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Fund Company Mergers
Will AGF and Global Strategy unitholders benefit?

Over the past two years, there have been over a dozen marriages between fund companies and/or investment management firms - including three over the past few weeks. Shareholders of the respective firms almost always benefit from a joining of forces. Those that benefit most tend to be the shareholders of the firm being acquired. It's not unusual for take-over bids to exceed recent market prices by 20% to 40%. For instance, when Templeton's parent firm bought Bissett earlier this year, the acquisition price was about 22% above recent market prices for the Bissett's stock at that time. In addition, shareholders of the newly merged company will surely benefit since some cost cutting is usually possible, thereby reducing the company's cost structure and increasing profits. So the benefits to stakeholders are clear but what about the unitholders of the companies' funds? Do unitholders ever benefit from increased investment resources and economies of scale?

Merger Benefits

There are three potential benefits for fund unitholders when fund companies merge. First, the team of investment analysts of the newly merged firm may be more effective as one cohesive team (and potentially kick out better stock recommendations), compared to the two separate pre-merger teams. This is extremely difficult to isolate and measure. Though each has an in-house management team, AGF and Global Strategy each have lots of strong alliances with outside foreign money managers. So the potential benefits appear to be limited in this respect.

Second, the merging of administrative and back office systems usually results in reduced operating expenses for the funds and, in turn, for unitholders. Though a direct benefit to unitholders, post-merger cost savings on funds have historically been quite small. Back in 1995, AGF purchased the small but strong 20/20 Funds Inc. Within a year of the merger, the Canadian equity funds of the two companies realized savings of just 9 basis points (or 0.09 percentage points) on average. The merging of balanced funds resulted in reduced operating expenses of about 10 basis points. The two firms' Canadian bond funds were merged and fees dropped by 2 basis points, despite a falling asset base. The maximum management fee on the AGF Growth and Income was reduced from 2.50% to 2.25% but that had a negligible effect on the fund's MER. For 1999, average net assets for this fund were more than 13 times larger the pre-merger level, but fees dropped by only 5 basis points over that same period (from 2.50% to 2.45%). Meanwhile, fees on specialty equity funds (Latin America, India, and Emerging Markets) were mixed during the year after the merger - with some rising and some falling.

The third potential benefit is really directed at investors who have bought funds on a deferred sales charge (DSC) basis. When purchasing funds on a DSC basis, investors are subject to a sales charge for selling out of a fund family (i.e. Selling Trimark to buy Templeton) within a six or seven year period. However, most mergers eventually allow full transferability between merged families. AGF's family of funds add a strong and deep product line to which Global Strategy unitholders will be able to transfer without penalty in the near future. For instance, if you've been frustrated by the performance of Global Strategy's Canada Growth fund (a deep value fund), you'll eventually be able to switch that over to AGF's Canadian Dividend fund (a relative value fund), which in my opinion is the family's best core Canadian stock fund.

Other Fund Mergers

There isn't a lot of history to go on when it comes to fund companies with lots of assets merging. However, going back a couple of years to the AIM-GT Global merger shows that unitholders really didn't benefit at all in the form of cost savings. While unitholders in these families reaped the huge rewards of great performance, it's not likely any of that was the result of the merger.

Likely Benefits

In most cases, the reduction of fund fees appears to be more attributable to continued net sales, rather than through fund mergers. So despite AGF's press release, which clearly noted that unitholders will benefit from cost savings, it seems likely that cost savings will be in the range of 5 to 10 basis points per fund on average. But with competition on fees heating up over the past couple of years and a substantial asset base, there is the possibility of greater cost savings over the next year or two. It's the least that unitholders deserve.

UPDATE ON PROPOSED TAX OF FOREIGN SECURITIES

On September 7, 2000 the Department of Finance issued a press release (http://www.fin.gc.ca/newse00/00-064e.html) extending the comment period on the draft legislation affecting foreign investment entities to December 31, 2000. Also, a couple of modifications have already been confirmed. In particular, some tax relief will be given to those who have already accrued big gains in affected securities, allowing their gains to be 2/3 (rather than 100%) taxable only upon ultimately selling such securities (rather than immediately upon the law's effective date). Further, investment funds that fall under the IRS's definition of "regulated investment companies" (RICs) will likely be exempt from this proposed tax. RICs include most US-based mutual funds and all exchange-traded funds (ETFs) traded on a US stock exchange. Corporations will be exempt as long as their main business is not an "investment business". As for holding companies, only those that are US RICs will be exempt from this tax. So holding companies and closed end country funds outside of the US will still be hit by this tax. If this still affects you, you still have time to comment - see my August 22, 2000 article for details.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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