The inside story of the mess at AGF

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In early December of last year, as the investment community was starting to gear down for the holidays, Blake Goldring quietly prepared to drop a bomb. As a dim morning light spread over Bay Street, the CEO of AGF Management Ltd. got ready to announce the most contentious move of his 15-year reign.

A fierce debate among investors and analysts had presaged the decision. Simple math suggested there was no other option but to cut AGF's dividend: By December, quarterly payments to shareholders ate up virtually all of AGF's free cash flow, leaving nothing to invest back in the business. Still, there was a major unknown: Would Goldring have the nerve to chop the payout? Few things irk investors more than dividend cuts, and the CEO was already under siege for AGF's ugly investment performance.

The uncertainty ended with an explosion. At 8 a.m. on a Tuesday, Goldring slashed AGF's payout by an astounding 70%. Caught off guard, investors struggled to digest the news. When the stock market opened for trading an hour and a half later, the company's shares tanked 21% in three minutes compared to the previous day's close.

Goldring had plenty of reasons to want to keep the dividend intact. As an investment manager with $35 billion in assets under its watch, AGF is an institution that Canadians count on to safeguard their retirement savings. Slashing the payout could send a message that the company couldn't manage its own finances. A cut would also personally look bad for the CEO. Blake's late father, Warren, co-founded the firm, and AGF was in fine form when Warren handed the reins to Blake, who is now 56, at the start of the century. By at least one reckoning, AGF was Canada's best-selling mutual fund company in both 2000 and 2001.

And regular investors wouldn't be the only ones to feel the pain. Of 82.9 million outstanding common shares in AGF, the Goldring family directly or indirectly own more than 13 million. The wealth generated by this stake, notably $14 million in annual dividend income, accounts for a large part of the Goldring fortune.

But in the end, Blake decided he had no other choice. Despite AGF's historic brand name, the company was in free fall, enduring a run of retail net redemptions—that is, those from mom-and-pop investors—that would stretch to 30 quarters. That meant more client money had gone out the door than had come in for seven years in a row. The only way to save face was to completely retool; the dividend cut offered up the cash necessary to start investing in a new strategy.

AGF's profits have long undulated, and Goldring has done his best to stir up hope in light of the dividend cut. "We've been down before. We've come back in a spectacular way," he says during a July interview. "You're talking to the quintessential comeback kids."

This time, few people are buying it. Two camps have emerged on Bay Street: those who think the company has had it, and are happy to say so—albeit in private—and those who are loyal to the Goldring family but still think a turnaround will be incredibly tough. Full-blown believers are virtually impossible to find.

Because the Goldrings control AGF through special voting shares—a class of stock the general public can't own—the family has an iron grip over the company. (Blake's sister, Judy, became chief operating officer in 2009.) Deep corporate change is often created by tossing out the old guard and installing new faces, but no activist or disgruntled shareholder can make the Goldring family do anything it doesn't want to do. Blake's leadership skills and strategy are constantly questioned, but he'll be in power as long as he and his family want.

The business of selling mutual funds isn't what it used to be, either. AGF is now an endangered species, one of the last big independent companies left in a business that has been gradually taken over by the Big Six banks and major life insurers. In the middle of this battle, the industry's rule book is being rewritten. For many years, AGF made a killing charging high fees to retail clients, but regulators are mandating changes that might make that much harder to do. Industry watchdogs are also debating whether to crack down on the way independent fund companies like AGF persuade investment advisers to sell their funds.

All of which is to say: Even if AGF has a history of re-covering, and even if the company rallies behind a leader, is the task too gargantuan this time around?

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Founded in 1957, AGF was the first firm to offer ordinary Canadians a way to invest in a pure U.S. equity mutual fund (AGF stood for American Growth Fund).

That gave it an edge. The mutual fund industry also looked very different back then, with only 65 competing portfolios in Canada at the end of 1960. Independent companies ran the show, largely because the country's banks had yet to consolidate the world of financial services. Top mutual-fund players of the day operated as an oligopoly of sorts, which allowed them to charge prodigious fees. Simply buying into a mutual fund could cost an investor up to 9% of the investment, and he or she then had to pay annual fees of as much as 2.3% on top of that.

As the industry matured, fund performance cycled through hot flashes and dark decades. The late 1960s were phenomenal; the 1970s were mostly rough; and the 1980s were largely prosperous. Whatever the returns, the industry's fees barely budged. Blake, who completed his MBA at INSEAD and worked for five years at Bank of Montreal, joined AGF in 1988 after his father had heart-bypass surgery. Even then, 30 years after the company was founded, its fees hadn't changed much. "I remember coming in this business when there was just one way to buy a fund," Goldring recalls with a laugh, marvelling at how egregious the industry used to be. "Somebody had paid 8% for one of our funds back then, and I thought, 'Wow, they got a discount from 9%.'"

