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Canadian market fertile ground for hedge funds

Date: Friday, October 26, 2007
Author: Mark Noble,Advisor.ca

There is a resurgence of interest among retail investors in the Canadian hedge fund market, according to one hedge fund manager.

At the second annual Meet Canadian Hedge Fund Managers Forum in Toronto, Allan Brown, a partner and hedge fund manager with Burlington Capital Management, explained that an inefficient Canadian market is attracting hedge fund investment here.

Investors are able to take advantage of greater opportunities for short-term trading than what is available in the U.S., especially in Canada's resource sectors. In the U.S., more traders and deeper pools of capital have made the day-to-day trading spreads very narrow.

"We don't try to trade the U.S. market [short-term]," Brown said. "In the U.S., there are thousands of hedge funds. It seems news about companies is priced in even before it happens."

Canadian hedge fund managers generally have a greater insight into the Canadian market, particularly in resources, than their U.S. counterparts, he said. This expertise, combined with the potential for greater trading spreads, has attracted high levels of foreign investors to Canadian hedge funds.

"If you go back in 2002 and 2003, there was nothing going on. There were hedge funds in Canada putting up phenomenal numbers [but they are] not getting any assets," he said. "Now, there is a lot of attention from overseas. People want to have exposure to energy and resources. The big hedge funds like the Sprott and Front Street, who are heavy in this area, are attracting lots of global investors."

Brown's fund has limited its long positions in the Canadian market, which, he says, has few opportunities outside resources, making risk diversification difficult. He has to look globally to offset Canadian market risk.

His fund aims for annualized returns between 10 and 20%. Since its launch in early 2005, his fund has been able to meet this goal and has realized a total return of 36.9%. The fund manager creates positions of paired companies in the same industry, where divergent performance is expected. Burlington takes a long position in the undervalued stock and a short position in the overvalued.

Many of these companies are U.S. equities. Because Brown believes it's extremely difficult to find value in trading U.S. equities over the short term, he usually holds U.S. investments for six to 18 months.

Through a little financial engineering, hedge funds can be made available to retail investors, and providers are making some headway. This particular market was hurt by the collapse of Portus Alternative Asset Management, which used deposit notes to raise a large portion of capital from non-accredited investors.

The collapse of Portus and subsequent regulatory and criminal probes have virtually killed off the mass market, but there are signs of regeneration.

Man Investments Canada, a subsidiary of global alternative asset manager Man Investments, has launched a new series of deposit notes with CIBC, the CIBC Man IP 220 Deposit Notes, which have 100% of their principal guaranteed at maturity by CIBC.

The notes provide notional exposure to a global fund of hedge funds that combines the strategies of Man's AHL Diversified Programme and Glenwood Portfolio. Through the combinination of AHL and Glenwood, investors gain exposure to 60 hedge fund managers who are invested in more than 100 global markets. The notes offer daily liquidity, meaning they can be redeemed at any time.

Man Canada's CEO, Toreigh Stuart, believes Canadian investors have gotten over Portus. For those who still have reservations about hedge fund investing, CIBC brand recognition provides some reassurance. Stuart thinks the current spate of market volatility will be the key driver in sparking investor interest.

Stuart says over the 10-year period, avoiding the steep drops during volatility has allowed the portfolio to post returns of 386.9%, compared to a global equity benchmark return of 96.7%.

"The major difference is making profits when markets are going down," Stuart says. "Recent and pronounced market volatility should, yet again, remind all investors that exposure to long-only investments may not fully achieve true portfolio diversification."

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com