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Does size matter?
Why a CI-Mackenzie merger could be problematic

What would you get if you merged two of the country's largest marketing and money management firms? Answer: the largest domestic mutual fund company, a wealth of innovation, numerous fund offerings in every conceivable asset class, and a potential consolidation nightmare. Two months ago we discussed the AGF-Global Strategy merger and how most of the benefits accrued to the respective companies' shareholders, leaving limited benefits for both firms' fund unitholders. Merger-mania continues.

Nearly two weeks ago, CI launched a hostile takeover bid for rival Mackenzie Financial Corporation, valued at nearly $4 billion. Usually, corporate takeovers occur between two parties that have complimentary strengths, but that's not the case here. This week, we'll take a look at what possible advantages lie ahead for this proposed merger, in addition to some road blocks that might put the brakes on the deal.

Similarities and Strengths

Overall, CI and Mackenzie are very similar firms, each offering a multitude of funds in all asset classes across the spectrum of investment styles. In fact, each firm offers a staggering total of about 200 funds according to Globefund, when all of the multiple versions are included (i.e. segregated funds, clone funds, various classes, etc.). CI and Mackenzie each have strong and deep internal management teams in addition to solid relationships with top-notch external advisors. CI has led the industry in the innovative alliances it has struck with external advisors, with whom CI typically establishes jointly owned money management firms. This structure minimizes manager turnover because the money manager has an ownership stake in the joint venture. Innovative product offerings are also commonplace within both organizations, with everything from segregated funds to tax deferred structures to clone funds. Mackenzie has clearly been the single most innovative fund company in Canada when it comes to new product development.

Ironically, the very thing that prevents each firm from having any glaring weakness is, itself, each firm's largest weakness. Offering funds in virtually every asset class in all styles results in a lot of mediocre funds, but also good funds in all of the major asset classes. The main weakness common to both firms is the excessive number of funds offered by each. In fact, the totals are downright silly.

A Maze of Fund Offerings

Let's look at Canadian balanced funds for example. If we exclude multiple versions of the same fund (i.e. multiple classes, clone funds, etc.), CI and Mackenzie would have a staggering total of 18 different Canadian balanced funds. Including all versions of all such funds brings the total up to 33. What about global equity funds? CI and Mackenzie have 15 different global equity funds - that excludes international equity funds which exclude North America. Include the multiple versions and you'd be looking at a dizzying total of 43 global equity funds.

The area about which I'm most concerned is in the Canadian equity category. Canadian small cap funds total "just" 4 among both companies - or 7 when including all fund versions. Funds specifically focussing on mid-to-large Canadian stocks total 16 - or 31 counting all versions. My guess is that a good chunk of the cost savings in the first couple of years would be eaten up by the legal and administrative costs of merging the huge fund line-ups. I think unitholders - particularly those invested in the families' Canadian stock funds - should be concerned if this merger proceeds as proposed. Adding up all of the money each fund has invested in Canadian stocks gives a total in excess of $14 billion. To put this figure in context, consider that the $14 billion that this merged firm would manage is:

  • 1.2 per cent of the total market capitalization of the S&P/TSE 60 Index;
  • approximately 10 to 15 per cent of all retail fund assets invested in Canadian stocks; and
  • More than triple the amount of actively managed Canadian equity money run by the Ontario Teachers' Pension Plan Board - one of the country's largest pension plans.

    Trading Restrictions

    While $14 billion isn't a prohibitive amount of money to manage domestically, I'm suggesting that it could be a problem if too many different management teams are investing money among a relatively small group of stocks. It's that combination of a large asset base and an excessive number of money managers under one roof that could prove problematic. What types of problems might occur?

    Trading restrictions are one possibility. For instance, let's say one fund puts in a buy order for a stock. If included on a restricted list of securities, other funds in the family would be prohibited from placing buy orders in that same stock for a period of time so that the price isn't pushed up before the stock is purchased by the first fund. Consider that each management team holds somewhere between 25 and 80 companies. With $14 billion chasing a grand total of, let's say, two hundred stocks, many risk being put on a "restricted list". The less frequently a stock is traded (i.e. low volume) and the higher the number of shares owned by the funds, the more likely it will be to get put on restricted list. Some would argue that it's not a big deal since many firms already have lists of restricted securities.

    The firms that currently have long lists of restricted stocks are typically global money managers with a huge universe of foreign stocks of all sizes in all industries from which to choose. With over 1,100 mutual funds (i.e. Canadian balanced, Canadian equity, and dividend funds) in Canada pouring money into domestic stocks and just 1,400 stocks available (a small proportion of which are large caps), this could clearly become an issue for many firms at some point. While I don't think it would be an immediate problem, I think the potential is there in the foreseeable future given the large number of Canadian equity management teams, an already large asset base, and the strong sales momentum of both firms. Two factors that mitigate this risk are that:

  • mutual fund sales have slowed dramatically, so much of the new sales in some funds may simply be switched from other underperforming funds; and
  • overall, the Canadian equity money at both firms would not see very frequent trading. The low turnover of big funds like Ivy Canadian, Universal Future, and CI Harbour keep overall trading frequency relatively low.

    The domestic liquidity issue is not a big deal - yet - but it could be. This is one of the many reasons why it's smart for a company that is so strong domestically, like Mackenzie, to seek a partner with global strength. We saw this played out in deals involving Trimark, Sceptre, and Perigee just in the last year.

    At the very least, both unitholders and shareholders will likely benefit most if Mackenzie merges with a firm having characteristics that are complimentary, rather than nearly identical. If CI is successful in its quest for Mackenzie, they would serve unitholders and shareholders well by streamlining the confusing array of current managers as much as possible - especially in Canada.

    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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