On the crest of a wave
Phenomenal returns have made AIC an industry star—and the target of criticism
In a restaurant lounge just steps from the salad bar, the mutual fund messiah rises to address a small gathering of the faithful. Jonathan Wellum, at 36 Canada’s hottest fund manager, speaks with the conviction of a true believer. He is used to preaching the good word about his firm, Burlington, Ont.-based AIC Ltd., at dozens of investment seminars he attends each year. But today’s lunch-hour speech to the Burlington Christian Businessmen’s Committee is different. Wellum, drawing on his master’s degree in theology, discusses Scripture and God’s guiding hand in the universe. Speaking in almost mystical terms, he explains how his long-term approach to investing is based on his belief in a creator who drives the progress of history. The men nod pensively between sips of coffee, and applaud warmly when Wellum sits down. “There’s no other company with as many funds at the top right now,” says one listener, Burlington financial adviser Ken Hopper. ‘You wonder if God is blessing them.”
Investors certainly are. Attracted by the consistently high returns on some AIC funds in recent years, Canadians have been pumping money into the firm at the rate of $15 million a day. Under the guiding hand of Michael Lee-Chin, a charismatic former fund salesman, AIC’s assets under management have exploded from $367 million at the end of 1995 to $7.3 billion today. In the process,
Wellum, the lead manager of the company’s top performing Advantage, Advantage II and Diversified Canada funds, has become a hero to thousands of investors who dream of a golden retirement. Last month, an indus¡ try panel named him the 1997 fund manager of the year. “I’m frankly damn near entranced by the guy,” says I 69-year-old John Parsons, an AIC unit-holder from Ajax, Ont.
At the same time, AIC’s runaway success has raised a few red ‘ flags. Critics take aim at the company’s practice of investing in big chunks of a relatively small number of companies, suggesting that I AIC’s buying sprees in themselves have helped to bid up the value of its portfolios. Other analysts warn that the company’s heavy exposure to a narrow sector of the Canadian economy—financial services—means that its funds would likely be hit harder than most if I interest rates rise or the stock market suffers a prolonged slump.
The firm has also come under fire for higher-than-average manf agement expense ratios on some funds. The MER represents the I percentage of a fund’s assets that go to paying management fees and other expenses. According to Portfolio Analytics Ltd., a mutual fund information service, the Advantage II fund has a management expense ratio of 2.71 per cent, compared with a median of 2.3 per cent for Canadian equity funds as a group. Overall, says one industry insider, “AIC is probably the company that sparks the most disagreement and controversy within the funds business.”
The loudest alarm was sounded in a report last July by Elizabeth Tuck, an analyst with RBC Dominion Securities Inc. in Toronto. Tuck cautioned investors to restrict AIC’s two largest funds, Advantage and Advantage II, to no more than 10 per cent of their portfolios because of their relatively low level of diversification. She also warned that, in a drastic market downturn, AIC investors wishing to redeem their funds might face delays. If AIC were forced to sell shares to meet redemptions, Tuck argued, it could take the company as many as 100 trading days to unload some of its large holdings based on the normal daily trading volume in those stocks. Any faster, Tuck said, and AIC might find that its own selling was driving down the price of its holdings.
WATCH IT GROW
The value of $10,000 invested in the A/C Advantage Fund since its introduction on Dec. 12, 1985:
Other analysts dismiss Tuck’s claims. “I think those [Advantage] funds have been beaten up for a lot of bad reasons,” says Peter Loach of Midland Walwyn Capital Inc. in Toronto. John Platt, an analyst with Nesbitt Burns Inc., says AIC has not played a big part in driving up the price of its holdings because it usually buys large blocks of stock at a negotiated price—minimizing the impact on the market. He adds that Wellum has recently been spreading the risk by investing in companies outside the financial services arena. Among the top 10 holdings in Advantage II, for example, are CanWest Global Communications and information giant Thomson Corp.
