Concerns about market volatility and poor returns in 2008 will hurt asset managers. Some analysts think Toronto-based CI Financial Income Fund will feel the pinch more than others.

Already, CI’s units have dropped by $10 each in the past year. And even with this drop, some analysts still don’t consider the units a “buy.”

Toronto-based RBC Capital Markets had expected CI units to underperform in the asset-management sector. But, following the release of the company’s fiscal yearend and fourth quarter results on Feb. 20, RBC’s Feb. 21 report upped its 12-month target price for CI units to $20.50 each That’s slightly less than the $22.80 a unit at which the 286.3 million units closed that day.

This upgraded target was based on the fourth-quarter conference call, during which CI CEO Bill Holland said that mutual fund net sales were in the $200-million range to date in February, and he thought they could be $350 million to $400 million for the full month, vs $357 million for the same period a year earlier.

In January, CI had net redemptions of $490 million. But that was a month in which most companies lost assets, many proportionately more than CI. Holland says the redemptions were primarily because of linked notes that have to be redeemed if markets go down.

RBC expects CI to have positive sales momentum relative to its competitors over the next 12 months, reflecting strong relative investment performance and its distribution capabilities.

Another plus for the firm is its segregated fund business, which is far less subject to redemptions because unitholders lose their principal guarantee if they redeem early. With more than $9 billion in SunWise seg funds, issued by Sun Life Assurance Co. of Canada, and another $2 billion that CI manages for Manufacturers Life Insurance Co., seg funds can easily account for 50% of CI’s net sales, even though they account for only 10%-15% of gross sales, Holland says.

Nevertheless, RBC suggests these positives are already priced into the unit price and prefers Winnipeg-based IGM Financial Inc., which it rates as an “outperform.” IGM, which trades at a discount to CI, has the advantage of an in-house sales force at Investors Group Inc. This tends to result in fewer redemptions, particularly during difficult periods in the market.

Other investment dealers such as Genuity Capital Markets and Catalyst Equity Research Inc. , both of Toronto, also prefer IGM, but aren’t as pessimistic about CI as RBC.

Genuity continues to rate CI a “hold” while Catalyst considers it a “buy.” However, both reduced their 12-month price targets in their Feb. 21 reports: Genuity to $23 an unit from $24.50 and Catalyst to $25 from $26.50.

As Catalyst president Robin Cornwall says, “CI remains probably the most efficient mutual fund company in Canada. But the outlook is weaker as growth in assets under management slows, with little room for cost cutting.”

Cornwall thinks CI’s margins are likely to “remain under pressure on the mutual fund side as competition, particularly from the banks, remains tough.”

CI itself is not particularly optimistic about 2008, as witnessed by the cut in distributions to 16¢ a unit from 19¢ that was announced on Jan. 23. Although Holland says the firm is always conservative in setting distributions, he admits this is the first time distributions have declined since the company became an income trust on June 30, 2006. CI pays out all distributable income — the amount necessary to ensure that the company pays no taxes.

Another area of concern for the firm is the changing face of the mutual fund industry, which is becoming more competitive and challenging, Holland says. He believes CI can grow organically at a rate of 10% a year, but only “if we do everything right.” The dark cloud is the big banks, which have 7,000 branches and “incredible brand recognition.” Holland stresses that the banks “want more market share and can keep pushing costs down.”

To succeed in such an environment, you need scale and you have to manage very carefully, Holland says.

CI is on the right path in these areas as it is well known as a company with a firm eye on costs and, as Genuity puts it, “a singular focus on building shareholder value.” Catalyst calls CI “one of the best-run mutual fund companies in Canada.”

@page_break@As for CI’s management team, it consists of Holland and president and chief operating officer Stephen MacPhail. There are also strong managers at CI’s distribution subsidiaries, including Joseph Canavan, chairman and CEO, and Steven Donald, president and COO, of Assante Wealth Management (Canada) Ltd. , as well as Bruce Kagan, CEO, and Wayne Adlam, president, at Blackmont Capital Inc.

CI has depended on acquisitions to fuel its growth. It bought BPI Financial Corp. in 1999; Spectrum Investment Management Ltd., Clarica Diversico Ltd., IQON Financial Management Inc. and Synera Financial Services Inc. in 2002; Assante, Synergy Asset Management Inc. and Skylon Capital Corp. in 2003; and Blackmont in 2007.

CI has also lost out on some major opportunities, including Mackenzie Financial Corp., which was acquired by IGM in 2001; London-based Amvescap PLC, the parent firm of AIM Funds Management Inc., for which CI put in a bid in 2005; and Clarington Corp., which was acquired by Industrial Alliance Insurance and Financial Services Inc. in 2005. (Some acquisition targets aren’t always enthusiastic about a CI bid because the firm is known as a cost-cutter.)

CI is certainly hungry for more acquisitions and it continues to look for targets. It was one of the bidders for DundeeWealth Inc. this past fall, which parent firm Dundee Corp. decided to keep.

In Cornwall’s opinion, being an income trust is a potential negative for making acquisitions, as targeted companies may not want to hold CI units because the tax implications of CI becoming a corporation again in late 2010 or early 2011 are unknown.

Future acquisition targets could include mutual fund manufacturers, investment managers, financial planning firms, investment dealers or private-client businesses. Holland says an acquisition should have $4 billion-$5 billion in AUM or assets under administration; and there has to be the potential to add shareholder value by cost cutting and synergies. In addition, an acquisition won’t work, he says, “if people don’t run the business the way you want them to.”

