In this issue:

FIGHT LOOMS OVER FUND FEES

By Gordon Pape, Editor and Publisher

All the ingredients are in place for a battle that could shake the mutual funds industry to its roots and open the way to lower costs for investors.

The recent release of an in-depth study of the impact of trailer fees on costs and returns appears to have drawn a line in the sand between regulators and consumers on one side and the advisory community on the other.

The report, awkwardly titled A Dissection of Mutual Fund Fees, Flows, and Performance, was prepared by three business school professors, led by Prof. Douglas Cumming, Ontario Research Chair at York University’s Schulich School of Business. It was commissioned by the Canadian Securities Administrators, which is made up of the provincial and territorial securities commissions across Canada.

The report concluded that there is a clear connection between the commissions that a fund pays out and the amount of new investment money that flows in. As a general rule, the researchers found that trailer fees rather than performance appeared to influence the purchase recommendations of a significant number of financial advisers. Trailer fees are paid annually to advisers by the fund companies to compensate them for their service to investors.

The study also found that an increase in trailer fees resulted in a decrease in performance and vice versa and that funds sold through affiliated dealers tend to perform worse than those sold by independent advisers.

Predictably, investor advocate groups immediately called for the abolition of trailer fees on mutual funds, as was done in Great Britain a few years ago.

“It’s time for the research to be translated into reforms – either by adoption of a best-interests standard or at least by banning trailing commissions,” The Globe and Mail quoted Neil Gross, executive director of FAIR Canada, as saying. (FAIR is an acronym for the Canadian Foundation for Advancement of Investor Rights.)

The adviser community fired back, claiming that investors are content with the current system and warning that banning trailers would price financial advice out of the reach of many people.

“Upon preliminary review, it appears that the report does not consider the monetary value of the financial advice provided to clients,” said Greg Pollock, CEO of Advocis, The Financial Advisors Association of Canada.

“Our anecdotal evidence tells us that Canadians are generally satisfied with the current commission system for mutual funds. There’s a cost associated with advice regardless of how it is paid. Not every Canadian can afford to pay an upfront fee for service, which can be several hundred dollars an hour.”

The issue is an important one. Many income investors use mutual funds to generate cash flow (we have seven active picks on our Recommended List). Trailer fees reduce the returns on those funds considerably.

Let’s look at CI’s Cambridge High Income Fund, which was updated as a Buy in our last issue. The A units of the fund, which are the ones sold to the general public, have a management fee of 1.9%. The F units, which are available only to fee-based accounts, have a 0.9% fee. The 1% difference represents the trailer, which is paid every year to advisers as long as the client owns the fund units. It’s a prime source of adviser income; for every million dollars of fund units on the books, an adviser receives $10,000 a year. Some funds pay even higher trailers, up to 1.5%, in an effort to attract more business.

Higher trailers translate directly into lower returns. The A units of Cambridge Growth showed a 10-year average annual compound rate of return of 6.72% as of Sept. 30. So $10,000 invested a decade ago would have been worth $19,163 at that point.

The F units, by contrast, had an average annual return of 7.84% over the period. The same $10,000 invested in those units would have been worth $21,272 on Sept. 30. That’s $2,109 more than the value of the A units, an improvement of 11%.

Of course, holders of the F units had to pay a fee to the adviser, which probably offset most or all of the improved return. If the advice received was beneficial, the cost was probably worth it.

But if the two-tier structure were eliminated, the whole dynamic of the investor-adviser relationship would change. A world free of trailer fees would give do-it-yourself investors access to the equivalent of F units without paying an adviser fee. Those who want advice would be able to negotiate a fee based on the degree of service required, rather than automatically having a charge levied against their fund returns.

This debate is going to take time to play out so don’t expect dramatic changes any time soon. But based on the report, it seems clear the regulators have trailer fees directly in their sights. 

I’d be interested to know your views on this issue. If you have a comment, send an email to gpape@rogers.com.

 

Return to the table of contents…

NOVEMBER UPDATES

Here are the updates for this issue. Prices are as of the closing on Friday, Oct. 30, unless otherwise stated.

