Man may not be able to serve two masters, but that doesn't stop fund companies from trying. The masters they serve -- the owners of the business and those who invest in their funds -- won't necessarily share the same interests. High fees, for instance, boost revenues for fund companies, but they reduce fundholders' returns. Launching narrowly-focused flavour-of-the-month offerings may attract assets, but such funds are prone to investor misuse, leading to a poor experience for fundholders. Fundholder-friendly firms put the interests of investors ahead of their own.
Morningstar measures how well these firms balance their interests with those of fundholders with its Stewardship Grade. Fund companies have tipped this balance increasingly in favour of the fundholder in recent years, as a new Morningstar white paper demonstrates. The paper paints a mostly positive picture of how Canadian stewardship practices have evolved since the Stewardship Grade's 2010 launch. (It also demonstrates a positive link between 2010 Stewardship Grades and subsequent performance, as I explained on Monday.)
Between 2010 and 2013 -- the most recent year we assigned Stewardship Grades -- fund companies improved their corporate cultures, better aligned portfolio managers' incentives with fundholder interests, and became more transparent. As a result, significantly more Canadian fund companies earned B Stewardship Grades in 2013 than in 2010; while just six earned B's in 2010, 12 did in 2013. Moreover, fewer firms received C's; 15 did so in 2010 versus 11 in 2013, and none garnered D's or F's. To be sure, the industry has more work to do -- no firm moved into the A column over the period -- but the overall trend has been positive, as Exhibit 1 indicates.
Exhibit 1: Stewardship and parent grades - then and now
Even better, a much smaller slice of Canadian investor assets were invested with middling stewards in 2013 than in 2010. Firms with C Stewardship Grades represented 70% of industry assets in 2010, versus 18% in June 2014. Meanwhile, B stewards now make up almost half of the industry's assets, versus about 10% in 2010.
Exhibit 2: Industry assets by grade - then and now
The dramatic shift is mostly explained by progress at some of the country's biggest fund providers including RBC, CI and Fidelity, which moved from the C to the B column. These companies gained market share at the expense of financial-planning behemoth Investors Group as well as large independent firms like Invesco Canada and AGF, all of which scored C's in 2013.
It's worth noting Morningstar issued fewer Stewardship Grades in 2013 than in 2010. However, analysts evaluated nearly the same number of parent organizations (26 in 2013 versus 27 in 2010) accounting for nearly 70% of the industry's total assets. In instances where we didn't assign a Stewardship Grade, we substituted our Parent Rating, which is a component of the Morningstar Analyst Rating, our qualitative rating for mutual funds. The Parent Rating uses the same criteria as the Stewardship Grade, though instead of letter grades, fund companies receive Positive, Neutral or Negative ratings. (Positive-rated firms would receive an A or B Stewardship Grade, Negative firms a D or F, and Neutrals a C.) In our study, we converted the Parent Rating to the equivalent Stewardship Grade based on our internal rating. (Premium users can find a listing of firms with Stewardship Grades here.)
Corporate culture: a higher bar
Corporate culture is the most important component of the Stewardship Grade, accounting for 50% of the overall grade. (The quality of manager incentives and fees make up the rest.) Our culture assessment rests on whether a firm's culture is built primarily to deliver investment success or business success. These aren't mutually exclusive goals -- strong performance usually attracts investor assets -- but stewardship should prevail over salesmanship.
Canadian fund companies have also bettered their corporate cultures in recent years, albeit not dramatically. Because cultures are usually deep-seated, they tend to evolve slowly. Overall, Canadian firms' corporate cultures headed modestly in the right direction over the period, with fewer receiving failing grades.
Exhibit 3: Evolution of corporate culture grade - 2010 to 2013
RBC and Fiera: Mergers leave their mark
Over the period, RBC Global Asset Management, Canada's biggest asset manager, rose from C to B in corporate culture. The firm had acquired Phillips, Hager & North in 2008, and in 2010 it wasn't clear how the two firms' distinctive cultures would mesh. Mergers often lead to personnel turnover, and some prominent managers had recently left. Fortunately, though, RBC has leveraged many of PH&N's strengths across the organization. Top brass at RBCGAM, including CEO John Montalbano, hail from PH&N.
RBC introduced PH&N's quantitative risk-monitoring tool, BondLab, to its fixed-income line-up and expanded PH&N's quantitative research team to build tools for RBC and PH&N funds. RBC hasn't stopped improving since completing its acquisition of PH&N, either. For instance, since luring Bill Tilford -- an alum of Canada Pension Plan Investment Board and Connor, Clark and Lunn -- in 2011, it has bulked up its quantitative effort overall, and he has built solid screening and portfolio-construction tools.
While RBC has evolved with its acquisitions, Fiera Capital has been transformed by them. Morningstar assigned a D to Fiera's predecessor organization, Sceptre Investment Counsel, in 2010; the company was a major investor in a pump-and-dump scheme, indicating poor risk controls, and had suffered from a spate of high-profile manager departures. While not a top-rated culture (it earned a B in 2013) Fiera has integrated a raft of acquisitions without disruptive personnel turnover. And while its acquisitive nature is not inherently fundholder-focused, Fiera has capped fast-growing funds and avoided gimmicky fund launches -- examples of fundholder-friendly behaviour.
