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BluMont offers team approach

Date: Tuesday, October 10, 2006
Author: Barry Critchley, Financial Post

Closed-end fund provides expertise in variety of styles

BluMont Capital, which has been absent from the world of closed-end funds for about a year, is determined to show that investors will respond if they are shown the right opportunity.

The firm has filed the BluMont Equity Advantage Fund. The idea is to maximize the fund's long term, but in such a way that the returns show a low correlation to the major Canadian equity index.

The fund has hired four local managers -- Salida Capital Corp. (based in Toronto); Vertex One Asset Management Inc. (Vancouver); Veronka Hirsch (Toronto) and Hillsdale Investment Management (Toronto). The proceeds will be allocated between the four managers: 40%, 20%, 20% and 20% respectively.

The managers have been chosen because, while they all invest in equities, they all employ different management styles.

"By combining exposure to each sub-advisor's investment style and techniques with respect to managing assets, the fund will attempt to deliver superior returns to investors for a given level of risk," says the preliminary prospectus, which notes that the fund has the option to rebalance the allocations to the four managers at irregular intervals.

It's worth noting that two of the managers -- Salida and Vertex -- are new to the average retail investor. These managers -- Salida manages about US$585-million while Vertex manages $850-million -- have high minimums.

The other two managers -- Hirsch and Hillsdale -- currently manage another BluMont fund, the Strategic Partners Hedge Fund, which was formed in 2002 and which garnered more than $200-million in proceeds. Because of redemptions and other changes, the fund is now about $40-million. (BluMont's other entry into the world of closed-end funds occurred late last year through the ManAlternative Yield Fund. That fund raised $21-million.)

Of course, the work that the four managers will do doesn't come for free. The fund has an annual management fee of 2.10% and there is a 40 basis points trailer fee that's paid to the retail broker. On top of that, there is a performance fee. In this case, the fee is set at 20% of the net gain of any of the sub-advisors' underlying fund.

The closed-end fund is like the others in a number of ways: 50 cents of their initial $10 per unit goes to pay the brokers and the underwriters, and holders can get out once a year and receive net asset value. In BluMont's case, May, 2008, is the first chance that holders have to exercise their redemption rights.

The fund is unlike a number of the others in two key areas:

- There is no defined termination date. Instead the fund will keep on rolling until the unitholders decide that they have had enough.

- The fund won't pay regular distributions. Instead the fund (like a mutual fund) will pay out all of its net income and taxable capital gains for tax purposes.

One of the great things about the market is that there are surprises every day.

About six weeks back, MACCs Sustainable Yield Trust closed an offering of 2.04 million warrants.

While no capital was raised at the time, the issuer put itself in a position to raise a maximum of $17.3-million. MACCs would achieve that goal if the warrants were exercised.

Under the deal, holders had about six months to exercise the warrants. Each warrant allowed the holder to ante up $8.64 and receive another unit. At the time the warrants were priced, the units were trading at $9.05.

At the time the fund's net asset value was $9.63, which means that the units were priced at a discount to NAV and to the market price. It was felt those discounts were attractive enough to encourage the unitholders to exercise. The warrants were listed on the TSX.

Since Aug. 28 two things have happened:

- There is way more trading in the stock than there was in the past. According to Bloomberg, average daily trading volume over the past six months was 6,312 units. Since the start of September, the average daily volume more than doubled to 14,595 units.

- Almost 190,000 warrants have been exercised. That's a high number given that on a "normal" warrant offering holders generally wait until the last minute before exercising.

Instead 10% of the holders have exercised early. And one of the reasons is the arbitrage opportunities that exist between the market price and the exercise price of the warrants.

By exercising early, holders know that they can capture the gap between the market price and the exercise price. Accordingly holders will sell a unit into the market, receive the market price and then use those proceeds to purchase a new, lower-priced unit. The difference between the two prices buys the beers after work.

On the other hand, the closer we are to Feb. 15 2007, the smaller the gap between the two prices should be -- under normal circumstances.