Sienna Senior Living Inc. (TSX: SIA, OTC: LWSCF)

Type: Common stock
Trading symbols: SIA, LWSCF 
Exchanges: TSX, Grey Market 
Current price: C$17.36, US$13.24 (Oct. 26)
Originally recommended: April 17/14 at C$11.93, US$11.01 
Annual payment: $0.90
Yield: 5.2%
Risk Rating: Higher risk 
Recommended by: Gordon Pape
Website: www.siennaliving.ca

Comments: Sienna’s share price is up 14% since my last review in June and is ahead 45% since the original recommendation as Leisureworld Senior Care Corp., this despite the fact I have never considered it to be a growth stock.

The company’s second-quarter results (to June 30) showed an increase of 3.8% in net operating income (NOI), which is an important metric in businesses of this type. Adjusted funds from operations (AFFO) were down slightly from the same period in 2014 to $12.2 million ($0.324 per share, fully diluted) from just over $13 million ($0.325 per share) a year ago. Dividends per share for the quarter were $0.225 so the payout ratio based on AFFO is a relatively conservative 67.2%.

For the first half of the fiscal year, AFFO was $24 million ($0.639 per share), down from $24.8 million ($0.655 per share) last year. The payout ratio was 68.1%.

Third-quarter results will be reported on Nov. 11.

So why has the stock done so well in the face of such mediocre numbers? Two reasons. First, there is the attractive yield, which looks solid based on year-to-date results to June 30. Second, there has been a lot of merger and acquisition activity in this sector in recent months leading to speculation an offer for Sienna might emerge. However, in a recent research note RBC Capital Markets said that was unlikely, noting the high percentage (74%) of lower margin long-term care facilities in the portfolio. The brokerage firm raised its price target to $17 but that is below the current level, which suggests the shares are fairly to slightly overpriced right now.

As a reminder, Sienna Senior Living is one of Canada’s largest owners of seniors housing and the largest licensed long-term care provider in Ontario. The company owns and operates 35 long-term care homes and 10 retirement residences, representing a combined 6,799 beds/suites/apartments across Ontario and British Columbia. It has about 7,500 employees.

Action now: Take half profits. The price increase has dropped the yield to 5.2% and, given the limited growth prospects, it’s a good idea to take some of that money off the table. – G.P.

 

Return to the table of contents…

Amica Mature Lifestyles Inc.

Type: Common stock
Trading symbols: ACC, ACCKF
Exchanges: TSX, Grey Market
Current price: C$18.35, US$13.98 (Oct. 5)
Originally recommended: July 31/14 at C$7.31, US$6.90
Annual payout: $0.42
Yield: 2.3%
Risk Rating: Moderate risk
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.amica.ca

Comments: This is another company that specializes in retirement residences and it has turned out to be a windfall for readers who bought shares at the time of Tom Slee’s original recommendation in July of last year. In early September, the Vancouver-based company announced it has agreed to be acquired by BayBridge Senior Housing Inc. at a price of $18.75 a share. That was a premium of 113% to the closing price on the day the deal was announced. The transaction is valued at $578 million.

BayBridge is a wholly owned subsidiary of the Ontario Teachers’ Pension Plan Board, which means that Amica stock will be delisted once the deal is closed.

On Oct. 9, Amica announced that the plan had received overwhelming approval from shareholders at its annual general meeting. A closing date has not been announced as the purchase remains subject to court approval, applicable regulatory approvals, certain lender consents, and the satisfaction of some other conditions.

Until the closing, it is business as usual so Amica released its financial results for the first quarter of fiscal 2016 (to Aug. 31) on Oct. 15. They showed an increase of 5.4% in revenue to $37.2 million. AFFO was up 17.1% to $0.157 per share, fully diluted.

Action now: Sell or tender. You can sell into the market now but you’ll receive a lower price by $0.40 than the BayBridge bid plus you’ll have to pay a brokerage commission. Alternatively, you can hold your shares until the closing (which could be a few months away) and receive a higher price plus a commission-free tender. If the shares are held in a non-registered account, another advantage of waiting could be to defer the taxable capital gain for a year if the deal doesn’t close until 2016. Including dividends of $0.525, we have a total return of 158.2% on this purchase. – G.P.

