When toronto-based money manager Gluskin Sheff & Associates Inc. went public in June, it floated 7.2 million subordinate voting shares at $18.50 a share. Since then, it has been all down-hill. The firm — founded by Gerald Sheff, chairman and CEO, and high-profile investor Ira Gluskin, president and chief investment officer — recently traded around $14 a share.

And while Sheff expresses some surprise at the market’s reaction, he isn’t concerned. “If we continue to focus on building the business, the share price will look after itself,” he maintains.

GS+A’s business is managing money for high net-worth investors and some institutions using its 14 model portfolios and pools or segregated accounts for accounts of more than $2 million. GS+A had $3.9 billion in assets under management at Sept. 30 and, Sheff says, there is lots of room to grow.

“Our single most important strategy for growth is to look after existing clients by delivering consistent returns, excellent risk management and a high level of service,” he says. “This results in both referrals and goodwill in the marketplace.

“As asset managers, we have proven adept at identifying when stocks are worth buying,” he adds. “We’re not trying to manage tens of billions of dollars but rather be the firm of choice for high net-worth individuals.”

There is some irony in the fact that a firm that has proven adept at stock-picking has seen its own stock drop so precipitously. So, what is behind the stock’s failure to perform?

No one knows for sure. Reasons probably include difficulty understanding the firm’s financial results, the small number of shares trading and choppy markets since the IPO, including the shutdown of income trusts.

The financials are confusing — at least, at first glance. When GS+A went public, it changed its yearend to June 30 from May 31, to coincide with the yearends of most of the firm’s portfolios. Thus, the fiscal year ended June 30, 2006, covered 13 months and performance fees for three periods — the year ended June 30, 2005, the year ended Dec. 31, 2005, and the year ended June 30, 2006 — which added $86.5 million to $45.8 million in base management fees (plus $1.5 million in investment and other income), for $133.8 million in total revenue. (The company charges a percentage of appreciation in its investment vehicles above specified rates of return.) For the 12 months ended May 31, 2005, revenue was $47.7 million, an awkward basis for comparison.

Comparing the bottom line is just as inconclusive. As a privately held company, GS+A paid out most of its pre-tax income in bonuses to employees and dividends. In fiscal 2006, it paid out all its pre-tax income and a pro-rated share of performance fees to May 31 to the selling shareholders. Therefore, the $2.8 million in net income for fiscal 2006 was just for the month of June. In fiscal 2005, the firm kept $4.7 million in net income.

In fact, Sheff says, the company is becoming more profitable. What you have to look at, he says, is earnings before interest, taxes, depreciation and amortization and before performance fees and bonuses related to performance fees — that is, base EBITDA.

GS+A also has provided adjusted EBITDA figures for 2005 and 2006, to reflect what these figures would have been had the company been public. Specifically, this means that 20% of base management fees are excluded because that amount will now go into an employee bonus pool and be paid out to employees.

These adjusted figures show a strong increase in profitability, to $27.1 million in the 13 months vs $10.1 million in fiscal 2005. Furthermore, base EBITDA for the first quarter of fiscal 2007, ended Sept. 30, was $7.9 million (vs $4.5 million for the three months ended Aug. 31, 2005). Net income in the first quarter, however, was still well below that of a year earlier: $3.1 million vs $5.5 million.

Revenue excluding performance fees for the first quarter was $13.8 million, vs $8.5 million for 2005 Q1. There was $10 million owing to the selling shareholders on Sept. 30 (for a loan of working capital for the transition period). However, Sheff says, this will be repaid shortly, as the firm had $38.1 million in cash or cash equivalents on that date.

@page_break@It will be another year before investors can compare financial results with the previous year’s numbers to get a quick picture of how the company is doing.

The small public float is possibly another reason for poor share performance. Only 7.2 million shares trade on the Toronto Stock Exchange — and they are subordinate shares with one vote apiece. There are also 397,500 subordinate shares in an employee trust, with 59 employees as beneficiaries. And, as of Sept. 19, Fidelity Management & Research Co. and related affiliates and associates owned 13% of the subordinate shares; Wellington Management Co. LLP had 12.8%.

The remaining 21.6 million shares outstanding are multiple voting shares, with 15 votes per share. These are in the hands of GS+A’s eight senior managers, who previously owned the entire company. These managers will be allowed to sell up to one-third of their shares one year after the closing of the IPO, another third one year after that and the final third two years later. If sold, the shares will convert to subordinate shares.

All multiple voting shares will convert to subordinate voting shares in 2016 or earlier, depending on certain conditions that primarily depend on whether Sheff and Gluskin are still officers or directors of the company and/or the level of their equity interest. Each owns 27.5% of the multiple voting shares, which translates into 20.3% each of total equity.

Neither Sheff nor Gluskin, both in their mid-60s, plan to retire in the foreseeable future. “We are committed to the long haul,” says Sheff.

A retiring Gluskin could concern investors. Sheff admits the three other portfolio managers — William Webb, Brad Dunkley and Jeannine LiChong — do not have Gluskin’s public profile. But they are well known to the firm’s clients and to the investment community. And the three are much younger — 42, 30 and 36, respectively.

