Investing Lessons From a Billionaire

It’s one of the most basic ideas in investing: Diversify and spread risk along various asset classes or, in the case of equities, among different industries. But self-made billionaire investor and entrepreneur Michael Lee-Chin begs to differ.

Taking a distinctly contrarian approach to investing, the founder and chairman of Portland Holdings Inc., a privately held investment company in Burlington, Ontario, argues that when looking at stocks, focusing on specific companies and industries trumps diversification any day. Lee-Chin also doesn’t try to read the tea leaves of economic indicators. “I didn’t create wealth by being a prognosticator,” he says. “I created wealth by finding businesses that are fundamentally sound and that have great business models that I understand and can buy inexpensively.”

According to the Jamaican-born entrepreneur, there are five principles to successful investing:

1.     Buy only a few high quality businesses.
2.     Make sure you understand these businesses.
3.     Make sure these businesses are located in strong, long-term growth industries.
4.     Be sure these businesses use debt prudently.
5.     Hold these few businesses for the long run.

Lee-Chin practices what he preaches. At the age of 32, he borrowed $500,000 to purchase shares in a single company: Mackenzie Financial, an investment management firm that’s now a subsidiary of IGM Financial Inc. (TSE: IGM). In four years, the stock grew seven-fold. Lee-Chin used the profits to make his first acquisition–Ontario-based investment firm AIC Limited. Under Lee-Chin’s leadership, AIC grew from $1 million in managed assets to more than $15 billion. In the process, Lee-Chin became one of only a handful of black billionaires in North America.

Lee-Chin’s investing strategy is radical–to say the least. Most mutual fund managers “buy hundreds of companies. It’s not possible for the manager to understand them all. And they cannot all be in strong, long-term growth industries,” he contends. The 59-year-old, who graced the cover of the August 2002 issue of black enterprise, also points out that managed mutual funds turn over virtually all their holdings each year.

So what exactly does Lee-Chin like? Believe it or not, financial services. More specifically, asset management firms. “Most people [investing in] financial services will gravitate to banks and insurance companies. What this economic recession has shown is that banks and insurance companies are fraught with a lot of risks that even their management did not realize, and it’s mainly a function of their balance sheet assets,” he points out. “Suppose you have a bank with $60 billion in assets and the assets shrank by 10%, that’s $6 billion coming right off the bank’s net worth. Poof, there goes AIG. Poof, there goes Freddie Mac. Poof, there goes Washington Mutual. Poof, there goes more than 130 U.S. banks in 2009.”

By comparison, the asset management business model does not have balance sheet assets, he contends. They derive a stream of income from the assets of investors–people who buy mutual funds, for example. So while they’re generating income from the associated fees, the principal of the investors’ funds is not on the asset management firm’s accounting books, and therefore the firms have no assets to shrink. “If you’re an asset manager that manages $60 billion, you derive a fee income from that $60 billion. And if those assets shrank by the same 10%, the asset manager’s net worth is unaffected,” he says. “Revenues will go down by 10%, but the net worth is unaffected, so wealth management companies really have a tremendously different business risk profile than a bank or insurance company.”

Lee-Chin points out that when Lehman Bros. filed for Chapter 11 bankruptcy protection in 2008, its asset management business, Neuberger Berman Inc., was still viable. Among the players he favors are Eaton Vance Corp. (EV), Franklin Resources (BEN) and Invesco Ltd. (IVZ). Lee-Chin, who also manages the AIC Advantage Fund, doesn’t just talk the talk; 62% of the fund’s holdings are in money management firms. From the market lows of March 9, 2009, Lee-Chin steered AIC Advantage to an 85% gain, compared with the S&P 500’s 65% increase over the same period.