QUIC RESEARCH REPORT Financial Institutions Group David Chan Neil Shah Adam Carnicelli Ioulia Malamoud An Overview of the Canadian Asset Management Space Introduction An asset manager partakes in the management of a client's investments, by investing on behalf of its clients and giving them access to a wide range of traditional and alternative product offerings. Today's Canadian asset management industry is marked by increased competition, heightened regulatory scrutiny and growing customer demands for more information on how to best invest their money. Highlights - This report will provide a brief overview of the Canadian asset management industry, including major players, drivers of demand, and the competitive landscape, while highlighting the service offering differences between banks and independent players - The report will further explain the business model of asset managers, explaining key revenue and expense drivers, as well as the various investment approaches available to clients - Next, it will outline larger trends and themes for the industry in 2016, including target market and product offerings. It will also dive into the current regulation in the industry - The report will conclude by providing insights on the implications to the QUIC portfolio in terms of the attractiveness of the industry and also potential investment opportunities QUIC Research Reports focus on emerging investment themes that affect current portfolio companies and companies under coverage. The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended to constitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members or directors, or Queen s University be liable to you or anyone else for any loss or damages whatsoever (including direct, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of this document, or reliance on the information or content found within this document. The information may not be reproduced or republished in any part without the prior written consent of QUIC and Queen s University. QUIC is not in the business of advising or holding themselves out as being in the business of advising. Many factors may affect the applicability of any statement or comment that appear in our documents to an individual's particular circumstances. Queen s University 2016
Table of Contents Overview of the Canadian Asset Management Industry 3 Asset Management Business Model 4 Trends in the Asset Management Space 5 Regulation 6 Portfolio Implications 7 References 8
Overview of the Canadian Asset Management Industry Companies in the asset management industry manage the financial assets of corporate, institutional, and retail clients. They operate by investing funds, providing professional management and an inexpensive way to diversify a portfolio, emphasizing margins, rather than ROE. Demand in the industry is driven by demographic and market trends, such as the growing population of retirees and the accumulation of wealth and investable assets, as well as returns on investments. The profitability of individual companies depends on the volume and performance of the assets they manage. Large companies have advantages in providing expertise in a wide range of investment options. Small companies can compete by focusing on a single product or client. Four main products are provided: mutual funds, managed accounts, institutional assets, and alternative assets, such as hedge funds and leveraged ETFs. These are targeted towards three focus segments: high net worth individuals, which are defined as having investable assets in excess of $1 million, retail players, and institutional investors. EXHIBIT 1 Increased Competition (AUM) 60% 40% 20% 0% 44% 23% 13% Source: IBIS World 40% 40% 33% 25% 11% 9% 42% 41% 34% 35% 11% 12% 4% 1999 2006 2007 2008 2009 Manufacturer/Independent Banks Tied Distribution Direct Sellers 3% Competitive Landscape Canada has a mature, competitive and wellregulated asset management sector, which has remained buoyant despite the pressures caused by economic turmoil. Canadian banks currently control 43% of the mutual fund market, based on assets under management, and 28% of fund distribution in Canada. With their extensive brand reputations, customer relations, extensive branch network, and house-brand funds, the banks have doubled their share of the market over the past decade. As a result, banks have managed to grow assets at a higher rate than the industry by becoming very effective at selling products and retaining assets. By virtue of being among the largest manufacturers of mutual funds, banks are in a better position to compete on price, forcing other asset managers to fight for market share. To combat banks, asset managers offer above average investment performance, superior customer service, competitive pricing, innovative products to serve specialized niches, and the ability to adapt quickly to changing industry trends EXHIBIT 2 Top Canadian Industry Participants (AUM) RBC Asset Management Cl Fund Management Investors Group TD Asset Management Inc Fidelity CiBC Asset Management Mackenzie Financial BMO Investments Inc. Invesco Trimark Investments Dynamic Mutual Funds AGF Fund Management Source: McKinsey & Co. $0 $20,000 $40,000 $60,000 3
