Desjardins pulls funds amid market plunge

Date: Monday, October 27, 2008
Author: Andrew Willis and Tara Perkins, Globe and Mail

Credit co-operative shuts down two lines of principal-protected notes, joining Sun Life and Manulife in protecting against losses.

Desjardins Group is winding down hedge fund-linked products, as Canada's largest financial co-operative joins life insurers in dealing with problems in guaranteed investments that have been pounded by the downturn.

Montreal-based Desjardins is shutting down lines of what are known as "principal-protected notes," or PPNs, an extremely popular product with individual investors. The move comes as Manulife Financial and Sun Life Financial take reserves against possible losses on annuities and other funds that promise customers' capital will always be returned.

The products that Desjardins killed bought hedge funds to offer the co-op's 5.8 million customers the upside of markets, along with a guarantee they would get back 100 cents on the dollar. Desjardins is closing PPNs called the Perspectives Plus Guaranteed Investment and Alternative Guaranteed Investment, both of which come due over the next five years.

Desjardins declined to comment on the value of the products, or possible losses. Quebec newspaper La Presse said last week that $4-billion in hedge fund investments are being wound down.

"We're not necessarily losing money out of this, it's just that we cannot offer the possibility our customers get a good return on these investments," said Desjardins spokesman André Chapleau, who said the company is steering clients into other savings products. He added: "The customer is not affected and the capital is guaranteed. We were never able to guarantee the performance."

"The process has been under way for a couple of weeks and it's going to last for a couple of months, as this is done in a very orderly fashion," Mr. Chapleau said. "It's not a fire sale, it's a structured process, it's very systematic."

After Desjardins sold PPNs, it put the bulk of investors' capital into bonds, which guaranteed capital will not be lost. Desjardins then invested the remaining cash, typically 20 cents of each dollar, in hedge funds, often using leverage on these holdings to boost results. That investment is now largely lost.

The credit union went into this market meltdown as one of the world's 50 largest players in what's known as 'funds of hedge funds.' Last year, the company held a $6-billion portfolio at its Desjardins Global Asset Management subsidiary that picked a variety of European, U.S., Asian and domestic funds on behalf of its clients. Many of these hedge funds have now failed. A significant portion of this portfolio would have been sold to the co-op's institutional clients.

Desjardins has been steadily redeeming holdings in hedge funds and sources say chief executive officer Monique Leroux decided on Oct. 1 to exit this entire line of business.

Desjardins' problems with PPNs come on the heels of the co-op's misadventures in the asset-backed commercial paper (ABCP) market. Desjardins has $1.7-billion frozen in ABCP, and took a $273-million writedown on the holding last year. A restructuring of the ABCP market is expected to be completed by the end of November.

"Desjardins really needs the ABCP rescue to work out, as they are painfully exposed to markets," said an executive at a rival financial institution.

Rival financial institutions are taking steps to deal with the damage a bear market inflicts on guaranteed investments. Manulife took a $1.4-billion reserve on its portfolio of annuities and segregated mutual funds, though it said it does not expect to lose money on these products over their full lifetime. Sun Life took a $134-million hit on third-quarter earnings last week to reflect potential losses on guaranteed investments.

To help financial institutions navigate choppy markets, the Finance Department backstopped federally regulated financial companies last week. Banks, insurers and an arm of Desjardins Group can take advantage of a program called the Canadian Lenders Assurance Facility that will insure wholesale lending.

Market volatility, falling interest rates and negative fund performance have caused many PPNs to experience what's known as a "protection event." Losses past a certain threshold trigger the complete sale of the active asset, in most cases a mutual fund. The remaining funds are then invested in a defensive asset, typically a zero-coupon bond.

A recent industry survey of the Big Six banks by TD Waterhouse found Bank of Montreal leads the pack, as a seller of 69 PPNs that have experienced a protection event. CIBC has done this with 26 products, Royal Bank of Canada has had a protection event on 20 PPNs, Bank of Nova Scotia has had 12 and National Bank 11. No PPN sold by TD Bank has experienced a protection event.