As president and CEO of CI Financial Corp., Stephen MacPhail talks to a lot of people. The most frequent interlocutors—besides those among his 1,400 employees he sees every day—are financial advisers, upon whom Canada's third-largest mutual fund provider depends to sell its products. MacPhail figures he meets with 500 to 600 advisers every year. "I've probably spent more time on the red-eye than anyone else in Canada," he says.
Lately, he has also been spending a lot of time talking to institutional investors in the wake of Scotiabank's sale of $2.6-billion worth of CI stock through a bought deal in June. "Institutional investors always ask us, 'What's the moat around your company to protect it from other forces?'" says MacPhail, 57. "And here's what I show them." He produces an investor presentation he's been giving recently and points to one slide that he's particularly proud of. It shows that in 2013, CI held two major conferences, 1,167 training sessions and roadshows, and 15,581 one-on-ones, branch meetings and conference calls–all of them with advisers. "If you figure there's 300 working days in a year–well, you do the math," MacPhail says. "So if you want to know the one competitive advantage about CI, it's our ability to do that. You can't just go out and do that."
As the old adage goes, investments aren't bought—they're sold. And it's fair to say that selling mutual funds is something CI Financial and, by extension, the advisers MacPhail meets with so often, have been very good at. In late June, the company reached $100-billion in assets under management (AUM), solidifying CI's third-place ranking among Canadian fund providers, after RBC Global Asset Management ($335-billion worldwide) and IGM Financial ($142-billion). And while other non-bank fund companies have struggled–AGF Management, for instance, suffered net fund redemptions of 8 per cent year-over-year to June—CI's net sales to the end of June were $2.7-billion, up 29 per cent from the same period in 2013. One big reason for that is the breadth and quality of CI's offerings. According to Morningstar, CI has the broadest selection of funds—more than 160 of them—and, in 2013, had the most top-rated funds in terms of performance in the entire Canadian mutual fund industry. "Everything is going exceptionally well for CI," says CIBC analyst Paul Holden, a long-time observer of the company. "Fund returns are good, they have a good product shelf in place, the distribution channels are strong, and net sales are fantastic."
What could possibly go wrong?
As MacPhail puts it, he isn't "drinking the Kool-Aid." He joined in 1994 after eight years in the oil industry and four in the trust business, including a stint at Central Guaranty Trust during its collapse in the early '90s. He knows how the worm can turn. But that doesn't mean he's being cautious, at least when it comes to his goals for CI. Along with Bill Holland, his charismatic predecessor and now CI's chairman, MacPhail has helped steer the company through 20 years as a public company, going from $3.7-billion in AUM to $100-billion. He doesn't think it needs to stop there–MacPhail's goal now is to hit $150-billion in five years.
On paper, that might look simple, especially for a company that has managed a compound annual growth rate in AUM of better than 20 per cent over the past 20 years. But neither Holland nor MacPhail is under any illusions it will be easy. "You could say we can just keep doing what we've been doing and we'll get there," MacPhail says. "But it never works out that way."
Adds Holland: "Right now, the headwinds we face are so significant that it would be hard to even describe them all."
That might well be true, but here's a quick attempt: First, and most obviously, a mutual fund company's performance is correlated with the markets, which have been on a roll for five years–the good times can't last forever. Second, the industry is facing significant regulatory changes, including strict new disclosure requirements for advisers and asset managers around fees and performance. Third, the popularity of low-cost exchange-traded funds (ETFs) and increasing regulatory interest in what the industry charges investors are exerting downward pressure on fees–the lifeblood of the industry.
Finally, and perhaps most significantly, all of Canada's big banks have been very public about their desire to expand wealth management revenues, dedicating their resources and thousands of branches to peddling mutual funds. That puts independent fund companies like CI at a huge disadvantage when it comes to distribution.
But MacPhail doesn't seem worried. In fact, he exudes confidence, especially when it comes to CI's ability to maintain and even grow its distribution channels. His not-so-little secret: Keep advisers happy, help them through the regulatory hurdles and other challenges facing the industry—oh, and put in lots and lots of face-time.
Bill Holland and Stephen MacPhail have enjoyed one of the longest and most successful executive partnerships in Canadian financial services. Yet they are, in many ways, a study in contrasts. The gregarious Holland joined CI in 1990 and became something of a media darling when he took over as CEO in 1999. (He was a long-time colleague of CI Financial co-founder Raymond Chang, who passed away suddenly in late July.) During Holland's tenure, which lasted until 2010, he grew CI into the largest independent mutual fund provider in Canada. MacPhail came to CI to oversee its listing as a public company, and served as chief financial officer, chief operating officer and president before becoming both president and CEO four years ago. He is quieter than Holland, more equivocal in his declarations. On the Street, Holland is known as CI's strategic master; MacPhail is the operational expert, the guy who keeps the trains running on time.
For shareholders, the results of that match have been sanguine. Since inception in June, 1994, CI stock has returned 4,523 per cent, for a compound annual growth rate of 21 per cent—making it the fifth-best-performing stock on the TSX over the past two decades. "One of the things I remember talking about when we went public was achieving a 20-year track record of 20 per cent growth a year," says Holland, 55. "And we ended up with 21 per cent. If I had understood how hard it was going to be, I wouldn't have said that 20 years ago."