But even AIC’s supporters emphasize that its Advantage funds are riskier than most Canadian equity funds because of their focus on financial services. “While that approach has paid off handsomely, it will have its periods of underperformance— which at times may be extreme,” says Platt. Together, Advantage and Advantage II account for 66 per cent of the company’s $7.3 billion in assets. The fear is that unsophisticated investors, bedazzled by the funds’ stellar returns since 1995, will rush into them without understanding their potential volatility. In a dramatic market drop, that could leave less savvy players considerably poorer—at least in the short run. Wellum himself is well aware of the danger. “People are driven by emotion,” he says. ‘We constantly say that the investors who really do well over time are people who keep their heads and just ride through the choppiness.”
Right now, AIC is riding a wave of success. The Advantage fund, 62 per cent of which is invested in financial services, returned 43.3 per cent in 1997 compared with an average of 13.6 per cent for Canadian equity funds. Advantage II, launched in October, 1996, returned 41.3 per cent last year. The Diversified Canada fund, 48 per cent of which is invested in financial services, returned 32.1 per cent.
Wellum argues that changing demographics make AIC’s focus on the financial sector a good bet over the long haul. As members of the postwar baby boom approach retirement, he says, they will increasingly save their money rather than spend it. At the same time, deregulation has fuelled growth in the financial services sector.
For all that, AIC’s funds have seen dark days. The Advantage fund lost 30 per cent of its value in the crash of 1987 and did not fully recover for 44 months, according to figures compiled by FundMonitor.com Corp., a Windsor, Ont.-based research firm. “If you bought at the wrong time, half of that 10-year track record is under water, which is stunning,” says FundMonitor president Duff Young. During the most recent bear market, in 1990, Advantage was the fourth-worst performing fund in Canada.
Wellum says he is unruffled by shortterm fluctuations in the markets. “Our preoccupation is not with the day to day,” he told 250 people at a Toronto investment seminar last October, days after the Asian financial crisis sent stocks reeling. ‘You’ve got to have an investment philosophy that will anchor you through the ups and downs of the marketplace.” It is exactly that philosophy, Wellum contends, that has made AIC the butt of criticism. “I think a lot of the concern comes out of the fact that we invest money just a little differently than other people do. It’s seen as unorthodox.”
Canadian investors are pouring $15 million a day into AIC funds
Unlike some money managers, who take their cues from charts that supposedly foreshadow the market’s ups and downs, Wellum says that AIC targets “bedrock businesses”—proven companies in industries with long-term growth potential. The hallmarks of those companies include “strong, free cash flow” and high return on equity. Once it finds such firms, AIC rarely lets them go. The annual turnover in most of its funds represents less than five per cent of the portfolio’s assets, he says. Wellum’s buy-and-hold strategy might lead investors to expect lower management fees, but he says that the abnormally high management expense ratios on some AIC funds still represent good value because of their generous, long-term returns. “We think we have a premium product that is very different from our competitors’, so we can charge a bit more.”
Wellum is working hard to maintain that performance. He says he visited 143 companies last year, searching for new prospects and checking up on old ones. And when he is ready to buy, he does not hesitate to plunge in. According to insider trading reports, AIC owns almost 20 per cent of Mackenzie Financial Corp., about 19 per cent of Trimark Financial Corp., and large stakes in other companies such as Newcourt Credit Group Inc. of Toronto. Because securities laws restrict funds from owning more than 10 per cent of a single company, AIC’s decision to open the Advantage II fund in 1996 was partly conceived as a bid to bolster the company’s stake in several companies. “If we could, we’d own 100 per cent,” says Wellum.
AIC says the inspiration behind its approach was U.S. billionaire Warren Buffett. Lauded as one of the world’s most successful investors, Buffett has made billions of dollars for shareholders in his Omaha, Neb.-based holding company, Berkshire Hathaway Inc., by buying and keeping large positions in such household names as Coca-Cola Enterprises Inc., the Washington Post Co. and Capital Cities/ABC Inc. As it happens, he has never invested in a mutual fund company. “It just didn’t catch his attention,” Lee-Chin suggests.
