Reaffirming PH&N

The Royal Bank of Canada’s February announcement that it had agreed to acquire Phillips, Hager & North Investment Management Ltd. (PH&N) was a bombshell that took even the savviest members of the mutual fund community by surprise.

PH&N had been rejecting overtures from various financial institutions for years, so more than a few eyebrows were raised when RBC finally sealed the deal.

As ardent supporters of PH&N’s lineup of low-fee funds – many of which are featured on the Morningstar Fund Analyst Picks list – our immediate concern was what the deal meant for PH&N’s unitholders. Now that we have had plenty of time to mull things over, we are reaffirming our opinion that those PH&N offerings on our picks list remain excellent options for investors.

We did not arrive at this decision without a good deal of soulsearching along the way.

At the time of the announcement, we had a number of concerns, not the least of which was the potential for a negative change in the firm’s corporate culture. Also, the presumptive result that the acquisition made many top PH&N managers meaningfully wealthier drew some questions about whether manager turnover may be high once the three-year “lock-in” period is over.

Over the course of several months, we had numerous meetings with PH&N and RBC personnel to discuss the merger and its impact on unitholders. We interviewed senior executives such as PH&N’s president John Montalbano (who is now also CEO of RBC Asset Management) and RBC AM’s chief investment officer Dan Chornous (who will now fill the same role at PH&N). Also, my colleagues David O’Leary, Mark Chow and I met with the key members of PH&N’s fixed income and Canadian equity teams in Vancouver.

Our meetings produced two key findings: first, the message from both RBC and PH&N has been consistently communicated across the board, regardless of whom we have questioned – and believe me, we have grilled a lot of people along the way. All parties held firm with their assertion that PH&N’s corporate culture would not be tampered with, and that the pooling of resources and ideas would be explored only in situations that made sense.

For example, PH&N can take advantage of RBC’s extensive corporate credit and foreign bond capabilities for its fixed income mandates. The firms can also put their heads together to create more sophisticated products such as 130/30 funds and portable alpha strategies.

Second, our visit to Vancouver reminded us that PH&N is a firm that is loaded with smart, engaging people in both fixed income and equity management. Thus, even if our concerns of higher than average manager turnover come to pass, we will at least take some comfort in knowing that other capable personnel will be ready to carry the torch.

Without question, we’re sad to see a storied low-fee independent fund provider gobbled up by a bank. We’d like to see more firms like this in Canada, not fewer. Also, no matter how consistent the communication of the combined firm’s intentions, we find it hard to believe that PH&N’s corporate culture won’t change over time, knowing that the firm once took pride in the very fact that it was an employee-owned alternative to a bank.

But emotional factors aside, PH&N remains an attractive shop due to its bevy of topquality management and industry- leading fees. In fact, we were very much encouraged to learn that the fees on several PH&N funds have actually been lowered, which is exactly the kind of thing we would hope to see from a merged entity that benefits from economies of scale.

Certainly, many questions remain about how things will play out. Will the top PH&N managers ride off into the sunset in a few years? Will the higher-ups at RBC decide to tamper with PH&N’s processes or introduce cost-cutting measures? Will institutional and individual investor sentiment be negative for an extended period, possibly leading to continued outflows that might ultimately hinder performance?

Only time will tell how PH&N’s unitholders will be affected. But from where we sit, despite the question marks, there’s still a lot to like about the firm’s offerings.

Brian O’Neill is a senior fund analyst with Morningstar Canada.