, passive investments, forcing asset managers to cut fees on actively managed mutual funds.

As a result, profit margins have begun to recede for the first time since the financial crisis.

The trend is likely to pick up. The CSA expects that new competition to the Canadian mutual-fund industry will drive MERs on actively managed funds down another three-quarters of a percentage point – which is bad news when you're charging an astounding 2.5 per cent for a mutual fund that underperforms the S&P 500 or the S&P/TSX composite index.

In response to these challenges, some asset managers have decided that bigger is better. Henderson Group's takeover of Janus Capital Group in October combined $320-billion (U.S.) of assets and signalled a potential round of consolidation among asset managers.

In Canada, the industry has balked at regulatory changes, even as some asset managers have finally begun to offer low-cost ETFs and are even exploring the possibility of adding robo-advisory services.

Are the changes enough to entice investors? Stock prices have begun to rebound from recent lows.

Since November, CI Financial has risen 20 per cent, but the shares still trade at just 15 times trailing earnings and come with an attractive 4.9 per cent dividend yield.

Over the same period, AGF has risen 28 per cent, trading at 12.5 times earnings with a 5-per-cent dividend yield.

It looks good. But until the industry can figure out how to ween itself off of hefty mutual fund fees, it is better to watch the rebound than join it.

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