Despite Buffett’s wealth, his investment style has found little favor with most professional money managers, says Robert Hagstrom, a Wayne, Pa., mutual fund manager and author of the 1994 best-seller The Warren Buffett Way. The reason, says Hagstrom, is that most managers live in fear that investors will flee as soon as their funds lose money. To reduce that risk, they load their portfolios with anywhere from 50 to 100 stocks and churn them constantly. “Warren Buffett has often said that diversification is nothing more than protecting the manager from having a bad year,” says Hagstrom. It also saves fund managers from going to the trouble of getting to know their companies. ‘To make large bets in companies,” says Hagstrom, “you have to have an intimacy with them that gives you the courage of your convictions. If the market moves against you, you know it’s just a market rotation—there’s nothing wrong with your company.”
Like Buffett, Lee-Chin has not been shy about making big bets. It is in his nature, says Mario Frankovich, one of the original founders of Kitchener, Ont.-based Advantage Investment Counsel Ltd., the fledgling company that Lee-Chin, a former fund dealer with Regal Capital Planners Ltd. in Kitchener, Ont., bought for $250,000 in 1987. The private firm, now 85-per-cent owned by Lee-Chin—the rest is split among Wellum, vice-president Neil Murdoch and a handful of other executives—is now worth an estimated $500 million. Despite suing Lee-Chin in 1988 to secure his proceeds from the sale, Frankovich says he remains a fan. “Mike is such a visionary person that he will always take the bold position—which will inevitably lead to controversy,” says Frankovich, now the president of Burgeonvest Financial Corp., a financial services holding company in Hamilton.
Lee-Chin remembers being struck by Buffett’s philosophy in 1980, when he first read about it in the book The Money Masters. A native of Jamaica who came to Canada in 1970 to study engineering at Hamilton’s McMaster University, Lee-Chin became known more as a high-living salesman than a visionary. As a branch manager for Regal Capital Planners, he had parlayed his persuasive powers into a $6-million fortune. He also encouraged his clients, most of whom were doctors, to borrow money to invest. (AIC’s retail arm, now known as the Berkshire Investment Group—a name critics suggest is an attempt to trade on the reputation of Buffett’s Berkshire Hathaway—also has a history of urging clients to borrow to finance their investments, a practice called leveraging. ‘We promote it where the situation warrants,” Lee-Chin says.)
Like other wheelers and dealers, Lee-Chin enjoyed his prosperity to the fullest, sporting $1,000 suits, expensive watches and a collection of fine cars that included a Rolls-Royce and a Ferrari. But it was at a lavish 1983 conference in Monte Carlo sponsored by Mackenzie Financial that Lee-Chin stumbled on his biggest moneymaker yet. Over drinks one evening, Lee-Chin and his Toronto stockbroker, Rob Grundleger, began debating which was the better investment: a Mackenzie fund or Mackenzie stock. Lee-Chin argued for the former, but was persuaded otherwise. Months later, he borrowed $500,000 to buy one per cent of the fund company.
It was three years later that Frankovich, an old weightlifting buddy from McMaster, approached Lee-Chin with a proposal. The Advantage fund’s assets had stalled at about $800,000, and Frankovich and his four partners were looking to drum up
sales. Lee-Chin went one better and offered to buy control of
AIC. “It was not an easy sell to my partners,” Frankovich recalls. “It was very stormy.” Two members of the group balked at the idea of a salesman having the ultimate say over investment decisions. In the end, however, the associates voted 3 to 2 in favor of the transaction.
Conflict erupted almost immediately. The new owner was determined to realize his vision for Advantage: a mutual fund made up largely of fund company stocks. Ken Rae, previously a portfolio manager for Dominion Life in Kitchener, opposed tying the fund’s fortunes to one particular sector. Frankovich tried to mediate the dispute, but finally gave up in frustration and left the firm. “After a while, I just got tired of the ego batties,” says Frankovich. “Mike is the stereotypical bull-headed entrepreneur—‘Nothing stands in my way, nothing stops me.’ ” LeeChin says the battle with Rae ended in 1989, when the former insurance man “decided to hang out his own shingle.” Rae is now a partner in a Kitchener financial planning firm.
