Cant hedge this

Date: Friday, October 31, 2008
Author: Sinclair Stewart

He's the first call on The Street. He can raise $40 million in two minutes. And now hedge-fund superstar Rohit Sehgal is afraid to open his e-mail.

The terrace at One, in Toronto's Yorkville district, is more a scene than a restaurant, a tangle of the lithe and the tanned, of bare midriffs, bling and Bay Street boys, their ties rakishly askew.

It is also Rohit Sehgal's local, and in more carefree times, the star hedge fund manager shyly admits, he has been known to roll past in his new BMW on the drive home, indulging in a moment of boyish preening.

But on a warm evening in early August, as a sea of flesh presses in against the tables, Sehgal barely takes notice. He is fixated on the blinking red light of his BlackBerry, which in recent weeks has morphed into a messenger of doom, spitting out grisly updates on the collapse of another Wall Street titan, on brutalized stock markets and, of course, on the plunging value of Sehgal's portfolios.

"I'm afraid to open my e-mail and see the numbers, because I know it's bad," he confides. "If you're down, your self-esteem goes down. I've been doing this for 30 years, but that never helps."

Sehgal, who is 62 and serves as chief investment officer of DundeeWealth's Dynamic Funds, is a walking embodiment of the swiftness and severity of the mortgage-fuelled credit crisis. Things have gotten so ugly, so fast, that even the smart money is getting killed--and Sehgal, who has gone from being a penniless crate-packer to one of the most revered money managers in the country, is one of the smartest.

Only a few months earlier, at the Lipper Awards in New York, Sehgal had been crowned the top hedge fund manager in his class in North America. Around the same time, Barron's ranked his flagship fund as the second best in the world: It had produced an annualized return of 60.2% over the previous three years, and a gaudy 38.6% in 2007 alone.

But that was before storied Wall Street firms began toppling like dominoes, inciting a wave of panic that turned the credit markets into a cryogenics project, and forced the U.S. government to embark on the biggest bailout effort in history.

When the commodities market began to unravel, sounding a prelude to the crisis, it was as though someone had removed a linchpin from Sehgal's growth funds, which have made heavy bets on the world's rising demand for energy, minerals and other natural resources.

July was especially painful. Sehgal's main hedge fund plunged 18% during that month alone--easily the worst 30-day spell the fund had experienced. His emerging markets fund, meanwhile, fell 20%. The results were only slightly better at his Canadian growth fund (down 11%) and his balanced fund (down 6.5%).

As he consoles himself with lobster spoons, a ribeye steak and frites, Sehgal confesses that in the course of his long career, he has never seen the markets behave this erratically. And it is getting to him. "I've never been more stressed," he says. "I'm getting tired. I'm getting older. This is the most responsibility I've ever had. I can't fail."

Sehgal was eight years old when he made his first trade, a precocious variant of what financial types call the "naked short." This is when someone sells stocks without technically owning them first. In Sehgal's case, the currency was stickers--a collection of adhesive cricket cards that had been painstakingly collected by his oldest brother, Lalit.

"One day the album disappeared," recalls Lalit, a retired nuclear physicist who has lived in Germany since the early 1970s. "He had traded off my album for another that was more to his liking. It made me quite furious."

The younger Sehgal was a popular, if mischievous, kid, and naturally inclined to sports. Yet he often struggled in school, and oddly, given his current profession, was particularly poor at mathematics. Lalit dispensed some after-school tutorials--and occasionally some corporal punishment when Sehgal failed to get the answers correct.

Sehgal was born in Lahore, in what is now Pakistan, in 1946, a little more than a year before India was partitioned by the British. His mother's family was considered part of the aristocracy, and his maternal grandfather was a senior magistrate. Sehgal's father, trained as an economist, worked for the government. The family fled Lahore when Rohit was an infant, placing him among what Salman Rushdie described as Midnight's Children. Leaving their possessions behind, the family headed for Shimla, near the Himalayas, where Sehgal's father was posted to help oversee village industries.

They relocated several times over the next few years before eventually settling in Delhi, where Sehgal and three of his four siblings spent the bulk of their adolescence. Sehgal followed his father into the economics field, earning an honours degree from the University of Delhi, but was soon consumed with wanderlust. The prospects looked bleak for a young man in India in the late 1960s, especially when juxtaposed with the cultural transformation that was sweeping the West, so Sehgal saved some money and embarked on a backpacking trip through Europe, where he worked odd jobs, lived like a hippie and, by his own admission, "chased women."