 

Return to the table of contents…

Evertz Technologies Ltd. (TSX: ET, OTC: EVTZF)

Type: Common stock
Trading symbols: TSX: ET, OTC: EVTZF
Exchanges: TSX, Grey Market
Current price: C$15.73, US$11.97 (Aug. 18)
Originally recommended: Aug. 14/14 at C$17.67, US$16.35
Annual payout: $0.72
Yield: 4.6%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.evertz.com

Comments: Evertz designs, manufactures and markets video and audio infrastructure solutions for the television, telecommunications and new media industries. Although I see it as a higher risk company, I recommended it because of its sound balance sheet, good growth record, and the potential for dividend increases.

The company delivered a 12.5% dividend hike at the start of this year to $0.18 per quarter ($0.72 per year), however the latest financial results were less than stellar. Revenue for the period to July 31 dropped 13.4% from the previous year to $84.9 million. Revenue in the Canada/U.S. region was off $5.5 million from last year while international revenue dropped $7.6 million.

Earnings were off slightly to $18.6 million ($0.25 per share) from $19.7 million ($0.26 per share) the year before.

The weak results are hopefully just a temporary hiccup. Year-end numbers for fiscal 2015 (to April 30) showed a 12% year-over-year revenue increase and an improvement of $0.02 in earnings per share to $0.87. However, it would be prudent to wait until we see the results for the second quarter of fiscal 2016 before taking new positions or adding to existing ones.

Action now: Hold. – G.P.

 

Return to the table of contents…

The Northwest Company Inc. (TSX: NWC, OTC: NWTUF)

Type: Common stock
Trading symbols: NWC, NWTUF
Exchanges: TSX, Grey Market
Current price: C$29, US$21.80 (Oct. 14)
Originally recommended: April 25/07 at C$18.83, US$16.65
Annual payout: $1.24
Yield: 4.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.northwest.ca

Comments: This company traces its history back to the original North West Company of fur traders that helped to open up Canada. Today it still operates general stores across the Canadian North and in Alaska but has expanded into warmer climes (the Caribbean and South Pacific) and to urban areas with its Giant Tiger brand.

This is not a high-growth company but its stable business and good cash flow make it attractive to income-oriented investors.  

North West recently released results for the second quarter of fiscal 2016 (to July 31). They showed an impressive sales increase of 11.9% to $448.7 million from $401.1 million in the same period of the prior year. Net earnings were up 7.6% to $18.1 million ($0.37 per share)

“We are benefiting from our exposure to U.S. economic growth, including tourism activity in our southern markets, which is more than offsetting weaker conditions in northern Canada,” said CEO Edward Kennedy. “Our Giant Tiger stores are also well positioned to serve customers who are more income constrained, especially in Saskatchewan and Alberta.”

The company announced a dividend increase of $0.02 a share (6.9%), bringing the quarterly amount to $0.31 ($1.24 annually) effective with the October payment. Readers who bought at the time of the original recommendation are now receiving a yield of 6.6% on their shares.

Action now: The share price is up $3.55 since the time of my last update in January, at which time I rated the stock as a Buy. It’s looking a little pricey at this level, so I am changing my guidance to Hold. – G.P.

 

Return to the table of contents…

YOUR QUESTIONS

Enbridge Income share issue

Q – Once again, a company whose stock I’ve bought in good faith, in this instance, Enbridge Income Fund, has issued equity, causing the stock value to drop 5+% today.? Could you comment for your readers on the ethics of this, and perhaps assist the reader in dealing with the inevitable sense of betrayal? – Charles W.

A – The new shares were issued as part of the deal to acquire the Canadian Liquids Pipelines business from parent company Enbridge Inc. The move has been described as ?transformative? for the fund. The acquired assets are valued at $15 billion and management says they will be a key source of low-risk, long-term growth. The deal closed at the beginning of September and the fund immediately announced a 10% dividend increase.

Stock dilution should always be a concern for investors and we need to look very carefully at a company?s reasons for issuing new shares. In this case, it appears the quality of the acquired assets justifies the action. Enbridge Income Fund now has a much stronger base and we should see the fortunes of the shares improve going forward. – G.P.