One morning in 1990, as he pumped iron in McMaster’s gym, LeeChin struck up a conversation with an outgoing 29-year-old auditor from the Burlington office of Deloitte, Haskins & Sells (now Deloitte & Touche). The friendship that blossomed between Lee-Chin and Jonathan Wellum during daily workouts ultimately forged one of the mutual fund industry’s oddest couples: the devout Christian money manager and the flamboyant fund mogul.
Lee-Chin, a divorced father of three sons aged 13 to 18, lives in a large home on the Niagara Escarpment near Hamilton that once be longed to Michael DeGroote, founder of transportation giant Laidlaw Inc. It bears little resemblance to the small house in Port Antonio, Jamaica, where the oldest son of a sewing machine salesman grew up with his nine brothers and sisters. “I’m fortunate that I can afford to indulge in whatever passion I may have,” says Lee-Chin, who now owns two Ferraris. “But what is foremost in my mind is I have three sons, and I have to set an example for them.”
In contrast to Lee-Chin, Wellum says he strives to maintain a modest lifestyle despite his wealth, although he recently splurged and bought a Pontiac Firebird to go with the family’s GMC Suburban. The son of a chiropractor, Wellum lives in a four-bedroom brick house with his wife, Heidi, whom he also met at the McMaster gym, their three-year-old daughter and twin sons, aged P/2. He attends a small Baptist church near Cambridge, Ont., and teaches adult Sunday school each week. “You’ve got to be careful you don’t get greedy,” he says. “This industry is full of a lot of greedy people.”
Wellum and Lee-Chin say their admiration for each other transcends differences in taste. “Jonathan’s been integral to the success of the company,” says Lee-Chin. “He’s brilliant—very meticulous, very thorough. I love that fellow.” Declares Wellum: “I’ve been able to shine within AIC. But I wouldn’t have been able to do that if Mike hadn’t put the trust and confidence in me in the first place.”
The breakneck pace of AIC’s expansion is evident at its Burlington headquarters, a low-slung building with gold-tinted glass that the firm moved into last May. The executive wing’s pink marble floors are still covered with paper, and construction workers are hard at work completing an extensive renovation of the building, which once housed Stelco Inc.’s research division. The company’s 325 head-office employees, up from 35 two years ago, are already running out of parking space. ‘We just haven’t stopped hiring,” says Murdoch, 37, a former lawyer and Price Waterhouse consultant who runs two of AIC’s funds as well as serving as vice-president.
Inevitably, AIC’s recent success has spawned imitators. Last August, the company filed suit against Infinity Funds Management Inc. of Toronto, alleging that the company has deliberately copied AIC’s investment strategy. Among others, the lawsuit names David Singh, chief executive officer of Infinity’s founding company, Fortune Financial Management Inc., and Richard Charlton, Fortune’s senior vice-president and a former AIC executive. Lee-Chin says the similarities between some AIC and Infinity funds are too close to be coincidental: “Not only did they try to clone our portfolios, but also our marketing materials.”
Charlton calls the lawsuit “silly” and points out that AIC itself copies Buffett’s investment philosophy. He says the lawsuit is likely motivated in part by Lee-Chin’s resentment over Charlton’s decision to start a competing mutual fund. “It’s a jilted-lover sort of thing, I suspect. It’s totally irrational.” Even so, Charlton calls his former colleague “an amazing guy.” He also defends Wellum’s practice of investing heavily in other mutual fund companies. “These are not some volatile, blow-apart sector funds,” Charlton says. “They’re positioning themselves to collect management fees off these sorryassed baby boomers who are lining up to pour money into mutual funds.” The language is less than saintly, but when even AIC’s enemies are praising the firm, it must surely be on the side of the angels—at least until the next downturn. □