03 April 2006

How RBC Asset Management Got to the Top of the Industry

Almost one-quarter of net mutual fund sales in Canada last year were generated by RBCAM, and it is far from resting on its laurels

Investment Executive, James Langton, 3 April 2006

RBC Asset Management Inc. is the Toyota Motor Corp. of the Canadian mutual fund industry, vanquishing traditional industry leaders in an ultra-competitive business with top-notch products, solid strategy and superior execution. Now, like fast-rising Toyota, RBCAM’s greatest challenge will be sustaining its advantage.

A quick glance at recent mutual fund sales figures reveals the breadth of RBCAM’s sales dominance.

Last year, the best year for the fund industry since 2001, saw $23.4 billion in net sales generated. RBCAM accounted for almost a quarter of the total, punching well above its weight class, with its market share of assets at slightly less than 10%. RBCAM boasts that it has led the net sales parade for nine consecutive quarters. That isn’t simply the result of a hot sector or two; RBCAM was ranked among the top three sellers in every long-term asset category in 2005.

Dominating fund sales so thoroughly is no small feat. The industry is already mature, saturated with products and filled with aggressive competitors. There are few easy sales, and no real secrets to success, as every firm knows it needs eye-catching investment performance and effective distribution. In such an environment, execution is the key differentiator.

Relative to the rest of the industry, RBCAM has executed exceptionally well. It has done perhaps the best job among the banks in capitalizing on their natural competitive advantage: large, built-in distribution networks. At the same time, it has skilfully expanded its distribution into independent channels, where it was once thought that bank-managed funds could never hope to compete. RBC has also exploited its scale to keep costs low, product development active and to improve governance, which can have its own salutary effect on returns.

The convergence of near-perfect conditions is no accident. George Lewis, chairman and CEO of RBC Asset Management and executive vice president of RBC Wealth Management, says the march forward is the result of excellent execution by his team in all key functions: distribution, investment performance and product development.

Most important is distribution. “We decided that to be a top one or two player in this business, we had to operate in more channels. So, five years ago, we began to market our funds to brokers and financial planners,” says Lewis.

Back then, RBC Asset Management ranked fourth in mutual fund assets, and just seventh in long-term assets, data from Toronto-based Investor Economics Inc. show. Since then, RBC’s share of long-term assets has grown to almost 9% from less than 6%, a gain that came primarily at the expense of the large, independent fund manufacturers.

In pursuing the independent channel, Lewis says, the firm first focused on its full-service investment dealer sister, RBC Dominion Securities Inc. , taking the approach that it had to earn the business one advisor at a time. The challenge was tackled with dedicated external wholesalers, product development that focused on stockbrokers’ needs and changes on the investment-management team, including bringing Dan Chornous over from RBC DS, where he was chief strategist, to serve as chief investment officer at RBC Asset Management in 2002.

After earning its stripes with the DS sales force, Lewis says, RBC is now doing a fair amount of business in the independent channel, principally with the other bank-owned investment dealers and some of the larger fund dealers. Indeed, he notes, the brokerage/ planner channel represented about 25% of RBC’s net sales in 2005, and the dollar value of sales in the channel increased 300% last year to about $1.2 billion. “I’d be disappointed if we didn’t double that in 2007,” he says.

The fact that RBC funds tend to be cheaper doesn’t hurt, either. Lewis says RBC has tried to align itself with dealers that want to use no-load funds or unbundle client costs by charging a fee for advice and using F-class units. He says the firm will continue to attract clients as regulators and investors demand greater fee transparency.

In the past, the dig at bank-owned fund firms was “no-load means no performance,” but RBCAM is proving that is not the case. “You can have the benefits of low management expense ratios, advisor-friendly trailer compensation and good performance,” says Lewis.

Although external dealers are a significant and fast-growing source of sales, the bulk of RBC sales comes through the parent bank’s traditional distributors: 7,500 branch-based reps and 1,500 branch advisors, known as investment specialists.