 

Return to the table of contents…

That’s all for this issue. The next regular issue will be published on Nov. 19.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

FIGHT LOOMS OVER FUND FEES

By Gordon Pape, Editor and Publisher

All the ingredients are in place for a battle that could shake the mutual funds industry to its roots and open the way to lower costs for investors.

The recent release of an in-depth study of the impact of trailer fees on costs and returns appears to have drawn a line in the sand between regulators and consumers on one side and the advisory community on the other.

The report, awkwardly titled A Dissection of Mutual Fund Fees, Flows, and Performance, was prepared by three business school professors, led by Prof. Douglas Cumming, Ontario Research Chair at York University’s Schulich School of Business. It was commissioned by the Canadian Securities Administrators, which is made up of the provincial and territorial securities commissions across Canada.

The report concluded that there is a clear connection between the commissions that a fund pays out and the amount of new investment money that flows in. As a general rule, the researchers found that trailer fees rather than performance appeared to influence the purchase recommendations of a significant number of financial advisers. Trailer fees are paid annually to advisers by the fund companies to compensate them for their service to investors.

The study also found that an increase in trailer fees resulted in a decrease in performance and vice versa and that funds sold through affiliated dealers tend to perform worse than those sold by independent advisers.

Predictably, investor advocate groups immediately called for the abolition of trailer fees on mutual funds, as was done in Great Britain a few years ago.

“It’s time for the research to be translated into reforms – either by adoption of a best-interests standard or at least by banning trailing commissions,” The Globe and Mail quoted Neil Gross, executive director of FAIR Canada, as saying. (FAIR is an acronym for the Canadian Foundation for Advancement of Investor Rights.)

The adviser community fired back, claiming that investors are content with the current system and warning that banning trailers would price financial advice out of the reach of many people.

“Upon preliminary review, it appears that the report does not consider the monetary value of the financial advice provided to clients,” said Greg Pollock, CEO of Advocis, The Financial Advisors Association of Canada.

“Our anecdotal evidence tells us that Canadians are generally satisfied with the current commission system for mutual funds. There’s a cost associated with advice regardless of how it is paid. Not every Canadian can afford to pay an upfront fee for service, which can be several hundred dollars an hour.”

The issue is an important one. Many income investors use mutual funds to generate cash flow (we have seven active picks on our Recommended List). Trailer fees reduce the returns on those funds considerably.

Let’s look at CI’s Cambridge High Income Fund, which was updated as a Buy in our last issue. The A units of the fund, which are the ones sold to the general public, have a management fee of 1.9%. The F units, which are available only to fee-based accounts, have a 0.9% fee. The 1% difference represents the trailer, which is paid every year to advisers as long as the client owns the fund units. It’s a prime source of adviser income; for every million dollars of fund units on the books, an adviser receives $10,000 a year. Some funds pay even higher trailers, up to 1.5%, in an effort to attract more business.

Higher trailers translate directly into lower returns. The A units of Cambridge Growth showed a 10-year average annual compound rate of return of 6.72% as of Sept. 30. So $10,000 invested a decade ago would have been worth $19,163 at that point.

The F units, by contrast, had an average annual return of 7.84% over the period. The same $10,000 invested in those units would have been worth $21,272 on Sept. 30. That’s $2,109 more than the value of the A units, an improvement of 11%.

Of course, holders of the F units had to pay a fee to the adviser, which probably offset most or all of the improved return. If the advice received was beneficial, the cost was probably worth it.

But if the two-tier structure were eliminated, the whole dynamic of the investor-adviser relationship would change. A world free of trailer fees would give do-it-yourself investors access to the equivalent of F units without paying an adviser fee. Those who want advice would be able to negotiate a fee based on the degree of service required, rather than automatically having a charge levied against their fund returns.

This debate is going to take time to play out so don’t expect dramatic changes any time soon. But based on the report, it seems clear the regulators have trailer fees directly in their sights. 

I’d be interested to know your views on this issue. If you have a comment, send an email to gpape@rogers.com.

 

Return to the table of contents…

NOVEMBER UPDATES

Here are the updates for this issue. Prices are as of the closing on Friday, Oct. 30, unless otherwise stated.

