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Analysts bullish on fund sector

Despite the enormous outflows of cash, firms seen well placed to weather slump


At first glance, running a mutual fund company seems like a dismal job right now: A harrowing two-year bear market has scythed the assets of many industry players and spooked investors into pulling bags of money out of their funds.

But a combination of cost cutting, mergers and fees that kick in when investors flee have helped to boost the coffers of fund companies.

Canadians yanked about $1.25-billion from their mutual funds in October, according to preliminary figures reported by the Investment Funds Institute of Canada on Monday. That makes seven months running that investors have withdrawn more money from funds than they've put in.

But Dougall MacPhee, an analyst at Raymond James Ltd. of Vancouver, said the economics of the industry remain very attractive compared with other sectors, with the largest players generating significant free cash flow, high returns on equity and very attractive operating margins.

In a note to clients, Mr. MacPhee said the amount of assets under management is the principal driver of revenue growth. Assets under management -- which tally the money unitholders invest and the rise or fall of the fund's holdings -- tend to swing with the performance of the market.

Bill Holland, chief executive officer of Toronto-based C.I. Fund Management Inc., said the approximately $300-million of net redemptions his company has seen this year amount to less than 1 per cent of the $33.4-billion of assets C.I. has under management.

"The market moves three times that in an hour sometimes," Mr. Holland said.

C.I., which recently acquired Clarica Diversico Ltd. and Spectrum Investment Management Ltd., has cut staff, reduced subadvisory relationships and merged some funds together, but Mr. Holland said those moves came about because of the acquisitions, not the doldrums in the industry.

C.I.'s low-cost structure means the company is a prolific generator of free cash flow, according to BMO Nesbitt Burns analyst John Reucassel.

One thing that helps to offset the plunging sales for fund companies is that some funds carry a deferred sales charge (DSC) -- also known as a back-end load -- that companies collect if an investor sells units in a fund within a specified time.

The typical DSC fund charges no up-front sales commissions -- that's the appeal for investors. Financial advisers receive a sales commission of up to 5 per cent paid by the fund company, plus annual trailer fees in the area of 0.5 per cent of the client's invested assets.

But investors who bail out within six or seven years of purchase must pay a sliding redemption fee starting at 5 or 6 per cent.

Meanwhile, the commissions fund companies pay to financial advisers are reduced as they lose clients. AIM Funds Management Inc. has recorded net sales for the past few months, but the company braced for brutal stock market performance last year by laying off about 11 per cent of workers. Spokesman Dwayne Dreger said the company is controlling costs by scrutinizing advertising budgets and no more layoffs are anticipated.

Scotia Securities Inc. vice-president Glen Gowland said the company is actually adding to staff levels.

Mr. MacPhee of Raymond James said the longer-term outlook for industry sales volume is favourable, with baby boomers entering peak earning years, and investors burned in the downturn likely to seek out funds that provide professional advice in the future.

© 2007 The Globe and Mail. All rights reserved.

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