The industry benefited from dramatic growth in the 1990s. At the start of the decade, the total amount of money stashed in investment funds—a category dominated by mutual funds—came to 6% of the Canadian financial wallet; by the end of 2011, that figure had jumped to 31%. As AGF grew over the decades, Warren Goldring's stature did too. In Toronto, he was a member of the ultra-Establishment National Club, and he was deeply involved in fundraising for the United Way and the University of Toronto. The AGF co-founder said he wanted to create the next great Canadian family—the next Westons, the next Desmarais.

By 1995, AGF had hit a rough patch, struggling to reinvigorate its fund sales growth. For a boost, the firm made its first major acquisition of a mutual fund company, paying about $100 million to acquire 20/20 Financial. The deal added $2.9 billion in assets, taking AGF's total to $7.3 billion. Five years later, Blake took over the company at the end of the market's technology bull run. The new leader was tested early. The same year he took the reins, CI Financial, then Canada's seventh-largest fund company, bid for bigger rival Mackenzie Financial Corp. Worried about being left behind in a consolidation war, Blake had already bid on Trimark Financial but ultimately lost. Eventually he settled on acquiring Global Strategy Holdings for $438 million.

Body blows followed. Like nearly everyone in the business, AGF was bruised by the dot-com crash. Then, in the spring of 2002, Goldring had to grapple with the news that Brandes Investment Partners, which oversaw the AGF International Value Fund, was cancelling its contract so it could set up a rival firm in Canada—a move known as the "Brandes Bomb."

From there, the problems kept stacking up. In 2004, Manulife Financial Corp. pulled $900 million it had asked AGF to manage. Retail investors kept fleeing, resulting in 16 consecutive quarters of net redemptions. Less money to manage translated into fewer fees for AGF. By 2004, profit per share plummeted 54% from its peak in 2001.

Instead of capitulating, Goldring dug in. "We are tigers on the prowl," he would say, playing off AGF's striped mascot. In 2003, he began a hiring spree, scooping up star Trimark portfolio manager Keith Graham. To run sales and marketing, Goldring brought in Randy Ambrosie, a former Canadian Football League player who had made a name for himself in asset management. That same year, Goldring presented an ambitious turnaround plan to 150 company executives and managers at Toronto's Four Seasons Hotel. Everything was on the table. "This is the beginning of the new AGF," Dan Richards, a part-time adviser to the company, said. "There are no sacred cows and there is nothing people are not willing to talk about."

Goldring had no choice but to go all in because the industry kept consolidating and AGF couldn't afford to stand on the sidelines as newly merged players muscled ahead. Mutual fund companies were buying rivals (Franklin acquired Bissett, Amvescap bought Trimark); insurance giants were scooping up mutual fund companies (Power Corp., the majority owner of Investors Group, bought Mackenzie, while Sun Life Financial acquired a 37% stake in CI Financial); and the banks were also invading (National Bank of Canada acquired Altamira, Royal Bank eventually bought PH&N). To counter, AGF acquired 80% of Highstreet Partners Ltd. in 2006, adding $4.8 billion in assets under management. Goldring also touted AGF's investment-lending arm, AGF Trust—a unique business line that would help the company grow.

The combination of aggressive sales strategies, soaring stock markets and a measure of luck did the trick. By 2007, AGF was at the top of its game, sporting $56 billion in assets under management. That December, Goldring was named the Canadian Investment Awards' Person of Influence, one of the industry's highest accolades. And it was a meaningful one, since his father had won the Career Achievement Award from the same organization years earlier. Jet-lagged after flying in from Singapore, Goldring got up on stage to accept his award at a gala dinner in Toronto. In his black tuxedo, he looked like a king standing over the industry.

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The glory didn't last long. The global financial crisis was starting to unfold.

For years, AGF had struggled to find the right replacement for Brandes, and by 2006 they thought they had it in John Arnold. After winning awards for his AGF European equity fund, the Dublin-based portfolio manager was handed responsibility for the International Value Fund, along with his partner, Rory Flynn. He quickly revamped the portfolio, replacing 41 of its 50 holdings and seeing returns of 41% in 2006.

But soon the bet backfired; when the euro crisis hit, Arnold's funds were heavily exposed to financial institutions. His European equity portfolio lost 37% in 2008, made some of it back in 2009, and then continued to lose 20% or more in the next two years. (Arnold left in 2011.)