Sienna Senior Living Inc. (TSX: SIA, OTC: LWSCF)

Type: Common stock
Trading symbols: SIA, LWSCF 
Exchanges: TSX, Grey Market 
Current price: C$17.36, US$13.24 (Oct. 26)
Originally recommended: April 17/14 at C$11.93, US$11.01 
Annual payment: $0.90
Yield: 5.2%
Risk Rating: Higher risk 
Recommended by: Gordon Pape
Website: www.siennaliving.ca

Comments: Sienna’s share price is up 14% since my last review in June and is ahead 45% since the original recommendation as Leisureworld Senior Care Corp., this despite the fact I have never considered it to be a growth stock.

The company’s second-quarter results (to June 30) showed an increase of 3.8% in net operating income (NOI), which is an important metric in businesses of this type. Adjusted funds from operations (AFFO) were down slightly from the same period in 2014 to $12.2 million ($0.324 per share, fully diluted) from just over $13 million ($0.325 per share) a year ago. Dividends per share for the quarter were $0.225 so the payout ratio based on AFFO is a relatively conservative 67.2%.

For the first half of the fiscal year, AFFO was $24 million ($0.639 per share), down from $24.8 million ($0.655 per share) last year. The payout ratio was 68.1%.

Third-quarter results will be reported on Nov. 11.

So why has the stock done so well in the face of such mediocre numbers? Two reasons. First, there is the attractive yield, which looks solid based on year-to-date results to June 30. Second, there has been a lot of merger and acquisition activity in this sector in recent months leading to speculation an offer for Sienna might emerge. However, in a recent research note RBC Capital Markets said that was unlikely, noting the high percentage (74%) of lower margin long-term care facilities in the portfolio. The brokerage firm raised its price target to $17 but that is below the current level, which suggests the shares are fairly to slightly overpriced right now.

As a reminder, Sienna Senior Living is one of Canada’s largest owners of seniors housing and the largest licensed long-term care provider in Ontario. The company owns and operates 35 long-term care homes and 10 retirement residences, representing a combined 6,799 beds/suites/apartments across Ontario and British Columbia. It has about 7,500 employees.

Action now: Take half profits. The price increase has dropped the yield to 5.2% and, given the limited growth prospects, it’s a good idea to take some of that money off the table. – G.P.

 

Return to the table of contents…

Amica Mature Lifestyles Inc.

Type: Common stock
Trading symbols: ACC, ACCKF
Exchanges: TSX, Grey Market
Current price: C$18.35, US$13.98 (Oct. 5)
Originally recommended: July 31/14 at C$7.31, US$6.90
Annual payout: $0.42
Yield: 2.3%
Risk Rating: Moderate risk
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.amica.ca

Comments: This is another company that specializes in retirement residences and it has turned out to be a windfall for readers who bought shares at the time of Tom Slee’s original recommendation in July of last year. In early September, the Vancouver-based company announced it has agreed to be acquired by BayBridge Senior Housing Inc. at a price of $18.75 a share. That was a premium of 113% to the closing price on the day the deal was announced. The transaction is valued at $578 million.

BayBridge is a wholly owned subsidiary of the Ontario Teachers’ Pension Plan Board, which means that Amica stock will be delisted once the deal is closed.

On Oct. 9, Amica announced that the plan had received overwhelming approval from shareholders at its annual general meeting. A closing date has not been announced as the purchase remains subject to court approval, applicable regulatory approvals, certain lender consents, and the satisfaction of some other conditions.

Until the closing, it is business as usual so Amica released its financial results for the first quarter of fiscal 2016 (to Aug. 31) on Oct. 15. They showed an increase of 5.4% in revenue to $37.2 million. AFFO was up 17.1% to $0.157 per share, fully diluted.

Action now: Sell or tender. You can sell into the market now but you’ll receive a lower price by $0.40 than the BayBridge bid plus you’ll have to pay a brokerage commission. Alternatively, you can hold your shares until the closing (which could be a few months away) and receive a higher price plus a commission-free tender. If the shares are held in a non-registered account, another advantage of waiting could be to defer the taxable capital gain for a year if the deal doesn’t close until 2016. Including dividends of $0.525, we have a total return of 158.2% on this purchase. – G.P.