Holland and MacPhail have sat next door to each other at CI headquarters for much of the past two decades; MacPhail says there is a "well-worn path" between their offices and that he speaks to Holland at least 10 times a day. Now that he's chairman, Holland still comes to work just about every day. "I'm kind of like Steve's assistant," he says. Despite their close working relationship—or perhaps because of it—they don't socialize together. "We don't agree on everything a hundred per cent of the time, but in 20 years, we've never had a heated argument," says MacPhail. "We don't chum out as pals, though we're good friends. Outside of CI, we lead our separate lives."
But the two clearly complement each other when it comes to running CI. "Bill and I had this common vision about economies of scale and growing the business, but also being fiscally responsible," says MacPhail. That vision largely arose, says Holland, around the turn of the millennium, when the twin bubbles of dot-coms and telecoms burst, and banks were left holding the bag on gazillions in trading losses and bad loans. Canada's banks, he and MacPhail reasoned, were going to turn their attention to the fee-based asset management business, which doesn't carry the risk of huge trading losses. In 2001, the pair sat down with CI's board and, as Holland recalls, told them: "We've got to change everything. The banks have decided they want to be in the asset management business. This time, they are going to make it work, and we're going to be in a different world. We've got to get distribution, we've got to be bigger than the banks, we have to operate cheaper than the banks, and we have to be better than the banks–because we don't have 7,000 bank branches."
What followed was one of the more remarkable growth trajectories in the Canadian mutual fund industry. In 2002, Sun Life bought a 37 per cent stake in the company; in return, CI got Sun Life's Spectrum Investments and Clarica Diversico asset management divisions and, just as importantly, gained access to Sun Life's network of more than 4,000 agents, becoming their exclusive provider of non-proprietary mutual funds. The impact on net sales was immediate: CI's fee-earning assets more than doubled in 2003. That same year, CI bought the Canadian operations of Winnipeg-based wealth management firm Assante Corp., which now has $29-billion in AUM through its network of 750 advisers. (Further distribution deals have followed—MacPhail says CI is now the No. 1 provider of mutual funds to Edward Jones, which has more than 500 offices across Canada.) By 2007, CI's fee-earning assets had grown to nearly $93-billion—three times what they were in 2002.
Then the markets, along with much of the global financial services industry, crashed. Again. In 2008, as investors fled and valuations plummeted, CI's assets under management dropped by 23 per cent. MacPhail trimmed tens of millions of dollars through layoffs and other cost-containment strategies.
The crash had another effect on CI's business–or at least its ownership structure. With insurance companies around the world teetering on the brink, Sun Life unloaded its stake in CI to Scotiabank for $2.3-billion (though CI's access to Sun Life's distribution network remained intact). Suddenly, CI enjoyed the prospect of a strategic alliance with a Canadian bank and its 1,000 branches, as well as the potential for international expansion through one of Canada's most globally oriented financial institutions. As it turned out, the potential never crystallized, beyond CI taking on a sub-advisory role on $2.3-billion worth of Scotia mutual fund products and gaining some access to the bank's distribution channels. The relationship was also contentious at times: In 2011, Holland and then-Scotia CEO Rick Waugh got into a public spat over CI's poison-pill provisions, eventually turning to the Ontario Securities Commission for a ruling (in CI's favour). A few days later, Scotia withheld its votes for Holland and MacPhail in their election to the board of directors.
Still, until Scotia announced its intention to sell a large chunk of its CI holdings this past May, some observers speculated that the bank would buy the firm outright, to bolster its asset management division. But there were plenty of reasons for Scotia to sell. For one thing, the bank already had a strong wealth management platform, owing to its $2.3-billion acquisition of DundeeWealth (now HollisWealth) and its Dynamic Funds, completed in 2011. Then there were the increasing regulatory constraints around investments like Scotia's. International regulations that came into effect following the banking bust now require banks to keep capital on their books to offset investments in asset managers. In other words, CI was already a drag on the bank's return on equity, and buying it outright would have only aggravated it. "Financially, buying CI at, say, a 25 per cent premium to the share price would have been materially dilutive to return on equity for Scotia," notes CIBC analyst Holden. "The simple way to sum it up is that a purchase was strategically not necessary and financially challenging."
The "sell" forces won out. In June, Scotia sold 82.8 million shares of CI, reducing its stake to less than 8 per cent and realizing a healthy return on the investment—it bought the stock at around $22 and sold for $35.
Not surprisingly, the consensus from CI is that the sale was good for CI. MacPhail says that after Scotiabank announced its intention to sell, CI's sales went up between 25 per cent and 30 per cent–a sign, he says, of investor support. As for distribution, he sees it as a positive, too, as it allows CI to explore relationships with other banks—something it might have been reluctant to do if Scotia had bought it up holus bolus. And finally, it frees up his time to think about other ways forward. Scotiabank, he says, "was a good partner, but in terms of where the relationship could have gone, that never really panned out. As CEO, I was always trying to say, 'How do we do more things with Scotia?' A lot of time went into that, but I don't think about it any more."