By now, this was familiar territory for AGF. Just as happened in the tech bubble, the company's scorching returns were obliterated almost overnight. Other financial services firms were also hurting. Even the once-legendary AIC Ltd., run by Michael Lee-Chin, was sold to Manulife Financial for a pittance. But AGF's slump was particularly bad because it never ended. Keith Graham, the onetime star portfolio manager, left. Randy Ambrosie did too. AGF Trust, the investment-lending arm, worried investors, because, unlike a bank, it didn't have a massive balance sheet to absorb losses in a down market. Worst of all: AGF's poor investment performance started another run of redemptions.

The company's been trapped in a downward spiral ever since, leading to a sea of troubles. Top talent started leaving in 2009—notable portfolio manager departures include Christine Hughes and Patricia Perez-Coutts—and the company's investment performance continued to be disastrous. By the end of 2013, only 30% of AGF's managed assets outperformed the median returns in the industry on a one-year basis, according to Morningstar Canada. That track record fell to only 15% above the median when looking back three years.

With such a spotty track record, it's nearly impossible for AGF to justify its fees. In an era when exchange-traded funds charge as little as five basis points, or 0.05%, annually, AGF routinely charges 2% to 2.5% to its retail investors—and sometimes more. The company's obsession with high fees is at odds with the industry's leading players, who continue to slash their own. CI Financial, Bay Street's current darling, started its fee-cutting campaign more than a decade ago. The gulf between the two companies is now so large that if AGF were to immediately cut its retail fund fees to match CI's, an estimated 50% of its cash flow would evaporate overnight.

With all these woes, it's tough to convince retail advisers that AGF funds are still worth buying. And the company's livelihood depends on them. Unlike CI, which built a distribution network for its funds by acquiring the likes of Assante Corp. in 2003, AGF has always been content to rely solely on other firms to sell its products. This isn't the sure bet it used to be—not when the big Canadian banks are hell-bent on creating their own proprietary products. By selling their own funds, they are able to reap better margins. And they're starting to dominate. In 2000, banks controlled 23% of all long-term mutual fund assets in Canada against 64% for independent firms. By June of this year, the banks' market share had jumped to 48%, while the independents' share was 42%.

Even more worrisome: Since 2012, the patchwork quilt of provincial securities watchdogs has been studying whether trailer fees should exist in Canada. These annual payments, made by mutual fund companies to advisers, are capped, banned or otherwise restricted in most other countries, including the United States. Should they be outlawed here, AGF will have fewer tools to persuade retail advisers to put their clients into its funds. At the moment, the company has the luxury of paying a Royal Bank adviser, say, 1% annually for simply choosing an AGF fund over another firm's.

AGF won't say much about the banks, likely out of fear of alienating a crucial partner. But Lee-Chin is much more vocal about current market realities as he tries to build a new firm. He says that it's now nearly impossible to go toe-to-toe with the banks on ordinary mutual fund products. Because the Big Six own major distribution channels in the form of their branch networks, they have an enormous leg-up. "The banks will be the best 'commodity' player," he argues, meaning they will own the game for plain-vanilla funds. "If you don't build your reputation as being different…you're going to be obsolete."

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What lies ahead for AGF is the equivalent of war for a financial services firm.

Winning the battle will require a phenomenal leader—someone who is just as deft at inspiring the troops as he is at developing a winning strategy. Goldring has struggled to prove he's that person.

"Every conversation about Blake starts out with what a great guy he is," explains a former senior AGF insider, accurately describing all the conversations that went into the reporting of this story. "People go out of their way to point that out, if only because there's a 'dot-dot-dot' behind it." Their next thought, the insider says, is almost always a comment suggesting the CEO's leadership is lacking.

Some people think Goldring would much rather do something else. A major supporter of the military—he is Honorary Colonel of the Canadian Army—his eyes light up when talking about the armed forces. The CEO himself has admitted he originally had no intention of joining the family business. Others say Goldring isn't a good enough communicator. Indeed, when speaking, he can seem nervous, even when he isn't.

Another concern: Goldring is "too nice." Even though returns had been rough for years, Goldring was loyal to his portfolio managers, often treating them with kid gloves, according to people who know the company well. Internally, it fostered a deep rift between the sales team and the portfolio managers, in the way of children competing for daddy's attention. Goldring was not one to lay down the law. "AGF has a long history of giving their portfolio managers almost carte blanche," says the former insider. "They are allowed to run their funds however they want." Goldring had a particular fondness for Martin Hubbes, whom he promoted to CIO in 2005. During the Hubbes era, AGF had lax rules around what managers could or couldn't buy in their funds. Hubbes considered portfolio construction—the process of determining what securities were bought and sold—to be more of an art than a science.