 

Return to the table of contents…

Evertz Technologies Ltd. (TSX: ET, OTC: EVTZF)

Type: Common stock
Trading symbols: TSX: ET, OTC: EVTZF
Exchanges: TSX, Grey Market
Current price: C$15.73, US$11.97 (Aug. 18)
Originally recommended: Aug. 14/14 at C$17.67, US$16.35
Annual payout: $0.72
Yield: 4.6%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.evertz.com

Comments: Evertz designs, manufactures and markets video and audio infrastructure solutions for the television, telecommunications and new media industries. Although I see it as a higher risk company, I recommended it because of its sound balance sheet, good growth record, and the potential for dividend increases.

The company delivered a 12.5% dividend hike at the start of this year to $0.18 per quarter ($0.72 per year), however the latest financial results were less than stellar. Revenue for the period to July 31 dropped 13.4% from the previous year to $84.9 million. Revenue in the Canada/U.S. region was off $5.5 million from last year while international revenue dropped $7.6 million.

Earnings were off slightly to $18.6 million ($0.25 per share) from $19.7 million ($0.26 per share) the year before.

The weak results are hopefully just a temporary hiccup. Year-end numbers for fiscal 2015 (to April 30) showed a 12% year-over-year revenue increase and an improvement of $0.02 in earnings per share to $0.87. However, it would be prudent to wait until we see the results for the second quarter of fiscal 2016 before taking new positions or adding to existing ones.

Action now: Hold. – G.P.

 

Return to the table of contents…

The Northwest Company Inc. (TSX: NWC, OTC: NWTUF)

Type: Common stock
Trading symbols: NWC, NWTUF
Exchanges: TSX, Grey Market
Current price: C$29, US$21.80 (Oct. 14)
Originally recommended: April 25/07 at C$18.83, US$16.65
Annual payout: $1.24
Yield: 4.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.northwest.ca

Comments: This company traces its history back to the original North West Company of fur traders that helped to open up Canada. Today it still operates general stores across the Canadian North and in Alaska but has expanded into warmer climes (the Caribbean and South Pacific) and to urban areas with its Giant Tiger brand.

This is not a high-growth company but its stable business and good cash flow make it attractive to income-oriented investors.  

North West recently released results for the second quarter of fiscal 2016 (to July 31). They showed an impressive sales increase of 11.9% to $448.7 million from $401.1 million in the same period of the prior year. Net earnings were up 7.6% to $18.1 million ($0.37 per share)

“We are benefiting from our exposure to U.S. economic growth, including tourism activity in our southern markets, which is more than offsetting weaker conditions in northern Canada,” said CEO Edward Kennedy. “Our Giant Tiger stores are also well positioned to serve customers who are more income constrained, especially in Saskatchewan and Alberta.”

The company announced a dividend increase of $0.02 a share (6.9%), bringing the quarterly amount to $0.31 ($1.24 annually) effective with the October payment. Readers who bought at the time of the original recommendation are now receiving a yield of 6.6% on their shares.

Action now: The share price is up $3.55 since the time of my last update in January, at which time I rated the stock as a Buy. It’s looking a little pricey at this level, so I am changing my guidance to Hold. – G.P.

 

Return to the table of contents…

YOUR QUESTIONS

Enbridge Income share issue

Q – Once again, a company whose stock I’ve bought in good faith, in this instance, Enbridge Income Fund, has issued equity, causing the stock value to drop 5+% today.? Could you comment for your readers on the ethics of this, and perhaps assist the reader in dealing with the inevitable sense of betrayal? – Charles W.

A – The new shares were issued as part of the deal to acquire the Canadian Liquids Pipelines business from parent company Enbridge Inc. The move has been described as ?transformative? for the fund. The acquired assets are valued at $15 billion and management says they will be a key source of low-risk, long-term growth. The deal closed at the beginning of September and the fund immediately announced a 10% dividend increase.

Stock dilution should always be a concern for investors and we need to look very carefully at a company?s reasons for issuing new shares. In this case, it appears the quality of the acquired assets justifies the action. Enbridge Income Fund now has a much stronger base and we should see the fortunes of the shares improve going forward. – G.P.

 

Return to the table of contents…

That’s all for this issue. The next regular issue will be published on Nov. 19.

Best regards,
Gordon Pape, editor-in-chief