When the novelty wore off--at least, the novelty of manual labour and penny-grubbing--Sehgal, like many Indians of his generation, decided to seek his fortune in North America. In the fall of 1968, he arrived in New York, 22 years old and virtually broke. He was met by Lalit, who was pursuing his doctorate in physics at Carnegie Mellon in Pittsburgh.

With the Vietnam War raging, Sehgal found the idea of Canada more appealing than the U.S. Lalit bought him a ski jacket to contend with the Canadian winter, and managed to scrape together a gift of $40. After the brothers spent the evening together, Sehgal left for Toronto. "I think he had taken quite a big risk, going there without financial backing, or any job," Lalit recalls. "I was a bit nervous about his prospects, but he's always been very determined."

Sehgal's first job, packing crates in a factory, did not go well. He came from a family that was not used to manual labour, and he was fired after two weeks--just enough time to put together a fortnight's rent for an apartment near the waterfront.

Next, he decided to apply for a financial position at Moss Lawson, a small Bay Street brokerage. "I wasn't a typical immigrant," Sehgal says. "I spoke well, and I presented myself well. They asked me, 'Do you want to do research or sales?' And 'what do you know about the stock market?' And I said, 'Enough.' Bullshit, of course."

Yet he got the job, and, equipped with a suit from Simpsons, began his career as a research analyst. His first assignment was to issue a research report on Falconbridge Nickel Mines Ltd. There were two problems with this. One, he knew nothing about the markets. And two, he knew even less about mining.

So he did what any nervous young stock-watcher would do: He published a bullish projection for the company, encouraging investors to pick the stock. Those who did were handsomely rewarded; Sehgal, with enviable beginner's luck, started his career on the cusp of a massive commodities boom.

Had he not met Jean Chamberlain and decided to get married, Sehgal might have spent his entire career on Bay Street. Instead, the cost of raising a family spelled a move to the hinterland. While the $8,000-a-year salary at Moss Lawson was more than respectable, there was no resisting the opportunity to move to the investment unit of London Life Insurance Co. and earn $2,000 more.

In 1970, he and Jean packed their things and moved to Southwestern Ontario. Initially, "I hated it," Sehgal recalls. "The first day in London was so dreadful."

London Life was a "coupon clipper," Sehgal says. Calling it conservative would be an understatement. The investment unit consisted of three people who spent much of their time trading bonds for safe but measly returns. The stocks they did hold were really held--many had been in the company's portfolio since the 1930s.

For several years, Sehgal toiled behind the scenes, earning his Chartered Financial Analyst designation after-hours, studying credit markets, and doing anything he could to attract the attention of management. Although he brushes aside questions about institutional discrimination, it's clear that he feels his ethnicity hindered his early career. "I always had a positive attitude," he says. "Even a mixed marriage was really unusual at that time. All it did was make me work harder. Because I knew I had to prove myself. I would do strategy reports on my own, just hoping someone would notice."

Finally, in 1981, after 11 years, someone did. Sehgal was given $50 million to manage. He felt he had to do something to set himself apart from other fund managers who were essentially betting on index moves, so he began to devise a strategy that might be described as top-down, bottom-up.

Top-down investing works something like this: You study macroeconomic trends and try to discern which countries or industries are primed for long-term, sustainable growth. Then you drill down again, into a particular sector, and then again, to the company level, until you find a stock that suits your big-picture view.

This is where Sehgal's background came in handy, particularly in the early years: He knew India's political and economic scene intimately, of course, but he was also more aware than most managers of what was happening in China and other parts of Asia. For him, a macro view was natural. "I was going to these countries in the '80s, well before anyone could spell emerging markets," he says. "I really, truly believe that's where the focus should be."

Bottom-up growth investors work in the opposite fashion: They look for companies in good financial shape, with strong management teams and appealing prospects, with less focus on larger trends.

The top-down perspective is dominant in Sehgal's hybrid strategy, but even today he still devotes plenty of time to analyzing the fundamentals of individual companies, and his circle of plugged-in traders and salesmen on Bay Street regularly present him with investment opportunities in specific firms.

This bifurcated approach worked well from the get-go--so well, in fact, that by the mid-1990s, Sehgal was managing $3 billion at London Life, and had become one of the most important fund managers in the country.