By 2013, there was enough pressure to force Goldring to do something radical. Too many fires had blazed. One of the worst: AGF had bought asset manager Acuity in 2011, and the acquired company's returns soon went south, fuelled by the collapse of the mining supercycle. Arguably, this performance wasn't Hubbes's fault, because Acuity had just been acquired, but the CIO still parted ways with the company in December, 2013.

People who know the two men say the change must have "killed" Goldring. "Those are always tough decisions," he explains. "It was very clear as we started to move past the crash that we needed to take a hard look at how we were operating the business.…You always hope that the strategy that you have is going to work, but at a certain point it's clear you've got to take a different direction."

In June, 2014, Goldring hired Kevin McCreadie, a wiry Wharton MBA, as his new president and chief investment officer. The two men are near-polar opposites: While Goldring is nice to a fault, McCreadie, who for the first year on the job commuted to Toronto every Monday morning from Baltimore, doesn't appear all that interested in winning anyone over. Together, they are a classic good-cop, bad-cop combo.

Under the Hubbes regime, AGF's CIO would sit and chat for an hour with whomever was in his office; with McCreadie, important conversations last eight minutes. This style is on display as he sits beside his boss in the conference room to explain his turnaround plan. McCreadie waits for Goldring to finish his rambling paragraphs-long answers before giving his own take in 13 words. He has the air of a professor listening to a student.

Watching the two men interact, it's clear that while Goldring is CEO, McCreadie has considerable say. AGF is trying to transform itself to restore its former glory, and the new CIO is the one responsible for executing the game plan. Before getting hired, he and Goldring exchanged ideas for five months. "We spent a lot of time together," the CEO explains. Those conversations, coupled with the company's string of rough results, made Goldring come to the "realization that we had to do something different"—a nice way of saying the situation was dire and a shakeup was necessary.

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Instead of rifling a cannon shot through the industry to make sure everyone knows AGF is still kicking, McCreadie is relying on basics to turn the company around.

"This is a pretty simple business when you think about what we do," he explains. "The product we make is about return on people's assets…I'm very simple-minded about that. If we drive investment performance, we do two things: We keep our clients, and we get new ones." Formerly the CIO of the American firm PNC Capital Advisors, McCreadie has three goals: improving investment performance; pushing for new products outside mutual funds; and putting an increased focus on risk management. Of these, he spends the most time talking about performance and risk.

"Where the industry has gotten offside, I think, is not understanding that clients don't want to go through 2002, 2008 again," he says. McCreadie, who is 55, spent much of his first year at AGF travelling across the country, meeting with more than 1,000 advisers. That's where he learned that investors can't bear another shock. "The world has changed, so risk has become the first part of the conversation, not the last." The new CIO isn't looking for the best returns—he simply wants to consistently be in the industry's top two quartiles.

McCreadie is also big on accountability, particularly for portfolio managers. He wants to hold them responsible for their returns. No one was quite sure of what that meant in his first year on the job, but by June he started sending messages. Marc-André Robitaille, who ran the Dividend Income Fund, left the firm after racking up a poor investment performance.

Then, in July, AGF announced internally that Gordon Forrester, the head of its dwindling retail arm, would leave—no small matter, considering this business generates an estimated 80% of AGF's revenues.

It could be that McCreadie is there to do all the things Goldring knows he himself isn't capable of. Whereas Goldring is personally invested in AGF, his CIO favours a systematic approach—something that matches his personality. McCreadie shows little emotion as he talks, rarely smiling or pausing in his no-nonsense delivery.

As for product lineup, AGF seems to adhere to Lee-Chin's theory that mutual fund companies will struggle to compete with the banks on plain-vanilla products. AGF is trying to look more like a specialized money manager; it spent much of the past year raising money for an infrastructure fund that will invest in toll roads, airports and the like—safe, stable assets that Canada's pension funds continue to gobble up. December's dividend cut freed up some cash that helped AGF to seed the fund's initial investment: joining the consortium buying the passenger terminal at Billy Bishop Toronto City Airport.

AGF is also trying to expand its institutional and high-net-worth businesses, meaning it hopes to manage money for big groups such as pension funds and for wealthy Canadians who want to invest in more than simple stocks and bonds. Until now, AGF's retail arm, with its high annual fees, has dominated profits, but it will be hard to keep these fees so high as rivals continually cut theirs. As well, the industry is emphasizing better disclosure. Thanks to new regulations taking effect in 2016, retail investors will receive annual tallies of how much they pay to advisers each year. The initiative, known as CRM2, has caused much consternation—the industry's Y2K moment, perhaps.

