Manager sees better days ahead

Date: Wednesday, November 14, 2007
Author: Shirley Won, Globe and Mail Funds Reporter

Hedge fund manager Hugh Cleland expects North American markets to recover from the recent downturn sparked by concerns about the fallout from the U.S. subprime mortgage mess.

"We are in the middle of a retest of the August lows," said the portfolio manager with Toronto-based Northern Rivers Capital Management Inc. "The [U.S.] financials have fallen through the lows, but the major indexes so far are holding above that level."

The S&P/TSX composite index, which fell to a low of 12,848.7 points in August, closed up yesterday at 13,705.14. The S&P 500 index, which slid to a low of 1,406.7 points, closed up at 1,481.04.

"I am expecting a scary, but ultimately successful, retest of the August lows in the major North American indices between now and Christmas," and that should set the stage for a flat or rising market in 2008, he said in an interview.

A solid rebound depends on the U.S. Federal Reserve Board easing rates again to avoid a major economic slowdown, he said. "I think we will squeak by without a recession."

He expects the U.S. central bank will lower its lending rate by at least 50 basis points to 4 per cent by the end of March.

The effect of the subprime mortgage woes on the balance sheets of the big banks is a question mark, he said. "If banks are losing capital, their ability to lend becomes constrained, and that in itself can have effects on the economy if they have to curtail their lending too much."

Third-quarter U.S. gross domestic product - which rose to a seasonally adjusted 3.9-per-cent annual rate from 3.8 per cent in the second quarter - indicates that strong exports can power the economy through the housing slump and tighter credit conditions, he added.

Mr. Cleland, who runs three long-short hedge funds with assets of about $125-million, invests in the technology, health care and resource sectors.

His portfolios are built around up to 10 core holdings in companies with a competitive advantage in rapidly growing industries. Another 30 to 40 stocks, or the "farm team," are actively traded.

His three hedge funds include Northern Rivers Innovation Fund LP, which posted an average annual return of 35.3 per cent for the three years ended Oct. 31.

Mr. Cleland is 60 per cent net long in his portfolios, saying that bias is driven by his view that North America is not heading into a recession.

He is long:

Vendtek Systems Inc. (VSI-TSX-VEN): The developer of software that allows the sale and distribution of prepaid products and services such as gift cards and prepaid cellular time is "growing rapidly worldwide," he said. "Within less than a year, the majority of their cash flow should be coming from non-Canadian sources." Vendtek is trading at less than 12 times his estimated profit of 10 cents a share for 2008, and about seven times his estimated profit of at least 15 cents a share for 2009. The stock yesterday closed down 5 cents at $1.12.

WebTech Wireless Inc. (WEW-TSX): He sees WebTech as an emerging global leader in wireless tracking devices for the transportation industry, but is a contrarian because its stock has "one of the largest short positions on the TSX relative to its size." He said he believes the company will have some large wins over the next three months. He expects WebTech to grow at an annualized rate of more than 100 per cent for each of the next three years, but its stock only trades at 18 times his fiscal 2008 profit estimate of 16 cents a share, and nine times his 2009 estimate of more than 30 cents. The stock closed yesterday unchanged at $2.97.

He is short:

SPDR Financial ETF (XLF-A): With the nexus of the global credit crunch emanating from the U.S. financial services sector, one of the best "market risk" hedges is being short or owning puts on the financial service sector exchanged-traded funds, he said. The units yesterday closed at $31.67 (U.S.), up $1.42.