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'Lose no money' oath sure pays off for this hedge fund

Date: Tuesday, February 6, 2007
Author: Rob Carrick, Globe and Mail

The most honest money manager in the country is not happy with his performance last year.

This explains why the headline on John Hillery's 2006 wrap-up statement to clients reads: "What happened? You can do better!"

It turns out that a Grade 11 teacher of Mr. Hillery's wrote this on one of his test papers. "I would not be surprised," he wrote in his client note, "if one or two of my partners thought those words equally applicable to my 2006 fund performance."

Partners are what Mr. Hillery calls the 50 people who have invested in his $26-million hedge fund, Hillery & Associates LP, which focuses primarily on U.S. stocks.

Now, let's be frank. These partners -- membership is closed, so don't even think about asking to get in -- have absolutely no right to complain about the fund's performance last year.

True, the 8.8-per-cent return lagged the S&P 500's 13.6-per-cent gain. But its 11.3-per-cent compound average annual return over the past five years annihilated the average U.S. equity fund, which lost 0.3 per cent a year over the same period.

When the S&P 500 lost 13 per cent in 2001, Mr. Hillery made 25.1 per cent. When the S&P lost 23.4 per cent in 2002, Mr. Hillery made 3 per cent.

Still, Mr. Hillery feels bad about 2006. "It sounds trite, but managing other people's money is something I take very, very seriously," he said in an interview.

Part of the problem last year was Mr. Hillery's risk aversion. He's a strict value investor who insists on buying stocks at big discounts to what he believes to be their true worth, and he won't buy just for the sake of keeping his fund's assets from sitting idle in cash.

Recently, he's found bargains to be scarce. The stock markets have been on a prolonged bull run, and undervalued companies are being snapped up by private equity firms. Net result: Mr. Hillery's weighting in low-yielding cash averaged 39 per cent last year and ended 2006 at a whopping 48 per cent of assets.

Some people get angry with funds that hold a lot of cash, arguing that it's a manager's job to put client money to work in the markets. Mr. Hillary told his clients that his top priority is to protect their money, and he likened his philosophy to the medical profession's "first, do no harm" oath. "My suggestion for a somewhat equivalent oath for value investment managers would be, 'First, lose no money!' "

Mr. Hillary's top performers over the past six months included TJX, the off-price clothing retailer that was in the news recently after computer hackers stole personal data about the firm's credit card clients; Berkshire Hathaway, the holding company controlled by famed value investor Warren Buffett; and, a Daytona Beach real estate developer called Consolidated-Tomoka Land.

The duds over that period included UTS Energy, Canadian Oil Sands Trust and Asta Funding, a company that buys defaulted loans and then tries to collect on them.

Some of Mr. Hillery's most interesting views are on the topic of his oil stocks, which he sold last year in what he freely admits was a "flip-flop." He still finds much to like about companies such as Suncor, Canadian Oil Sands, EnCana and Canadian Natural Resources. But, thanks to a variety of financial and environmental concerns, he now questions whether they're the best way to profit from the long-term increase in oil prices that he expects.

If you're wondering about Mr. Hillery's preferred way of playing oil, it's an iPath Barclays exchange-traded note (ETN) that tracks the value of the Goldman Sachs Crude Oil Total Return index. An ETN, by the way, is an exchange-traded debt instrument that exactly tracks the return of the underlying index, minus fees. The symbol on the New York Stock Exchange is OIL.

Here's some more honesty from Mr. Hillery: He redeemed $375,000 (U.S.) of his own holdings in the fund to pay for a new cottage under construction. Unitholders needn't worry that he's positioning himself for a bad 2007. In fact, Mr. Hillery said he's still the fund's largest investor with 24.1 per cent of the assets.

Why provide this level of disclosure in a routine annual summary? It's good business, Mr. Hillery explains. Since he started the fund back in 1998, just four clients have left. Two were estates or trusts that were wound up, one was an individual who died, another was a person who cashed out in order to pay a large income tax assessment. "If you treat people honestly," Mr. Hillery said, "they'll treat you well."

The most honest money manager in the country may not be happy with his performance in 2006, but his lucky clients have to be happy with him. Other investors can only look with disdain on the stuff their fund companies are sending.


By the numbers


Hillery & Associates compound average annual return over past

five years


Average U.S. equity fund return

over past five years