With assets under management approaching $1 billion, NexGen Financial Corp. of Toronto is converting into a corporation from its limited partnership structure and preparing for a public listing on the TSX Venture Exchange by the autumn.
The change in corporate structure is largely for tax reasons, which is not surprising, considering that NexGen\u2019s family of mutual funds has been designed to minimize taxes for investors. When NexGen was launched in the autumn of 2006 by CEO Jim Hunter and a small band of fellow stakeholders, the LP structure allowed losses to flow through to investors, who were able to use the losses as a tax deduction. But with deductible losses virtually used up, the LP structure no longer makes sense. Thus, converting into a public corporation provides liquidity for shareholders and also provides a way to encourage new employees to become owners in the firm.
\u201cThe tax losses during the first four years or so were allowed to flow out to the original inves-tors and reduce their cost of investing in NexGen,\u201d says co-founder and president Laurie Munro. \u201cThose tax losses are pretty much exhausted, and we\u2019re on the cusp of profitability. We are converting to a corporation and hope to list our shares on the [TSXV].\u201d
Munro, who, like Hunter, is a former executive with Toronto-based Mackenzie Financial Corp., says NexGen\u2019s medium-term business objective is to corner 1% of the Canadian investment funds market, which currently totals about $700 billion. Munro hopes to hit this target within five or six years. Currently, NexGen has about $845 million in AUM spread among 18 investment mandates. Growth has been steady and the firm has had positive net sales every month since inception.
\u201cThe first milestones, such as the $1-billion mark, can take a while to hit,\u201d says Dan Hallett, vice president and director of asset management with Oakville, Ont.-based HighView Financial Group. <\/b> \u201cBut as [NexGen] gains traction, it can double from here in a fraction of the time. NexGen offers clients a unique structure that allows them to choose the type of investment income they would like to receive and to control the timing. It has taken time for advisors and their clients to understand the taxation structure and how it works. But four years into the business, we\u2019re seeing an acceleration in growth.\u201d
NexGen has designed its fund family as both a tax-efficient corporate-class structure for clients who hold (taxable) fund units outside registered plans and a trust structure for clients who hold their (non-taxable) units in RRSPs or RRIFs. The entire NexGen family of 18 equity, fixed-income and balanced funds is available within either structure, but, Munro says, about 82% of NexGen\u2019s AUM is held in the corporate-class structure.
Although many fund firms offer a corporate-class structure, what sets NexGen apart is that it allows investors in its corporate-class funds to choose from among four options for how they receive the returns generated by any of the funds:
> Capital Gains Class. <\/b>The objective is to increase value through capital appreciation. This class of funds is ideal for clients who have tax losses from previous years that they wish to carry forward and deduct against the annual capital gains paid by the fund. Capital gains are taxable at half the rate of interest income.
> Return Of Capital Class. <\/b>The funds in this class provide income in the form of monthly distributions, consisting primarily of return of capital. Return of capital is not taxable in the year received, but it does lower the cost base of the original investment, affecting the eventual capital gains or losses upon the sale of the fund units.
> Dividend Tax Credit Class. <\/b>Monthly distributions consist primarily of dividend income, which receives preferential tax treatment. If a client has no other income, he or she can receive about $50,000 in dividend income before being subjected to taxation due to the dividend tax credit.@page_break@> Compound Growth Class. <\/b>The objective here is to maximize long-term growth through reinvestment of gains. These funds are designed to avoid annual distributions and provide full tax deferral until the fund units are sold. This class is for clients who don\u2019t need the income immediately.
Clients can mix and match classes. For example, they may like the low-risk profile of a bond fund but not the traditional tax treatment that sees interest income taxed at the maximum personal rate. NexGen\u2019s structure allows clients to take income from the bond fund in a more tax-advantaged form, such as dividends, return of capital or capital gains.
Alternatively, a client who wishes to received regular dividend income is not restricted to the usual Canadian blue-chip stocks, but can invest in a more aggressive equity fund, such as NexGen\u2019s Global Resource, NexGen Global Value or NexGen North American Small\/Mid-Cap funds, to create a dividend stream from the fund\u2019s return, even if the stocks in the portfolio don\u2019t pay dividends.
A strategy for a client who wants to minimize investment income in order to avoid being subjected to the old-age security clawback is to invest in any asset class but take monthly income in the form of tax-deferred return of capital that is not immediately taxable.
Clients can choose the class of fund that best suits their circumstances, but they have complete flexibility to switch at any time among the various taxation options \u2014 as well as among the various types of funds and fund managers \u2014 without triggering any tax consequences.
\u201cIn a taxable account, all incomes are not taxed equally,\u201d say Munro. \u201cThose subject to the highest rate are interest income and foreign dividends. All things being equal, investors who have a choice would not want to receive income in those forms. It\u2019s punitive \u2014 they\u2019re giving away almost half their income in taxes.\u201d
NexGen\u2019s most popular class is the compound growth class, which accounts for about 60% of the AUM held in corporate-class funds. Another 20% is held in the capital gains class. In terms of investment strategy, the most popular fund is NexGen Canadian Bond Fund, which has about $400 million in AUM, Munro says, although there\u2019s recently been a shift toward NexGen\u2019s balanced funds. As more seniors seek income from their investment portfolios, Munro foresees the tax classes that provide regular income will become increasingly popular.
No other firm, says Munro, offers NexGen\u2019s tax advantages, which are the creation of Hunter, a chartered accountant with a history of innovation when it comes to new mutual fund products. An application for patent protection \u2014 which, Munro says, usually takes five to seven years to \u201ccure\u201d \u2014 has deterred competitors.
\u201cThe product line represents quite a feat of financial engineering,\u201d says Rudy Luukko, investment funds and personal finance editor with Morningstar Canada<\/b> in Toronto. \u201cIt\u2019s a structure only an accounting professional would love; it\u2019s so complex. But once you understand the benefits of the different classes and distribution structures, it makes sense. The NexGen funds can be a lot more customized to an individual\u2019s tax planning needs than the typical corporate-class structure.\u201d
NexGen has expanded its national wholesaling team to 10 from the original three. Much of the team\u2019s time is focused on making presentations to accounting firms to teach them about NexGen\u2019s beneficial tax structure, particularly some of the strategies that are useful for small-business owners who want tax-efficient income. Munro says about 25% of the firm\u2019s AUM is held in incorporated accounts owned by small-business people or professionals.
In addition to the tax benefits, NexGen offers a competitive pricing structure that allows for fee reductions for larger accounts. This tends to attract wealthier, more sophisticated clients with an average account size of $60,000 \u2014 about four times the industry average.\tIE<\/b>
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