Invesco and AGF: Manager turnover takes a toll
Heavy manager turnover drove Morningstar to downgrade Invesco Canada's Corporate Culture grade in 2012. Invesco had already lost top talent by the end of the 2000s, but that trend continued into the new decade. CIO Graham Anderson was pushed out in 2011, replaced by a five-member team of portfolio managers. By 2013, two of the five replacements had left. Invesco's entire fixed-income team also turned over during the period, and new head Jennifer Hartviksen rebuilt the group with fellow outsiders. The equity side of the house also witnessed notable departures, including Dana Love and Darren McKiernan. Even if the turnover wasn't reflective of cultural problems -- many left involuntarily on performance grounds -- it still creates a fair bit of uncertainty.
Prominent manager departures also soured our view of AGF's corporate culture in 2012. Star emerging-markets manager Patricia Perez-Coutts left with nearly all of the firm's global research team, leaving a gaping hole. Meanwhile, the firm had made questionable product-related decisions, handing a Canadian equity mandate to a Dublin-based team with no Canadian market expertise. The Dublin team also suffered tremendous losses in the 2008 financial crisis, calling into question AGF's risk-control practices.
We raised AGF's Corporate Culture grade to C from D in 2013 after the firm demonstrated significant progress in cleaning up its mess. By 2013, it had replaced Perez-Coutts and her team using a thoughtful process. It also had bulked up its domestic analyst group under head Terri Ellis, who also brought a more disciplined approach to its research. The firm also had cut fees, albeit from nosebleed levels, and introduced measures to ensure better alignment between managers and fundholders.
Investors Group: Falling behind by standing still
Outright deterioration drove most culture downgrades, but Investors Group fell from C to D in 2013 because it had stood still while its rivals upped their games. Despite its financial strength, IG showed little evidence it reinvested in its business, leaving it underresourced relative to other large rivals. Mark Rarog, manager of Investors Canadian Small Cap 
, covers the entire domestic small-cap universe without dedicated analyst support, while IG's fixed-income team led by Jeff Hall has limited manpower given its workload. The firm's bond analytics also appear weak next to other large rivals like RBC and TD.
There is some hope for IG. It has expanded its talent pool in recent years by establishing a larger presence in Toronto, and new CIO Jeffrey Singer has better organized its research capabilities. But the firm still has plenty of room for improvement.
Mawer, Steadyhand, Capital International: The best get better
The best corporate cultures evolve to stay ahead. The cultural strengths we identified in 2010 at Mawer Investment Management remain in place, but it hasn't rested on its laurels. While adhering to the same disciplined focus on reasonably valued, high-quality companies, it has brought its risk-management tools to the portfolio level. The fast-growing firm risked disrupting its culture with a larger team, but it has carefully vetted new talent for cultural fit and groomed the next generation of leadership in deputy CIO Paul Moroz and research director Vijay Viswanathan. Lastly, Mawer has continued to put fundholder interests first by capping (in whole or part) Mawer New Canada and Mawer Canadian Equity to preserve their flexibility. The firm will be challenged to maintain this culture as it continues to grow, but it remains one of the industry's best.
While Mawer was well established when Morningstar launched its Stewardship Grade, Steadyhand was just three years old when Morningstar awarded it an A for culture. Founder Tom Bradley, a former head of PH&N, adopted industry-leading stewardship practices right from the get-go. He kept the firm's fund line-up simple and gimmick-free. He also hired capable subadvisors who employed concentrated, index-agnostic portfolios and charged reasonable fees for the funds, both of which improve fundholders' odds of success. Steadyhand's funds have been strong performers overall, and the firm has distinguished itself with its focus on transparency. Its communication with current and prospective investors is clear, honest and jargon-free. In addition to informative commentaries, its website even discloses the dollar value of Steadyhand employees' investment in the firm's funds -- a rarity in the industry.
Steadyhand, like Mawer and Beutel Goodman (another grade A culture), oversees a fairly compact fund line-up and employs the same investment strategies within its organization. By contrast, most large fund providers offer an array of investment styles across a broader line-up. Such diversity can make it harder to build cohesive corporate cultures, but it is not impossible as Capital International shows. The U.S.-based company, while still a relative small fry in Canada, is one of the biggest in its home market.
As with Mawer, Capital puts heavy emphasis on cultural fit in hiring investment personnel. Once hired, analysts and portfolio managers (which it calls "counsellors") typically build their entire careers at the firm, making them among the most experienced in the business. Its unique multimanager approach, whereby portfolios are divvied up across several managers, means the firm plays host to different investment styles. While adopting different approaches, the managers nonetheless tend to share long-term-oriented, low-turnover strategies. Moreover, packaging an array of distinctive styles within a fund has helped moderate volatility and keep the company's line-up uncluttered.
Capital hasn't been as successful in the fixed-income realm, but it has paid greater attention to macroeconomic risks and brought in some outside talent to improve its effort. The company has also been a laggard in the transparency department. While Capital has finally begun providing more detail on how it divides its funds across managers, it still may not disclose managers overseeing a small percentage of a fund's portfolio, demonstrating that even the best cultures still need improvement.
Editor's note: Today's article is the second of a three-part series this week, based on our manager-research team's newly released white paper on fund-company stewardship in Canada. Part 1 discussed the positive relationship between Stewardship Grades and performance. Part 3 on Friday will focus on whether fund managers have put more skin in the game and consider whether fundholders have shared in fund companies' success.