Nor does the small float bother Sheff. The partners wanted to sell only 25% of the company. And they believe continued strong growth in profitability — GS+A has grown by an average 25% a year since it was founded in 1984 — will get the stock price moving up, even with relatively thin trading. Sheff notes that investors will also be rewarded with special dividends based on profits coming from performance fees and with regular quarterly dividends, currently set at 9.25¢ a share.

Certainly, the federal government’s recent decision to impose the same tax regime on income trusts as on corporations may have shaved $1 off GS+A’s share price. The company has $650 million, or about 17% of AUM, in income trusts. Concern about the firm’s exposure to income trusts may have also taken the share price lower.

RBC Capital Markets, the lead underwriter in the IPO, is the only firm that covers GS+A. In a report dated Nov. 10, RBC raised its 12-month target price to $21 a share from $19, while maintaining an “above-average risk” rating on the stock. Clearly, RBC doesn’t view the firm’s exposure to income trusts as a big negative; indeed, it expects GS+A to do better this year than originally expected. In a Sept. 20 report, RBC had said that it views GS+A “as one of the best vehicles for investors seeking leverage to long-term equity market returns.”

Nevertheless, it’s worth noting that the underwriters did not take up the 10% overallotment allowed in the IPO.

The question then becomes whether GS+A can deliver on its promises of earnings growth. An equity specialist that requires new clients to have $2 million in investible assets, the company has its $3.9 billion in AUM spread among private clients and some institutions, mainly in Ontario and Quebec. Its growth strategy is focused on high net-worth clients, particularly those in Alberta and British Columbia. GS+A personnel have already made a number of successful visits to Calgary and Vancouver to meet with existing and prospective clients.

Some of GS+A’s future growth is also expected to come from clients investing more of their assets with the firm. Indeed, clients with a lot of assets often start by bringing only a portion to GS+A. As their confidence in the firm increases, they allocate additional assets.

The company offers a risk-management service for all its clients. This can encompass assets held at other institutions. This is a natural extension of the “rigorous” risk management GS+A employs in its in-house money management.

There’s a clear line between money management and client service. The asset-management team consists of Gluskin, the three other portfolio managers, four analysts and three securities traders. There are 12 equity model portfolios; managers have responsibility or co-responsibility for the models that best suit their skills and for the risk management of their assigned portfolios.

More than 80% of AUM is in equities, says Jeremy Freedman, GS+A’s COO and executive vice president. The firm does offer a short-term and basic Canadian bond portfolio as a no-fee service to clients, But if clients want to invest significantly in fixed-income, they tend to go elsewhere.

Canadian and U.S. money management is done in-house, while the Europe/Australasia/Far East portfolio is contracted out to Toronto-based Gyphon International In-vestment Corp. There are no plans to bring management of the global portion of the portfolio in-house. “We have a lot to do here and there’s no shortages of opportunities in North American markets,” says Sheff.

Nevertheless, the GS+A team travels outside North America to attend conferences and to talk to companies that compete against the North American firms in its investment universe. This is necessary because it’s a global marketplace, explains Sheff.

The model portfolios include three hedge funds — income trust, equity (both managed in-house) and high-yield, the last managed by Marret Asset Management Inc. of Toronto. Performance fees are charged for all model portfolios except the RRSP pool. Excluding performance fees, client pay about 1.35% of asset value a year on average.

GS+A has been adding to its investment team and looks for a clear skill set, an understanding of the firm’s investment philosophy and the ability to work as part of a team. “We want people who really love the investment business and process, who have a passion for it — to the point at which they would do it for free,” says Sheff.

The firm’s investment style straddles the “value” and “growth at a reasonable value” camps, but GS+A does have style-specific value and growth funds. The managers are bottom-up stock-pickers who hold a relatively small number of stocks at any given time; usually, 10 stocks account for 30%-50% of each model portfolio.

“We are not at all afraid to invest in less well-known small- or mid-cap companies,” says Webb.

The four-member client-service team is made up of investment professionals — not salespeople, Sheff emphasizes. It’s these people who help clients make their asset-mix decisions, advise on risk management and monitor a clients’ sector diversification, the performance of clients’ individual portfolios and the continuing appropriateness of their asset mix.

“We look for smart, well-qualified people who understand risk,” says Freedman. “They are key to managing the risk profile of the client.”

Ideas for new portfolio models can come from either team. Some models are based on investment areas in which clients have expressed interest; others on strategies with the potential to increase returns and/or lower risk for clients’ overall portfolios. The investment team then examines a proposed model’s feasibility and recommends how to construct a portfolio to achieve the desired result.

The client mix as of June 30 included 11 relationships in which clients individually had more than $30 million invested with the firm, for total AUM of $780 million. At the other end of the spectrum, there were 594 relationships worth the $5 million or less, amounting to $1.6 billion in AUM. In the middle, there were 133 with AUM of $1.4 billion.

Institutional mandates accounted for $614 million of the total AUM. Individual accounts made up the rest. IE