Several years of limp performance in its flagship mutual funds have been an endurance test for once high-flying AIC Ltd. of Burlington, Ont.

After 40 consecutive months of redemptions, assets have plummeted by more than a third to $9.2 billion, and the firm continues in redemption mode. The company has also been plagued by a revolving door at the executive level of its sales and marketing departments, high turnover among wholesalers and questions about its management style.

Yet company founder and chairman Michael Lee-Chin remains deeply committed to the “buy, hold and prosper” investment philosophy that made AIC a $15.4-billion company at its peak in 2002, and him a billionaire a few times over. (Forbes magazine reports he is the eighth-richest person in Canada.) Lately there is a glimmering that the worst may be over. Redemptions have dropped in the past couple of months, and performance is perking up. Lee-Chin is convinced a turnaround is inevitable.

“We’ll hang on as long as it takes,” says Lee-Chin, who at 54 is tall, stylish and remarkably fit. “If I ask myself why I am here and how I am adding value to society, it’s not by running just another mutual fund company giving investors what they want in the short term. AIC will ultimately be a case study of how a company handled difficult times and survived through thick and thin.”

Lee-Chin believes the value in AIC’s blue-chip equities — which have been overshadowed by the stock market frenzy in resources stocks and income trusts — will once again be recognized. Performance showed an improvement recently when the $1.2-billion AIC Advantage Fund, a key fund in the AIC stable, generated a return of 14.6% for the year ended July 31, a respectable gain that nevertheless puts it in only the third quartile of performance, according to Morningstar Canada. The fund’s lack of exposure to income trusts, small-cap stocks and red-hot resources resulted in the fund continuing to lag the S&P/TSX composite index’s total return for the year of 25.5%, as it has for the previous four years. The fund’s five-year average annual compound return is a skimpy 1.1%, but its 10-year average annual return of 11.7% puts it in the top quartile — and ahead of the index’s 10.4% gain.

Lee-Chin, who plays a key role in managing AIC Advantage Fund, adamantly believes in the long-term potential of the select handful of companies in its portfolio. The question is whether advisors and their clients will come back after so many years on the performance sidelines, even if Advantage and other lagging AIC funds make a comeback.

“AIC’s underperformance has gone on for a painfully long time, and many advisors have lost confidence or simply tuned out,” says Dan Richards, president of consulting firm Strategic Imperatives Inc. “Even if performance turns around this year, that won’t be enough. It will take at least three years of solid, sustained performance before advisors give AIC a second look.”

How low assets will fall before the redemption wave recedes is anybody’s guess. Lee-Chin is determined to hang on, and refuses to entertain offers for the company or waver from his investment strategy.

“We are not financially vulnerable in any way,” says Lee-Chin, who also receives revenue from ownership of mutual fund distributor Berkshire Investment Group Inc. and its related companies and AIC’s 75% interest in the National Commercial Bank of Jamaica. “I’d rather see the company shrink to zero than change our investment philosophy, but that won’t happen.”

There have been rumours that if AIC’s assets fall below a certain level, its bankers at TD Canada Trust could force a sale because of certain loan covenants. Lee-Chin says there is no truth to those rumours, and if his bankers were tightening the noose, he could easily pay off the loan. AIC’s net redemptions of $211 million in July, while still negative, were the lowest they’ve been since August 2004. Lee-Chin says this August has shown a continuation of the improvement.

“The end [of heavy redemptions] is in sight,” he says. “There has been a retardation of redemptions and, at some point, the people who bought without commitment will be gone and we’ll be left with the hard core. Performance will come back. Those who were not believers will be gone, while those who remained with us will benefit.”

@page_break@AIC funds have been hurt by their lack of participation in the few areas that have shown strong market returns, as well as by weak share prices during the past few years for their major holdings, such as Amvescap PLC, AGF Fund Management Ltd., Thomson Corp. and MDS Inc. Commodity-related stocks tend to be cyclical and don’t fit Lee-Chin’s criteria, nor do small-caps that lack established track records. Income trusts, which tend to operate in stable rather than growth industries, are usually not of interest. Income trusts, which pay out generous distributions on a regular basis, are less tax-efficient than holding on to a growing company and letting capital gains accumulate and compound on a tax-deferred basis, Lee-Chin says.

“Minimizing taxes is very important to long-term returns,” he says. “Any manager who has stocked up on commodity-based stocks is taking higher risks as the valuations increase. Selling stocks in a popular sector is not only psychologically difficult for a fund manager to do, but it triggers capital gains taxes. Cyclical stocks must be sold at some point, and triggering taxes is the bane of wealth creation.”

