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Clone Funds Attract Canadian Investors


Toronto - The Canadian fund industry's hottest new product trend will make it easier for foreign-owned firms to compete in Canada, a senior fund executive told the annual conference of the Investment Funds Institute of Canada.

Joe Canavan, president of Synergy Asset Management, was referring to clone funds which rely on customized derivatives contracts to mirror the performance of actively-managed foreign funds. Introduced in May by Mackenzie Financial of Toronto, there are no limits on the use of clone funds in registered retirement savings plans.

The clones have been an instant hit with Canadians who have staged an investing revolt against lagging returns in their domestic market and federal tax laws that restrict holdings of foreign assets to no more than 20 percent of the book value of registered retirement savings and other registered pension plans.

Mackenzie's first two clones alone have gathered more than $1 billion (Canadian) in assets in their first several months since inception, and others are scrambling to get in on the cloning craze. As of early October, more than a dozen companies had launched their own clones, or were nearing final regulatory approval.

The arrival of fund clones represents "a significant change in the business," said Canavan of Synergy, one of five panelists speaking on the future of fund distribution in Canada at the conference last month.

"It gives leverage to those who are outside Canada," he said.

Since the clones come close to matching the returns of the foreign funds to which they are linked, Canadian investors will be inclined to substantially boost their foreign exposure, and that this will be largely to the benefit of foreign firms, Canavan said.

Among the firms that Canavan predicted would be winners are Merrill Lynch Canada of Toronto, AIM Funds Management, Fidelity Investments Canada and Templeton Management, all of Toronto. These foreign-owned firms are among the first to develop clone funds for the Canadian market to build on sales of their existing foreign funds.

Canavan's vision of a Canadian industry polarized between world-class giants and innovative boutique firms, such as his own, clashed with that of a top executive of one of the country's largest domestically-owned firms.

"I personally don't think the middle ground is a bad place to be," said James Hunter, president of Mackenzie Financial, the third largest fund firm in Canada.

Hunter said the Canadian market is driven by adviser-sold funds, and despite the proliferation of electronic trading and information services, the advice channel continues to grow.

"The Internet increasingly will be a boon to financial advisers," said Hunter, citing the greater efficiencies and cost savings possible through on-line communications.

Ted Cadsby, president and CEO of CIBC Securities, a subsidiary of Canadian Imperial Bank of Commerce of Toronto, concurred that Canadians place a far greater emphasis on financial advice when buying mutual funds.

"It's a different world here than in the U.S.," said Cadsby. "Canadians don't like to buy direct." For that reason, Cadsby believes that even a global direct-sales giant like Vanguard would need a distribution partner in Canada.

To meet the demand for advice from their massive customer bases, CIBC and other banks have made a huge effort to expand their sales forces, upgrade their qualifications and introduce compensation schemes that reward higher productivity, said Cadsby.

"The banks are slowly evolving to a system that can compete more effectively with independent brokers and planners," said Cadsby.

Several banks, including CIBC, Bank of Nova Scotia of Toronto and Toronto Dominion Bank of Toronto, have diversified their offerings into third-party funds, he said. (Historically in Canada, bank branches have offered only their house brand of no-load funds.)

Cadsby, who recently wrote a book on index funds, also said that indexing is another product trend with significant growth potential. He estimated that index funds have accounted for about 18 percent of sales of equity funds in Canada so far this year, well below the estimated level of 50 percent in the U.S.

But the CIBC executive said that, because the direct sales market accounts for nowhere near as large a proportion of the market in Canada as it does in the U.S., the level of penetration of index funds probably will never be as high as in the U.S.

Disagreeing with some of his fellow panelists, Paul Bates, president of Charles Schwab Canada, said the use of technology - not whether or not a company offers advice - will determine how well money management firms are able to compete.

"It's not about discount brokers versus full service any more," said Bates. "It's about technology-enabled intermediaries versus non-technologically enabled intermediaries."

Evidence of that trend, according to Bates, is his firm's ability to offer various levels of fees within a single account, depending on the advice, service and order method that a client chooses for a particular transaction. This allows the brokerage to customize its account structures for each of its customers.

Bates said a similar trend toward customization will evolve among mutual fund sponsors and he predicted "the end of the fund industry as we know it."

"It's going to be replaced quickly by the personal fund industry," said Bates. "The business of a family of funds is out the window."

Citing the need for large investments in technology and marketing, Bates, agreeing with Canavan, said the industry will become polarized between giant firms and niche players.