The current issue of Advisor’s Edge Report has an exclusive feature with Michael Lee-Chin. For Advisor.ca readers, we’ve included additional content not covered in the print publication.
Lee-Chin, the founder and CEO of Portland Holdings, recently sold his privately held mutual fund company AIC Limited to Manulife Financial. He says the sale hinged on him retaining lead manager responsibilities on the AIC Advantage Fund, a role he has held since 1987.
In a candid interview with Advisor Group’s Mark Noble and Philip Porado, he explained that in many ways he’s happy to be focused on one of his true passions in life — investing. When it comes to that, not a whole lot has changed in his approach.
Mark Noble (MN): You recently sold your mutual fund company, AIC Limited to Manulife Financial. How did it feel to sell that business?
Micheal Lee-Chin: The decision to sell was made easier by the fact that I continue to manage The Advantage Fund, which I have managed since 1987. The Advantage Fund is really an expression of who I am and how I invest. I would like that legacy to continue. Manulife has acquiesced in terms of giving me that opportunity.
On the other hand [selling AIC] was painful but in life you have to look forward, not backward.
MN: Has your view of investing changed at all since 1987?
LEE-CHIN: No. My investing style can be defined by one word: understand. You buy things that you understand. That hasn’t changed since 1987 and if you look at the composition of the Advantage Fund, 60% of the businesses remain in the wealth management space, and that is the business that I grew up on and understand.
MN: The margins on the wealth management business have compressed over the last few years. Do you still think as a long term investment it still offers the opportunities that it once did?
LEE-CHIN: Okay, I’m going to ask you a question? How many banks went under over the last year?
Philip Porado (PP): Getting close to a hundred.
LEE-CHIN: Phil, don’t nudge him! Don’t give him the answer!
MN: It’s probably over a hundred, there are a lot of small regional banks that failed.
LEE-CHIN: Exactly. That was question one. Question #2: How many wealth management companies have gone bankrupt in the United States this year?
MN: Other than small/broker dealer firms — not many.
LEE-CHIN: None! So you’ve got a comparison of 100-to-zero. Let me ask you another question. If you were to look at your typical mutual fund in Canada and examine how it’s diversified across industries, if you were to single out the financial services component of that mutual fund, typically, what type of financial services stocks do you usually see represented?
MN: It’s usually the large insurance companies and the large banks.
LEE-CHIN: Exactly! Isn’t that quite risky given what we’ve just discussed? On hundred banks have gone bankrupt and no wealth management companies have. Therefore which business model would you want to invest in?
MN: Well, here’s my question then. Who’s buying wealth management firms?
LEE-CHIN: Before we get to that, you have to ask yourself a question, why would a money manager, whose job it is to minimize risk, expose themselves to that kind of risk? Why are money managers buying banks and insurance companies when the money management business is model is one that is a lot less risky? It has a 100-to-zero failure rate as we discussed.
The reason is most money managers are index huggers. They can’t deviate from the index for too long, or they will lose their job. The financial services component of the index is chock full of banks and insurance companies.
If the money managers were being totally business rational, you would have an inverted scenario where there are more money managers than banks and insurance companies because the risk profile is better.
We need to ensure that advisors are aware of this. Money managers are actually exposing their investors to more risk. This is a gaping hole in logic.
MN: The wealth management business in Canada has changed drastically over the last two decades. The last two decades have been earmarked by growth and the incursion of large financial institutions such and the bank and insurance companies.
Are the margins there? Are the next 20 years going to be as profitable as they were between 1997 and 2007?
LEE-CHIN: The margins are not going to be as they were in the early 1980s. This is a scaled business, so the margins may be going down, but the volume is going up. Therefore on an absolute basis on profitability, these are good businesses to be in.
MN: Once you become an investor in the wealth management space, where do you find the opportunity then? Take Manulife for example, which is a huge diversified financial services player, which now owns two of your former companies. How do you get opportunity investing in companies like Manulife, which seem to be the template for where the large wealth management companies are going? Is it just holding them long term and letting growth compound over time?
LEE-CHIN: In the case of Manulife, you have to understand that its revenue is not derived purely from risk management.
I would suspect — in fact I know — they want to grow their wealth management business faster than any of their other business units because it is actually the least risky of all of their businesses.
You ask me how do I participate in their success of these companies. You buy into them, and you simply hold them.
MN: If we focus on the Advantage Fund, what type of time horizon are you focusing on with your 60% allocation to financial service companies?
LEE-CHIN: If we go back in history, we bought AGF in 1987, when I started managing the [Advantage] fund. I’ve held AGF for 22 years. AGF is the single largest holding in the Advantage Fund, representing 13% of the fund. We bought more of AGF in March, when it had gone down to around $8.00 it’s now at $17 (at time of interview).