Lee-Chin looks for companies he would be happy to own in the entirety for 20 years or more. The wealth-management industry continues to be one of his favourite businesses due to favourable demographics as baby boomers struggle to finance retirement, and this sector makes up 52% of the Advantage fund’s holdings.

“The leverage is fantastic in wealth management,” he says, “as assets can rise significantly without increasing overhead or requiring more managers.”

Lost in the shadow of such major funds as AIC Advantage, Advantage II and AIC Diversified are other, smaller funds within the group that have shown healthier performance in recent times, such as AIC Dividend Income and AIC Canadian Focused, both managed by James Cole. Bond funds managed by Randy LeClair also have done well, as has as AIC Canadian Balanced, managed by LeClair and Cole. Some critics say AIC missed a marketing opportunity by not promoting these funds more aggressively.

Advisors and analysts also criticize AIC’s team of wholesalers for neglecting them during the tough times, and they say high turnover in the AIC sales department has made it difficult to establish steady relationships.

“We’re not hearing about the AIC funds and managers that have done well,” says Raynor Burke, director of investment funds for National Bank of Canada. “The sales and marketing side is important, as that’s where advisors go for help and information, but AIC has not been very present. Maybe there’s been too much turnover in staff, but there have been times my calls weren’t returned.”

As with any style, AIC’s investment philosophy can be in the doldrums for periods of time, but neglecting advisors makes it harder to rebuild if performance turns around, Burke says.

“In the past, our sales force was not front and centre,” Lee-Chin admits. “We’ve changed the team, and now have people who don’t carry the baggage and who thoroughly understand the product and philosophy. They’re contacting five advisors a day.”

The departure last March of Dave Whyte, AIC’s executive vice-president of sales and marketing, after only nine months on the job also eroded confidence in the firm. Whyte, who came from AIM Funds Management Inc., was well known to advisors. It is said he felt hobbled in his efforts to execute a cohesive strategy to staunch the flood of redemptions, and that he quit because he was frustrated with his lack of decision-making authority and with what he viewed as Lee-Chin’s autocratic style.

Lee-Chin is reluctant to comment on Whyte specifically, but says: “It can be difficult bringing someone in at a senior level who did not grow up within the company.”

Whyte’s replacement, John Miller, previously a co-manager of AIC Value Fund, has been with AIC for eight years and is “ensconced in the culture.” He has done some tinkering with the compensation structure of the sales team to encourage customer contact. Previously, the team was rewarded only for new sales, meaning there was no incentive to make the difficult calls to advisors who were redeeming. Through a compensation structure that rewards cutting redemptions as well as new sales, wholesalers are now being encouraged to build bridges and maintain frequent contact with advisors.

AIC also needs to communicate with advisors about how its products can best be used within client portfolios, says James Gauthier, a fund analyst with Dundee Securities Corp.

“We sense that, to a certain extent, AIC’s philosophy on the sales and marketing side has been ’our way or the highway,’ and this simply will not work any more,” writes Gauthier in a recent report. “We believe John Miller is aware of these issues, and we hope he has been granted the leeway to address them.”

AIC has added selectively to its product lineup, and recently took the step of hiring an outside manager with a compatible style, Third Avenue Management LLC of New York. A deep-value shop led by legendary investor Marty Whitman, the firm is managing AIC Global Focused Fund, introduced in April. The new fund has garnered about $30 million in assets. Lee-Chin says he would consider bringing in another high-profile fund manager with a long record of success and similar investment style, although there aren’t many out there.

Lee-Chin believes AIC will emerge as a role model for businesses in weathering difficult times by never losing sight of the strategy that created its original success and remaining focused and disciplined. While it’s possible AIC may have been able to stem redemptions by offering a broader product lineup, including sector funds and income trust funds, Lee-Chin prefers to concentrate on funds that employ AIC’s philosophy of buying and holding a small group of superior companies. He wants to avoid becoming like any other supermarket fund company offering a multitude of investment choices. He says differentiation is the key: “AIC is not just a marketing machine — if we were, we would simply bring in all the products people want. I have the option. Why don’t I do that? Am I a fool?

“We believe we have the opportunity as a private company to stick to our philosophy of buying and holding excellent businesses that we understand, and not confuse people with a mix of products,” he says. “The challenge is to educate advisors and investors as to what successful investing is all about.” IE