Of the 1,500 branch advisors, about two-thirds serve the retail bank’s bigger clients that already have investments with Royal Bank of Canada. The other third are so-called “mobile” advisors — an asset-acquisition force that aims to bring in clients that are either new to the banks or existing clients that don’t do any investment business. The 500 mobile advisors focus on making the initial sale and then hand off the client to one of the 1,000 planners to manage the ongoing relationship.

The different objectives of the two parts of the branch advice sales forces is reflected in their compensation. The mobile advisors are commission-based, whereas the others are paid salaries and bonuses based on the size and growth of their books.

The branch advisors are distinct from the larger sales force in that they provide financial planning, aren’t locked into proprietary products and can also offer third-party funds. Lewis says RBC was so confident in its ability to compete as a manufacturer that it funded half the cost of equipping its parent’s sales force to sell third-party products.

Why fund your rivals’ distribution? Allowing branch advisors some flexibility to offer third-party funds gives them the ability to establish credibility with clients by demonstrating independence, and possibly improving returns, even if it means using a competitor’s product. The sales force accounts for 30%-35% of RBC’s assets under management, Lewis says, and third-party funds represent about 5% of that amount.

RBC finds the use of multiple channels reinforces its competitive advantages. “We’re in a situation in which we’re in a virtuous circle,” says Lewis. “We have very strong relationships with our distribution partners, both internally and externally. Because of that, we have good product development to meet the needs of those distributors.”

The success in winning independent distribution, in turn, validates the quality of its products to the bank’s internal sales forces, he adds, because having independent advisors selling a bank fund is a benefit.

Apart from distribution, Lewis says, the bank also has advantages as an investment manager because it has a large team of portfolio managers in Toronto as well as offices in Montreal, London and Hong Kong. Although it uses a variety of sub-advisors, having a large group of managers who are focused globally gives it a different perspective on the markets.

That perspective has helped RBC make some solid asset-mix calls, and to bump up investment performance in recent years. As a result, Lewis says, RBCAM ranks among the top three firms with the proportion of funds in the top two quartiles over six-month, and one-, three- and five-year periods.

Good investment performance makes life easier for distributors, and it has also changed the reputation banks had of being second-rate asset managers. Lewis says RBCAM’s success shows “banks can operate an asset-management business well, and that was not the perception seven or eight years ago.”

The solid performance has helped push RBC’s AUM to $61.5 billion at the end of the recent RRSP season. It is also powering the parent bank’s growth. In the first quarter ended Jan. 31, 2006, the bank reported that wealth-management revenue increased 17% compared with the same quarter in 2005, a time when overall revenue rose 10%. It attributes the gains primarily to robust fund sales and greater fees resulting from higher AUM, along with higher volumes in full-service brokerage and improved spreads.

The AUM total has the firm at the top of the industry rankings, but it wants more. Lewis says RBCAM aims to surpass the $100-billion mark by 2010. The goal is well within reach if RBCAM can sustain its momentum. Maintaining current sales levels over the next five years would mean total sales of about $30 billion through 2010. Throw in a modest lift from the markets in that time, and that goal is easily attained.

Moreover, industry trends appear to be tilting in RBCAM’s favour. Investor Economics projects the overall wealth market will grow by 8% annually in the next decade, with branch advice running at 12% and full-service brokerage at almost 11%.

Domestic acquisitions don’t figure prominently in the plan. Lewis indicates RBC’s acquisition ambitions are global and not local; it is more likely to do deals that would open asset-management businesses in other markets, and not bulk up in the domestic market. He says that is RBC’s philosophical position, not an active ambition, although the parent bank has been rumoured to be pursuing a fund-management venture in China.

As there are no domestic acquisitions in the cards and the markets are an inherent unknown, the big challenge at RBCAM is to maintain its sales record. Given its current performance and momentum, however, it looks like the Toyota of the fund business is only getting stronger.