Investors Group was the same. We bought IG in 1987 and it represents about 12.5% of the Advantage Fund.
We bought CI in 1994 — one year after it went public. We still own CI today. CI is 6% of the Advantage Fund. We have Invesco, we bought that in 1994 (as Trimark).
This goes back to the financial crisis. One of the reasons that banks and insurance companies got into trouble is they had on-balance sheet assets. Mutual fund companies do not have on-balance sheet assets.
They derive a royalty steam income from off-balance sheet assets, which makes them low risk from a business standpoint. That’s why we once again have the 100-to-zero comparison.
Insurance companies are deriving more of their assets from wealth management assets. Advisors should have their clients core portfolio in wealth management companies before the banks and insurance companies which is the not the case today.
Normally I would own banks and insurance companies before wealth management companies. Today that is not the case given the business risk (of banks and insurers).
MN: Why own shares in wealth management companies versus the mutual funds that they offer?
LEE-CHIN: (Laughs) That is a loaded question Mr. Mark.
MN: When you’re looking at investing in the actual shares, are their tangible revenue growths within investment management firms that can’t be derived by investing in their mutual funds?
What do you see in the operation of wealth management companies that makes them a good opportunity for investors?
LEE-CHIN: Let’s look at the history. If over the past 14 years you had bought a CI fund — as of June 30, 2009, the best CI mutual fund, would have been the CI Canadian Investments Fund — $10,000 invested in that would have earned you $41,000.
Had you owned CI stock, that derives its money from revenue generated from that fund. That $10,000 was worth $164,000. The best AGF fund over the last 14 years was the AGF Precious Metals Fund: $10,000 invested in that would be worth $35,000 now. Owning AGF stock would have given you $56,000.
Investors Group: $10,000 [invested in their best fund] over the last 14 years, would be worth $26,000, shares in IG would be worth $63,000.
That is a quantitative historical result.
PP: A lot of people projecting the real estate market going forward are saying the real housing bubble may in fact end when baby boomers want to retire and sell off their principal residence. People in line who want to purchase those assets are probably not going to be able to afford to purchase those assets. Could the same thing not hold true for wealth management?
LEE-CHIN: That question presupposes that we’re in a static economy, that has shrinking population and that we have an aging population that is not be replaced by immigration.
As you age, your income needs become less. As we age our income needs coalesce, I’m not too fussed about what’s going to happen 20 years from now, I’m sure there will be other compelling reasons whereby if this inversion of wealth becomes so prominent that the government will be prodded to open the immigration gates and let in the young people to start producing.
I’m not really focused on extrapolating the trend that we’re seeing today with regards to an aging population.
MN: You have diversified your holdings if I’m not mistaken. You now have interest in Indian port facilities? Is that investment a result of expected growth in emerging markets?
LEE-CHIN: The hallmark of what we do is to invest in things we understand. We own a port in Jamaica. The port of Kingston is actually busier than any port in the Eastern United States; it’s even bigger than Panama. That is a function of Jamaica’s ideal location between North and South America.
There are two operators there, one is the government and the other is us. So we own a port and understand the port business.
About two years ago, this port facility — Mundra port and economic zone in India — had an IPO.
The port includes 129 square kilometres of land that is designated a special economic zone. This means if you locate your factory there you get duty free importation of raw material and capital goods. When you make a profit, you get tax-free profits.
It reminded us immediately of [the Chinese port city] of Shenzhen. Shenzhen 30 years ago was just a fishing village and the Chinese government designated it a special economic zone. Shenzhen went from essentially a population of zero to nearly 10 million in just over 20 years.
The city has the highest income per capita in China. What we saw in Mundra was a Shenzhen in the making. Mundra’s location is in northwest of India, where you have 70% of the country’s industrialization. We felt the port was ideally located.
India is not an exporting economy. It’s a net importer. We buy this port and we get beside it this special economic zone the size of Boston or San Francisco for free.
When they sell land, their cost is 35 rupees per square meter; their producing price is 1355 rupees per square metre. That’s 50 times their cost — where in the world can you get that?
We wanted to buy in for US$100 million from the Advantage Fund. The issue was 115 times oversubscribed, we got $1 million worth. It was initially 0.1% of the Advantage fund from November of 2007 until March of 2009.
The price of the IPO went from 440 rupees to 1200 rupees that same day. It peaked at 1400 rupees per share. The global financial crisis came and it knocked down the price of everything including this port, which still remained very profitable.
Foreign investors who had margin calls, had to sell their assets, and I bought from them at 290 rupees a share. Mundra has gone from 0.1% to 8.1%. It’s gone up from 290 a share to 560 rupees per share (as of October 15, 2009).