Professionally, he was a success. But as work consumed more and more of his time, his personal life suffered. He and Jean separated (they remain good friends). And while he is close with his three children, who are in their 30s, he concedes that he was often an absent figure in their childhoods. "I don't even remember how my kids have grown," he says. "I've seen the pictures."

One evening, after a late dinner of Indian takeout, Sehgal and I are sitting in his home office, a sprawling room with wide French windows that afford views of his garden, three storeys below.

Sehgal is wearing a pair of blue jeans and a short-sleeved white polo shirt with navy trim. He is tall, with a developed paunch, and his greying hair is parted in an epic sweep, the nadir of which threatens to conceal an eyebrow. Arthritis, a family scourge, has attacked one knee, and as a result he moves with a shuffling gait, dipping a shoulder as he pulls his bad leg forward.

He often comports himself with a statesman's quiet solemnity, but on this night, he is in a jocular mood, kicking back on a long leather sofa in front of a precarious stack of newspapers.

The room, like much of the house, is filled with a motley collection of Indian art: There are massive canvases of women in traditional Hindu garb; an impossibly ornate carving sprung from a single piece of sandalwood; modern abstract paintings; and a bronze Buddha sculpture, sitting on a landing, that is thought to be a thousand years old.

This is where Sehgal comes every morning at about 6 o'clock to read North American and Indian newspapers, to check the overseas markets and tune into CNBC. It is also where he likes, on nights like this, to unwind with a glass of wine and a cigar. "This one is a Cohiba," he volunteers, scissoring the cap off, "but I don't really know anything about cigars."

When talk turns to his art purchasing habits, which seem driven more by visceral attraction than any attachment to styles or names, he offers a similar answer. "If you ask me anything about Indian art," he says, with some diffidence, "my knowledge is zero."

And the new sports car he enjoys so much? "A year ago, I didn't even know what a BMW M6 was."

There's a pattern here. Mike Wekerle, a vice-chairman at GMP Securities who is one of Sehgal's closest friends and business relationships, puts it bluntly: "I view him as a trading savant. He knows 110% about the market and very little about anything else."

"He's one of those guys who can't tie his shoelaces," adds another friend, Dave Fleck, who until recently jointly ran rival money manager Salida Capital Corp. "He's a brilliant fund manager, but he can't do anything else."

And so it goes. Lukas Lundin, who heads Lundin Mining Corp., was recently in Geneva with Sehgal. "Instead of going out and looking at the town, he was very keen to stay in his hotel room looking at his computer." Fleck recalls scenes of Sehgal poolside at his home back in his London days. "The pool was a dark, dark green, and he was out skimming it. The grass would be four inches high. The bathroom door would be missing. All hell could be breaking loose around him, but it'd be no big deal," Fleck says. "His day is the market, and he cannot disconnect himself from the market."

There is a bit of well-intentioned ribbing going on here. The point isn't so much that Sehgal can't do anything else--it's that he doesn't. He enjoys wine and art, and is an engaging storyteller. He plays golf occasionally (poorly, by most accounts), and likes to cook (very well, by most accounts). Yet friends know that he often logs 20-hour days. If something is bothering him, he'll wake in the middle of the night and obsess about it until he's thought it out. On Saturday, when most people are easing out of their work routine, Sehgal will pour a cup of tea, gather up newspapers from around the world, and begin preparing for next week's trading.

This bird-dog focus has been a key ingredient in Sehgal's success. Indeed, it was what appealed to DundeeWealth, which poached him from London Life in 1998.

Dundee, which was founded by Ned Goodman more than 50 years ago, has always been a value shop: Its strategy, in the mould of Warren Buffett and Benjamin Graham, is to search for stocks whose true worth isn't being recognized by the market. Yet the firm's Dynamic mutual fund division was flagging in the late '90s, and the Goodman family felt the need to diversify by adding a different investment model to their offerings: growth.

Sehgal, who was becoming bored at London Life, appeared to be a good fit. He had honed his strategy over the years, and he came blessed with important connections on Bay Street. He was aggressive, as hedge fund managers tend to be, but also very disciplined.

Hedge funds, unlike more conventional mutual funds, trade very actively, can bet on a stock's decline through short-selling, and can operate with leverage, borrowing money to pour into funds in the hopes of juicing returns.