Asset Management Business Model By definition, an asset management company invests its clients' pooled fund into securities that match its declared financial objectives. By investing in assets and markets growing in value, the firms hope to maximize their clients' returns on their money. These companies earn income by charging service fees to their clients. EXHIBIT 3 Overview of How an Asset Management Company Works Revenues The typical asset manager business model revolves around managing investments of clients based on fees such as: Management Fees Fees generated for managing investments; steady source of earnings, usually a % of AUM annually is attributed to management fees Performance Fees - Fees that are generated based on purely on performance, tend to be more volatile source of earnings as they are more sensitive to equity market. Performance fees are a coupled with performance metrics such as the hurdle rate, the minimum rate which is required before performance fees can be earned, and the high water mark, the highest peak in value that the fund has reached. Operating Expenses Asset managers are subject to various operating expenses. As any company, they incur selling general & administrative expenses, as well as commissions, amortization, and interest expenses. A useful metric in indicating the state of an asset manager s operating expenditures is the management expense ratio (MER). The MER is the total of management fees, operating expenses (or administration fee) and GST/HST charged to a fund each year, expressed as a percentage of a fund's average net assets for that year. All mutual funds have an MER., Finally, for asset managers, EBITDA should be generally above 40% Source: The Association of Investment Companies Investing Approaches There are a variety of way a company can approach the investment strategy for a client. Asset Allocation Involves periodically rebalancing the portfolio in order to maintain a long-term goal for asset allocation, where investments are held in a mix of stocks, bonds, cash, commodities or alternative investments. Alternative Investments Include hedge funds, managed futures, real estate, commodities, and derivative contracts. Most alternative investment assets are held by institutional investors, or high net worth individuals. 4
Trends in the Asset Management Space Expansion of Middle Class/Mass Affluent Clients As the global economy continues to grow and developing nations modernize, the asset management industry can expect to see record inflows over the coming years. The economies of South America, Asia, Africa and the Middle East (referred to collectively as SAAAME) will see the wealth of their mass affluent population (individuals with between $100,000 and $1 million of investable assets) double. Moreover, the global middle class is projected to grow by 180% between 2010 and 2040, and will see Asia replace Europe as the home of the highest proportion of middle class consumers. This represents a unique opportunity for asset managers to capitalize on the rapid increase in potential investors. As many (if not all) North American asset managers are relatively unknown overseas, a unique opportunity is also presented to develop a strong reputation among this new generation of investors. EXHIBIT 3 Global Mass Affluent Wealth Projections by Region for 2020 ($T) $125 $100 $75 $50 $25 $0 Source: PwC $2.1 $59.5 $20.5 $22.8 $4.5 $43.3 $31.6 $13.7 $20.1 North America Asia Pacific $100.4 2012 2020E Europe Latin America EXHIBIT 4 ETF Growth in Canada ($B) $100 $80 $60 $40 $20 $0 The Rise of ETFs $6.6 $87.6 1999 2015 Source: Mackenzie Investments Exchange traded funds have skyrocketed in popularity in recent years. Their liquidity, transparency and low-cost structure have helped the industry grow to almost $5 trillion AUM, while the Canadian space expects to reach $100 billion AUM by the end of 2016. asset managers have been keen to capitalize, as the number of ETF providers in Canada has nearly doubled over the past two years. Aside from passive, index-tracking ETFs, many companies have introduced actively managed ETFs, which have live PMs adjusting the weightings of each fund, as well as smart beta ETFs, which track a non-market-cap-based index that can be tied to momentum, dividend yield, volatility, etc. Advancements in Fund Construction and Distribution Roboadvisors such as Wealthsimple and Nest have begun to offer low cost, online-only alternatives to traditional asset managers, selling index-tracking ETFs to investors that are new to the market. These startups have inevitably compressed the margins of typical asset managers, as they compete with lower cost bases and challenge the true utility of the management fees traditional dealers command. 5