There are no capacity constraints at CI and no limit, in Holland’s view, as to how big CI can get. But the firm isn’t interested in just size; acquisitions will only be made if they add to earnings.

Geographically, the focus is on Canada, but Holland doesn’t rule out purchasing a U.S. investment management company, even though it is not particularly interested in a U.S. investment at this time. CI already owns 25% of Old Greenwich, Conn.-based Altrinsic Global Advisors LLC. Altrinsic is a fundamental value investment firm, which manages about US$7.6 billion in AUM as of Dec. 31, 2007, including a number of CI funds, institutional funds, endowments and high net-worth clients.

“It’s a decent way to do business in the U.S. and a decent way to be in institutional asset management,” Holland says of Altrinsic. CI has chosen not to be on Altrinsic’s board, but does help the firm with training and back-office operations.

The Altrinsic investment was a natural fit for CI because CI had worked with the U.S. firm for seven or eight years. CI was very impressed with the company. Holland believes it could be 10 times as big in 10 years.

In terms of CI’s financials, its reported net income was $625.1 million for the fiscal year ended Dec. 31, 2007, vs $471.9 million during the same period in 2006. The 2007 numbers reflect average retail AUM of $65 billion during 2007, vs $58.1 billion in 2006 and an income tax recovery of $63.8 million as a result of it becoming an income trust, vs a tax bill of $165.6 million the year prior. CI had revenue of $1.7 billion in 2007, vs $1.4 billion in 2006. The company reported long-term debt of $793 million as of Dec. 31.

There were 139.4 million CI units outstanding as of Dec. 31, 2007, as well as 146.8 million LP units that don’t trade, but which have voting rights and are convertible into ordinary units at any time. Sun Life Financial Inc. owns 36.5% of the units and the LP units; non-executive chairman Ray Chang owns 4.9% and Holland owns 4.6%.

Sun Life got its ownership stake in CI in 2002 in exchange for the four subsidiaries it sold to CI. At the beginning, Sun Life owned 31% of the shares and was restricted to no more than 34% for three years. There are now no ownership limits for Sun Life, but there are also no expectations that it will substantially increase its interest.

CI benefits from the Sun Life association both through distribution of CI products via Sun Life agents, which currently account for about 20% of gross sales, and potential financial backing, including share purchases should CI go the market to raise money for a major acquisition.

Here’s a look at CI’s businesses in greater detail.

> Mutual Funds And Segregated Funds. CI is the second-largest mutual fund company in Canada, with AUM of $61.5 billion as of Jan. 31. That’s ahead of Toronto-based TD Asset Management Inc.’s $54.9 billion and Winnipeg-based Investors Group Inc.’s $57.9 billion, but well short of Toronto-based RBC Asset Management Inc.’s $81.6 billion in AUM.

Mutual and seg funds account for 83% of CI’s revenue and 97% of its earnings before interest, taxes, depreciation and amortization.

Holland expects seg funds to grow faster than mutual funds. Seg funds currently account for 15% of AUM and Holland thinks they could easily be 20%-25% in five years. Overall, he says mutual and seg fund revenue will increase about 10% a year going forward, provided the firm stays on its toes and doesn’t make any mistakes.

AUM as of Jan. 31 was down $4.5 billion since May 31, 2007, entirely due to market depreciation of $4.2 billion. Net sales were $290 billion during the period.

AUM includes assets in CI subsidiary United Financial Corp. ’s funds, which are distributed by Assante. These funds accounted for $8.9 billion as of Dec. 31, down $1.3 million from $10.1 billion on May 31 due to market depreciation.

Investment performance at CI funds has been good in the last two years, with slightly more than 60% of long-term assets in funds with first- or second-quartile performance in both 2006 and 2007. Holland expects net sales for fiscal 2008 be around $2 billion.

> Assante Wealth Management (Canada) Ltd. “Assante has developed into a first-class financial planning firm,” Holland says. “It has the most productive practice by a mile, with average book size about double that of the industry. The level of advice is the best ever and it’s in great shape with really, really great management.”

Assante’s AUA, including United Financial funds, was $24.6 billion as of Jan. 31, down $3.4 billion from its peak of $28 billion on Mar. 31, 2007. The drop is partly the result of a number of advisors who left IQON to join Toronto-based Investment Planning Counsel. But, as with CI’s fund business, Assante’s AUM has also been affected by market depreciation.

Holland expects financial planning to grow only 5%-6% a year going forward, but only about 40% of Assante’s business is financial planning. The rest is in private client, which he thinks will grow faster than both CI’s mutual funds business, at 10% a year, and its brokerage business, at more than 10% a year. Holland defines financial planning as advisors who only sell mutual funds.

> Blackmont Capital Inc. CI acquired control of Blackmont on April 4, 2007. AUA was $9.1 billion as of Dec. 31, down $1 billion from a $10.1 billion peak on June 30, 2007.

Holland thinks highly of Blackmont: “It has developed into a really decent retail brokerage firm.”

The brokerage firm has added about 40 investment advisors with books averaging $80 million in the past year and a half and now has 170 advisors.

CI plans to grow the business “in a very prudent way.” This means hiring a couple of advisors a month.

> Asset Management. Besides CI Investments Inc., CI owns Vancouver-based KBSH Capital Management Inc., which had about $3.3 billion in AUM at Dec. 31, and Toronto-based Lakeview Asset Management Inc. , both of which were acquired along with Blackmont. IE