Thursday, August 13, 2009

Mutual funds - is the honeymoon over?

Too much of a good thing: The AIC buy-out.

Consider the recent marriage of Manulife Financial and AIC.

AIC’s founder, Mike Lee-Chin, is an inspiration to ambitious young finance students everywhere. The rags-to-riches story of the Jamaican immigrant who became a billionaire inspired me too. I knew Mr. Lee-Chin when he was merely a millionaire; he was the manager of Regal Capital Planners Hamilton office and I was the manager of Merrill Lynch Canada’s Hamilton office. He had a passing interest in my specialty which was technical analysis of the stock market. I had more than a passing interest in Canada’s top mutual funds salesman, rumoured to be earning a million dollars a year in commission!

In 1983 I moved to Toronto to search for opportunity in the financial capital of Canada. Mike stayed in Hamilton and proved that there was plenty of opportunity there too.

Apart from the human interest angle, will the Manulife-AIC wedding have any impact on the Canadian investment scene?

In my recently released investment book, Beyond the Bull, I talk about the three great drivers of the stock market: investor brains, investor heart and investor position. Brains is the easiest to understand: investors are motivated to buy and sell because of rational logical facts and figures about stocks and companies. Heart is easy to understand too: when investors are fearful or worried, they often sell stocks at too low prices – when they are full of confidence they sometimes pay too much for stocks. It’s the last one, investor position, that poses a potential problem to the Manulife-AIC newly weds.

AIC mutual funds’ core holdings include TD Canada Trust, AGF Management, CI Financial and IGM Financial. A quick check of Manulife’s website showed me that they too love the financial sector: about one third of their largest mutual funds are invested in this one sector alone. But, can a mutual fund own too much of a good thing? At one time it was rumoured that AIC had 10% of their total assets in one stock: TD Canada Trust. Portfolio managers refer to this as ‘concentration.’ Critics would say ‘over concentration.’ That’s an investor position problem.

If this mutual funds company wedding results in Manulife having too many of their collective eggs in one basket, they will be selling some of AIC’s TD, AGF, CI Financial and IGM stock. And the reason for the selling has nothing to do with the growth and value of these four companies. Nor does it have anything to do with Manulife’s portfolio manager’s emotional liking or disliking these four companies. The problem is their position: they own too much of a good thing.

Part 1 of the problem
Manulife may have to sell significant amounts of financial stocks because of this merger. This selling could dampen the performance of that sector over the next few months.

Part 2 of the problem
Use your imagination: if you were managing a big mutual fund or pension fund and you saw this AIC-Manulife wedding, what would you do? What if you had been planning to sell of some of your financial stocks over the next few months? Would you wait until the Manulife selling starts, or would you sell now? Of course, you would sell now. This selling could also dampen the performance of the financial stocks for a while.

Using position analysis, we might expect the financial sector, specifically TD Canada Trust, AGF Financial, CI Financial and IGM Financial to under perform the market until Manulife’s possibly over weigh position is liquidated.

Part Three.
What about the brains and the heart? Are there logical or emotional reasons why bank stocks and mutual funds management stocks might under perform? Wasn’t it only last year that the biggest banks in the USA and Europe were being bailed out? And isn’t the mutual funds industry in consolidation? AIC shrunk from $14 billion to $3.8 billion: it seems unlikely that AGF, CI or IGM would be thriving in times like these.

Part Four: it gets worse
Speculation has it that Mr. Lee-Chin received a dowry of around $150 million in Manulife Financial stock in exchange for his beloved AIC. Talk about an over concentration! Is it reasonable to assume that he might like to sell some shares of Manulife? Could his selling contribute to the under performance of Manulife stock?

Manulife management knows all about their position problems and will act prudently, so as to protect their shareholders and unit holders. They will have made plans for this wedding months ago. My company, CastleMoore Inc, manages investors’ portfolios too. We have no plans to buy financial stocks until the honeymoon ends.

Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc

Links to Beyond the Bull:


No comments: