Lee-Chin: Working with the wealthy

And to hear him tell it, he’s happy to more or less be back in the role where he started.

When Lee-Chin first bought AIC in the 1980s he was overseeing $3 million in assets, in less than 20 years, the firm was atop the industry overseeing nearly $12 billion in the early part of the decade. But the last few years were not kind to the firm’s focus on financial services and wealth management stocks. When Lee-Chin finally sold the company in August, it only managed a third of the assets it had during its peak.

Lee-Chin is undaunted that the investment philosophy he employs, and counsels clients and advisors to embrace, will continue to work. And he insists there’s more to it than the “Buy, Hold and Prosper” tagline AIC famously employed.

To be more specific, he says he’s recognized five investment characteristics that all very wealthy individuals possess, and through his career he’s demonstrated these with sometimes frustrating discipline.

“We need to make sure as advisors our behaviour has some resemblance to how wealth is created. At the end of the day, the client is coming to us and essentially saying, ‘Advisor, either make me wealthy or preserve my wealth.’ Those are the primary objectives clients have,” Lee-Chin tells AER. “The behaviour of folks in the wealth management industry certainly has nothing to do with how wealthy people became wealthy.”

Lee-Chin says almost every single billionaire in the world has the five following characteristics:

• They only own a few high quality businesses;
• They really understand those few businesses;
• The investments are in industries with strong long-term growth prospects;
• They created their wealth by using other people’s money; and
• They hold their businesses for the long run.

Lee-Chin argues the central piece of most advisor business in Canada – selling mutual funds – most likely undermines the five habits of the ultra wealthy. Despite the fact much of Lee-Chin’s wealth comes from the mutual fund business, he believes the majority of Canadian mutual funds hold little value either for clients or with the encroachment of cheaper exchange traded funds. They are becoming a liability to the business of advisors. Clients are becoming aware of the index-hugging performance of the mutual fund industry in general, Lee-Chin says, so unless advisors can demonstrate true wealth creation, they’ll lose their most profitable revenue stream to ETFs.

“Most managers have too much beta in their funds; they’re not alpha oriented. You can easily substitute most money managers with an index fund. Therefore advisors who don’t recognize the distinction are going to have clients who substitute 200 basis point [funds] with 10 basis point funds over time,” he says. “The only solution for advisors if they want to have a sustainable business is to explain the fundamentals of investing [to the clients they’re advising] which is not index hugging.”

Lee-Chin says mutual funds break most of his five wealth creation rules by benchmarking the index; adding that they end up with far too many holdings, which means some stocks will be in sectors with questionable business growth. A need to respond to changes in the market, meanwhile, means most funds turn over some of their holdings at least once a year.

“Wealth is created by understanding what you own has a reasonable long-term growth trajectory. If you own a hundred different businesses, would all of them be in strong long-term growth industries?” he asks. “Essentially funds turn over their holdings every year. Name one wealthy person in the world who turns over his business every year.”

“I’m not concerned about beating the index. I’m concerned about creating wealth,” Lee-Chin adds. “I’m not concerned about getting fired. The problem with most mutual fund managers is that if they deviate from the index for too long, they get fired.”

Fund business is still a money maker

Some might find irony in the fact that while Lee-Chin has a low opinion of most mutual funds, he believes the mutual fund and wealth management business model has terrific growth prospects.

Of course, he has an inside understanding of the business having run a wealth management firm for nearly three decades, with wealth management companies accounting for 60% of the Advantage Fund.

While he concedes the margins he obtained in the 1980s will probably not be duplicated, he notes what’s being lost in margins is being offset by an increase in volume of business. Even in an era of consolidation, Lee-Chin says wealth managers will be profitable because of revenue streams they earn from fee-earning assets.

“Let’s look at the history. If over the past 14 years you had invested $10,000 in the best CI mutual fund [which as of June 30, 2009 would have been the CI Canadian Investments fund], that would have earned you $41,000,” he says. “Had you owned CI stock that derives its money from revenue generated from that fund, that $10,000 [would be] worth $164,000. The best AGF fund over the last 14 years was the AGF precious metals funds [DASH] $10,000 invested in that would be worth $35,000 now. But owning AGF stock would have given you $56,000. Investors Group’s best fund would be worth $26,000, [but] shares in IG would be worth $63,000.”

Lee-Chin anticipates an ever-increasing demand for wealth management services. In the end, sales don’t matter as much as building on assets; and private pools of capital will increase as public pension options wane. If anything this consolidation of assets helps end shareholders of wealth management firms, due to what he views as the inevitable growth of wealth of over time.

This growth of the assets – triggered by long-term positive performance – will far outpace net new sales, according to Lee-Chin. But in order to manage these larger pools of capital, wealth managers only have to increase their overhead expenses marginally. “Wealth manages have no inventory to lose. It’s not like a supermarket where the lettuce can go rotten. There are no loans receivable because they don’t have loan provisions,” he says. “Think of this, how many businesses do you know that don’t have an accounts receivable department? This is a business that is highly scalable because it can grow without having to pay an extra dime of cost. They have great operating leverage.”

In fact, Lee-Chin says regardless of how the wealth management business evolves on the product side, if it can build large enough pools of assets net sales become irrelevant.

“The world is getting is scale is much more important than sales,” he says. “If your sales don’t grow but you have a $10 billion fund, and the assets grow 10%, that’s the equivalent of $1billion in net new sales. It would take most firms 10 years to get that in net sales. Once you get to a certain size, net sales are not as important as market appreciation,” he says. “Even if baby boomers start putting in less, over time the assets they have will become more valuable. Market appreciation will start to overshadow net sales in terms of growth of assets.”

Lee-Chin, suggests advisors should look at this business model, which most likely their own, and realize the best investment they can make right now is in their own business.

“I don’t know a better business model in the world. What is ironic is that almost every advisor would know these characteristics because they are living it. Their own assets under administration are a function of these characteristics,” he says. “I believe the biggest diamonds will always be found in your own backyard. The biggest investment we can make as advisors is to invest in our own income streams.”