When FMF Capital Group Ltd. spiralled into its precipitous slide a few weeks ago, shedding more than 90 per cent of its value virtually overnight, outraged investors began to ask some tough questions.
How could a company plunge from $10 a share to penny-stock indignity in less than eight months of trading? Why was a company with a heavy dependency on low interest rates brought to market as an income trust in the first place? And just what was BMO Nesbitt Burns Inc. thinking?
It's an understandable line of inquiry. The investment banking arm of Bank of Montreal was tarred by bad press, not to mention a class-action lawsuit on Tuesday, for leading FMF's $200-million initial public offering in March.
But the mortgage company's flameout clouds a larger issue: When you compare the performance of Canada's bank-owned underwriters in the business trust market in the past four years, BMO ranks a distant last, and on balance its deals have given investors almost no return in that period.
The annual total return of the 24 business trust deals that BMO led or co-led between January, 2001, when the income trust sector blossomed, and June, 2005, is a meagre 0.3 per cent on average, according to a study by The Globe and Mail.
This measurement includes both distributions and unit price appreciation, and assumes that unitholders reinvested these distributions in the underlying trust.
In the same span of time, Scotia Capital Inc.'s average annualized return was 12.5 per cent, CIBC World Markets Inc.'s was 8.5 and RBC Dominion Securities Inc.'s was 6.7. National Bank Financial Inc. and TD Securities only managed eight deals apiece, but their performance was still strong: 11.7 and 13.1 per cent, respectively.
BMO's performance is particularly striking because it, along with the other banks, strenuously lobbied Ottawa to leave the trust sector alone, presumably because its high yields and frequent distributions gave valuable income potential for retiring Canadians. These trusts have also been a source of lucrative fees for the banking sector. Based on industry averages for commissions, BMO could have earned as much as $60-million on these 24 deals, including more than $4-million on FMF alone.
All of these statistics are based on the business trust sector, a group of companies that does not include the more stable and established trust players in the energy and real estate markets. The study does not count any trusts that launched IPOs in the past six months, since their returns -- both positive and negative -- can be grossly exaggerated on an annualized basis.
Sources say BMO was late to the trust party, and compensated for this by being more aggressive. With income funds as the single dominant source of investment banking revenues in recent years, there was intense pressure on other corporate finance departments to find potential new trusts.
CIBC, RBC and Scotia Capital each declined an opportunity to participate in the FMF underwriting, which paid the dealers a total of $11.4-million in fees. It's rare for a brokerage house to turn down a secondary role in an IPO, since the lead dealer does most of the work. A senior financier at one of the banks that passed said: "We didn't think there was a real business here."
Officials at BMO declined to comment on why they chose to lead FMF, citing client confidentiality, but maintained they are diligent in choosing which business trusts to sell to investors.
"We put a concerted effort into the income trust arena in the last couple of years, and that is borne out in the number of deals that we had the opportunity to lead, and our performance record is as it stands," said William Butt, co-head of investment and corporate banking at BMO. "Our objective is to bring forward the highest-quality companies and products, and that's what we strive to do."
Mr. Butt also rebuffed suggestions that BMO's retail broker network has become reluctant to sell the bank's trust products following the FMF fiasco, insisting there has been no "material change" in how the sales force is operating.
There are several ways to measure performance. If one assumes unitholders did not reinvest their distributions in the underlying trusts, BMO fares marginally better, with an annual total return of 1.1 per cent. That's still less than an investor could obtain by socking money away in a GIC. Even on a book-runner basis, which only includes the brokerage that manages the book of securities being sold in the IPO, BMO still delivered a return of just 0.3 per cent.
BMO insists upon a different methodology. It prefers to use the book-runner numbers, and assumes that investors did not reinvest their distributions. It also weights its different deals by size, so that a large business trust that did well would have a much bigger impact than a smaller trust that performed well.
The bank claims the most accurate way to benchmark its performance is to begin in 2004, since it only led a handful of offerings before that time. When you adopt these parameters, BMO says it produced an annualized return of 8.7 per cent, second to National Bank at 34.7 and well ahead of CIBC World Markets at negative 15.8.
"We think our track record is actually pretty good, compared to our competitors," said Ken Manget, managing director and head of income funds at BMO.
Critics of dollar-weighting, however, argue that regular investors don't tend to run their portfolios this way, and point out that the average holdings in business trusts are remarkably similar from one company to the next, regardless of size. Pension funds may weight their investments, but they have not been major players in the trust market, and for the most part they were not the ones getting burned in smaller companies that imploded, like FMF.
Performance can also be tracked by much simpler means, like a tally of winners and losers: Of the 24 deals BMO led or co-led, just 14 have provided a positive return to trust investors.
The trusts boom
Business income trusts have been a boon for investors, but some investment dealers have done much better than others in bringing winners to market. Deals led by BMO Nesbitt Burns have, on average, earned meagre returns since the trust market began to mushroom in 2001.
Scotia Capital - 25 deals
12.5%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
11.7%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
CIBC World Markets - 41 deals
8.5%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
10.5%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
RBC Dominion Securities - 24 deals
6.7%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
6.7%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
BMO Nesbitt Burns - 24 deals
0.3%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
1.1%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
National Bank Financial - 8 deals
11.7%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
11.2%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
TD Securities - 8 deals
13.1%
AVERAGE ANNUALIZED
TOTAL RETURN WITH
DISTRIBUTION
REINVESTED
12.5%
AVERAGE ANNUALIZED
TOTAL RETURN WITHOUT
DISTRIBUTION
REINVESTED
Average annualized total returns, as of Dec. 2, from business trusts IPOs that were completed between Jan. 1, 2001 and June 4, 2005. Includes trust conversions that were accompanied by a prospectus for secondary offerings.
© The Globe and Mail
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