With a Scotia takeover out of the picture, MacPhail and the CI team have lots of other things to think about. And the bought deal suggests there are no other "strategic investors" waiting in the wings to buy a chunk of the company. Which means that whatever challenges CI faces as it chases MacPhail's goal of $150-billion in AUM, it will be facing them on its own.
Among the things CI is thinking about are more acquisitions, largely to broaden its product offerings and asset management roster. (Its most recent significant purchase occurred last September, when it acquired a majority stake in Marret Asset Management, a move designed to expand CI's fixed-income product line.) Holland says that Scotiabank's exit "broadens the things we would be willing to look at" in terms of acquisitions, and MacPhail agrees with him—though perhaps not on the scale. "I hate the word 'transformational,' but we could do a transformational acquisition in Europe or the U.S.," Holland says. "I don't think we will, but we will be more open-minded to it today than we would have been 90 days ago." MacPhail is less enthusiastic. "We're just not interested in looking at a massive acquisition—we're not going to bet the farm on a $3-billion deal," he says. "My appetite is more in the under-$1-billion category—ideally, $500 or $600-million."
Even before MacPhail became CEO, CI had a reputation for keeping a laser focus on costs. On the Street, the word on CI is that it pays fund managers less than top dollar and negotiates hard to keep their share of fees in check. Holland braces at any suggestion that CI is, well, cheap. But cost control is core to the culture. For his part, MacPhail has a reputation of being a tough negotiator when it comes to acquisitions. And he has his eye on expenses.
On a tour of 15 York Street, a 240,000-square-foot secondary office space near Toronto's lakeshore that opened in 2011, MacPhail is in his element. The facility houses much of CI's operations and customer service staff, as well as Assante and training facilities for staff and hundreds of independent advisers. The space—sleek, modern and open—was designed with younger employees in mind. There's not an oak panel in sight. "I didn't want to build a place that appealed to people my age," he says. He also takes pride in the little things: The art on the walls is really just photos printed on fabric, and the in-house dining space helps keep food-and-beverage entertainment expenses in check.
The 15 York facility is also a symbol of MacPhail's approach to growing CI to $150-billion, and to meeting the challenges it faces both from the competition and from regulators. Here, hundreds of financial advisers—from Assante, Sun Life and Edward Jones, as well as a host of independents—get to not only meet and greet CI's fund managers and executives, but also sit in on training sessions designed not to push CI funds, but to help the advisers grow their businesses. CI trains them on compliance, technology, client management and so on.
A big topic in those sessions is CRM2–industry shorthand for Customer Relationship Management 2, a rigid set of disclosure requirements being phased in by the Canadian Securities Administrators over the next two years. When it comes into full force in July, 2016, CRM2 will require advisers to disclose to clients the dollar value of all fees, including the dealer's operating and transaction charges; the total fees the client paid during the year; and trailing commissions, the fees investors pay an adviser for buying and holding a fund. Some expect widespread sticker shock, at least in cases where advisers are providing relatively little service to clients, and it has many in the industry "shitting their pants," as one observer puts it.
But MacPhail says he isn't overly concerned. "CRM2 sounds pretty intimidating, but in fact it's not," he says. "If you're in a value-add situation, it's not an issue at all." MacPhail claims CI has been leading the industry in helping advisers deal with the compliance requirements, including providing templates for reporting and walking them through how to have the disclosure conversation with clients.
MacPhail also downplays the impact of exchange-traded funds, claiming ETFs have made larger inroads in the United States because they appeal to do-it-yourself investors, of which there are fewer in Canada (total ETF assets south of the border are $1.8-trillion (U.S.); here, they're $70-billion). "We haven't seen a big impact on our business," he says. "And we're big believers in managed money." Still, he doesn't shut the door on getting into the ETF business down the road—"I'm not going to make any predictions on where we'll be five years from now, because the world is always changing."
For his part, Holland sees the rise of ETFs as part of a larger trend, with which CI is very familiar: the downward pressure on prices. Average management expense ratios (MERs) have been declining across the industry, including at CI, whose average MER—once 263 basis points—is now 171. "This industry is going to lower fees, any way you cut it," Holland says.
At the core of CI's confidence lies a faith in the value of independent advisers, and of maintaining and caressing the distribution channel—what Holland calls "good, old-fashioned relationship stuff." As for the banks, MacPhail acknowledges they're excellent at wealth management. But he says that they're better at meeting the needs of younger investors who are beginning to save, and are happy to roll in an RRSP contribution while visiting a branch. But CI's network, he says, tends to attract older clients, who might have kids, a spouse, aging parents—and larger portfolios. "A 38-year-old has much more complex needs," MacPhail says. "That's where we excel." More to the point, he claims that CI simply understands advisers and distribution better than the banks do.
So it may be that CI's tried-and-true formula for growth—low costs, diverse funds, strong non-bank distribution—really will take it to $150-billion. Or maybe not. "I'd say we're winning," says Holland. "I wouldn't say we've won."