Regulation One historic criticism of the asset management industry has been a tendency of advisors to provide information that is misleading and/or difficult to comprehend. In many circumstances, it is difficult for investors to understand what the true cost is of purchasing a fund without having fairly substantial prior knowledge of investing, as much of the literature provided by asset managers lacks transparency and is ridden with jargon. As asset managers continue to focus on developing their retail operations, more and more Canadians with little to no prior financial education are beginning to invest in mutual funds and other similar investment vehicles. As such, the Canadian Securities Administrators (CSA) decided to implement the Client Relationship Model Phase II, commonly referred to as CRM 2. The legislation, currently nearing the end of its three year implementation period, aims to harmonize rules from the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). It will require more thorough cost and performance disclosure to clients, with the hopes of increasing transparency and making the lives of investors easier. Stages of CRM 2 CRM 2 is broken down into three phases. Phase 1, ending in July 2014, required advisors to disclose all charges before completing any trades, as well as explaining performance benchmarks and their utility. Phase 2, which ended in December 2015, introduced enhanced account statements that provides information such as the market value of each fund, the cost of each underlying security, etc. Finally, phase 3, currently being implemented, mandates the introduction of annual performance reports and annual charges and compensation reports. Why CRM 2? The main goal of CRM 2 is to bolster investor confidence, while challenging asset managers to be transparent about the real returns of their funds and the fees that managers collect. The explicit documentation of real performance returns and management fees are designed to make the investor question the true value of the services they are receiving, and ultimately demand that advisors are acting in their best interest at all times. EXHIBIT 5 CRM 2 Implementation Timeline The adoption period is spread over three years to allow firms to adequately adapt to changing regulations July 15, 2014 Pre-trade disclosure, advisor compensation reporting December 31, 2015 Enhanced client statements with detailed cost info July 15, 2016 Annual reporting of charges and performance Source: BMO Global Asset Management, IGM Financial, PwC 6
Portfolio Implications Opportunities to Invest in Canadian Asset Managers Given our investable coverage universe in Canada, there are few companies within the space. However, there are many hurdles that Canadian asset managers must overcome in order for the FIG team to feel comfortable to make an investment. Broadly, asset managers must implement cost cutting initiatives and focus on new investment solutions. Hurdle 1: Increasing Costs The costs of asset managers will continue to soar as they have in recent years and margins will continue to be compressed. Today, profits are still 15-20% below their pre-crisis highs, and there seems to be no improvement in sight. Furthermore, commercial cost pressures will also rise as firms grow their distribution networks and product manufacturing capabilities to take advantage of increasing market size. In addition, fees earned by asset managers will be under continued pressure amid the ongoing push for greater transparency and comparability from investors, as well as scrutiny from policy makers and regulators. Lastly, investment in technology and data management will also need to be maintained or increased to maximize distribution opportunities, or to benefit from new opportunities offered by new technologies and social networks. Hurdle 2: Shifting Investment Landscape Investors are increasingly looking for bespoke investment solutions that deliver predictable absolute returns while reducing volatility. This shift to outcome-based investment requires asset managers to develop new products that harness a broader range of asset classes and investment techniques. We expect multi-asset solutions to be the investment strategy that contributes most to business growth over the next three years. However, fulfilling this potential may be challenging for asset managers. Currently very few asset managers are equipped to thrive when it comes to offering multiasset class investment solutions. We believe asset managers need to focus on 3 things in order to be successful in the changing economic landscape: Transformation restructuring operations around the changing needs of investors and regulators Tools investing in state-of-the-art analytics to give clients real-time insights across increasingly complex investment portfolios Talent shoring up capabilities to support new investment strategies Although no names stand out at the moment, we will continue to evaluate our coverage universe in search of a Canadian asset manager that embodies these three characteristics. Market Enterprise EV / EBITDA P / E ROE AUM EV / AUM Div. Yield Asset Managers Cap ($MM) Value 2016E 2017E 2016E 2017E 2016E 2017E ($MM) (%) (%) IGM Financial Inc. $8,724 $16,690 12.6x 13.3x 11.3x 12.3x 15.7% 15.8% $132,900 12.6% 6.2% CI Financial Corp $7,319 $7,806 8.3x 8.9x 13.2x 13.8x 28.8% 29.7% $108,715 7.2% 5.1% Fiera Capital Corporation $979 $1,194 14.6x 11.8x 12.6x 11.1x 12.8% 15.7% $97,988 1.2% 4.7% Sprott Inc. $631 $405 14.1x 12.0x 39.1x 25.4x 5.4% 4.0% $8,800 4.6% 4.7% Guardian Capital Group Ltd. $602 $501 nmf nmf 18.7x 14.6x 34.0% 47.0% $24,817 2.0% 1.6% Gluskin Sheff + Associates, Inc. $485 $435 5.7x 6.6x 11.4x 14.9x 6.9% 6.8% $8,199 5.3% 3.4% AGF Management Limited $418 $652 4.9x 6.0x 9.0x 10.8x 4.3% 4.6% $31,450 2.1% 6.1% Mean 10.0x 9.8x 16.5x 14.7x 15.4% 17.7% 5.0% 4.6% Median 10.4x 10.3x 12.6x 13.8x 12.8% 15.7% 4.6% 4.7% 7
References 1. IBIS World 2. McKinsey & Co. 3. The Association of Investment Companies 4. PricewaterhouseCoopers 5. Mackenzie Investments 6. IGM Financial 7. BMO Global Asset Management 8. Capital IQ 8