Sitting together, Goldring and McCreadie continually brush off questions about being flustered by the negative spotlight. The only thing they admit to getting frustrated by is the market's refusal to ascribe any value to anything but their retail business—something that is especially frustrating because the other arms are the focus of their growth plan.

"If you really dissect it, the sum of the parts is worth more than where the stock price is today—I don't argue that with them," says Scott Chan, an analyst at Canaccord Genuity. "But the problem is that AGF has that dual-class structure and Blake…doesn't seem to want to sell the company or divest some of these business units. So there's no real catalyst to unlock the value."

In other words, investors only see a long slog ahead—one where many rivals are trying to market themselves as alternative asset managers, including Lee-Chin.

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The obvious question, then, is why not sell—if not the whole business, at least some divisions?

If only there were a simple answer. Right before the financial crisis, when AGF was trading around $38 per share, CI put in an offer, according to people familiar with discussions at the time. Some of the banks also circled AGF. For the Goldrings to have rebuffed those overtures and then sell the business today, when AGF's shares are trading around $6, may simply be too hard for them to stomach. AGF's market value, as of early August, is roughly $500 million, down from $3.4 billion in 2007.

Family dynamics also loom large. If Blake threw in the towel, it'd be much tougher to fulfill his father's wish of creating a dynasty. AGF is what keeps the Goldring name in the headlines—for better or worse. The Goodman family proved willing to sell its stake in DundeeWealth to Scotiabank in 2011, but the Goldrings don't seem willing to let go.

There is also the possibility that AGF may not be able to sell, even if it wanted to. Buying the company probably doesn't make sense for CI or a Canadian bank today because the differential between their fee structures and AGF's is so large. It'd be tough to pay a premium to acquire AGF and then turn around and slash its fees in half to make them palatable for the buyer's existing clients. Maybe there's an insurer who sees a scarcity of wealth management assets available in Canada and is willing to do it for the sake of bulking up—traditional life insurance is a tough business because interest rates are so low—but that's a big maybe.

Asked why he doesn't just sell, Goldring won't admit that he's even thought about it, instead opting for the canned response about being comeback kids. He also says his company has a lot of things going for it—some of which are undeniable. In an era where six big banks dominate Canadian's financial decisions, he believes investors will look to independent firms. AGF is also diversifying its product offering and has boots on the ground in different parts of the world, with offices in places such as Singapore, Beijing and London, which he believes adds global expertise—something his father specialized in. And there are signs the emphasis on performance is paying off: 45% of the company's assets now sport returns above the industry median over the past three years. Not exactly stellar, but an improvement.

Eventually Goldring admits any turnaround won't be easy. "I'd love to just snap my fingers and have everything done in a quarter, two quarters," he says. "But it's not that way." McCreadie is on the same page, ruling out any transformative acquisitions for the sake of bulking up quickly. AGF's done that, and it's been burned. Acquiring Highstreet in 2006 added about $5 billion in assets under management, but nine years later only $1.4 billion remain. "There's no Hail Mary pass that wins the game overnight," McCreadie says.

Ironically, it's possible the company's incredible recovery leading up to the global financial crisis was the worst thing for AGF in the long term. Getting out of that rut made Goldring believe anything's possible. This time around, as sound as AGF's performance-driven strategy seems, it may not be enough because the competitive landscape looks entirely different than it did a decade ago, and AGF's current downturn is about twice as long as its last one. During this drought, AGF's hype has lost its edge. No matter how good its new products are, it will be a struggle to win back public opinion. Ask anyone at BlackBerry Ltd. how hard that is to do.

People who know Goldring well say everything that's transpired has personally wounded him. McCreadie's in a different boat. He could have stayed in Baltimore, but he wants to take a run at one more major challenge before he retires, and hopes the rest of the company also revels in the complexity that lies ahead. "The journey is what this is all about. The fun is taking the Cubs to the World Series." (They haven't been there since 1945.)

In a funny way, it's an apt analogy for what AGF must endure if its recovery is going to happen. McCreadie still thinks like an American, and the mutual fund market south of the border is dramatically different. The banks and insurers have much more power here, and the new guy calling the shots has to learn to navigate the Canadian market. Our culture is different, too, and he'll have to make the adjustment to win over the retail advisers AGF relies on to sell its funds.

No sooner is the Cubs comparison out of McCreadie's mouth than Goldring jumps in to politely tell him the better analogy is the Toronto Blue Jays.

They haven't made the playoffs since 1993.