"One of the key success factors in being a great portfolio manager is having an open mind--being able to distinguish between proper fact and noise," says Goodman's son, David, who runs DundeeWealth. "In a previous market cycle, five years ago, Rohit was up a lot, and the market had a little hiccup. And he had to re-evaluate his positions and portfolio. We went for lunch and I said, 'You may have to protect some of your gains.' And he said, 'No, my discipline says this is where I should be right now.' I think it took a lot of strength of character to ride it through. And it worked out great."

Sehgal may be an amiable dinner companion, but on Bay Street he has a reputation for being intimidating, no-nonsense and occasionally short-tempered--especially to those outside his inner circle, which is famously difficult to crack.

"There's no point in giving him information that's too weak or too strong, or you're dead," says Jeff Tonken, president of Birchcliff Energy, a junior oil and gas explorer in Calgary. "If you mess with Rohit, you've got real problems."

Principal among those problems will be that Sehgal will dump your stock. Because of the large positions he typically holds, the results can be punishing, especially for smaller companies.

"If they lie to us, we'll sell the stock," Sehgal says of companies he invests in, recalling a recent incident involving a well-respected chief executive whose name he won't disclose. "There's a point at which you do things on faith, and I was so disheartened. And then it's just, 'No way, José.' I'm done with them."

Yet, when this faith is rewarded, say Sehgal's friends, he is intensely loyal. And it is this loyalty, as much as his knowledge of the markets or his understanding of the developing world, that has underpinned his success.

With loyalty comes reciprocity. Sehgal trades ferociously, and is widely viewed as the biggest dispenser of commission dollars among Canadian portfolio managers. This has created a virtuous circle: People with whom he deals regularly bring him opportunities before presenting them to anyone else, as a kind of offering. Indeed, even those who are outside this group do the same, eager to ingratiate themselves and join the circle. A typical act of tribute came on a recent night at Vertical, a downtown Toronto restaurant in which Sehgal owns a 15% stake: An acquaintance slipped him an envelope, eager to share a report he thought Sehgal might profit from.

When someone brings you a hot idea before showing it to anyone else on Bay Street, it is known as being the "first call." Sehgal is the first call, and it gives him a tremendous edge. "He uses the system better than anybody--he's got a great network," says Peter Brown, the Vancouver-based chairman of Canaccord Capital. "There's not a single brokerage firm in North America that doesn't know of him personally," adds Wekerle.

Sehgal estimates he pays about half of his annual commissions to just five trusted brokerages, and then spreads around the remainder to keep a healthy flow of information streaming in. "It would be foolish for me not to reward people who have given me good ideas. It's a quid pro quo," he says. "I deal with four or five dealers, since I manage bigger funds. Because I'm an active manager, I want to get things done quickly. I have an advantage--they will never say no. Today I raised $40 million in two minutes."

Sehgal's notion of loyalty can also extend beyond his first-call status; sometimes, he will stretch the quid pro quo to include personal investments in his hedge funds. Several of his closest partners, like Wekerle and Gene McBurney at GMP, and even CEOs like Tonken, number among his investors.

"He'll sit you down and say 'You know, Jeff, I'd really like to make this investment, but I notice you're not invested in my fund,'" says Tonken. "'I'd really like to see your name on it.' So he's busy selling his funds to you."

The network Sehgal has carefully nurtured over the years is particularly strong in commodities; thus he was positioned almost perfectly for the massive worldwide bull market in energy, mining and metals when it took hold a few years ago.

Take his investment in Athabasca Oil Sands Corp., a privately held junior resource company based in Calgary. When the company was trying to raise some capital in early 2007, its bankers, believing it to have dramatic growth potential, rang Sehgal and handed him the opportunity to become an early investor.

After he heard about the strategy, and saw how it fit with his world view, Sehgal agreed to commit $10 million: 10 million shares, at a dollar apiece. A year and a half later, the company commissioned an independent study of its properties, and the verdict was stellar. Athabasca was sitting on about seven billion barrels worth of oil. This past summer, the company raised an additional $400 million in debt to fuel its growth, and Sehgal estimated its market value is close to $3 billion. That would make his stake worth more than $200 million.

But just because he's a deep pocket when companies need money doesn't necessarily mean Sehgal's their ideal shareholder. "I'll bet he's been in and out of my company at least a dozen times," Jeff Tonken says. "Rohit is a very supportive individual if you're doing a transaction he likes. But he's also a trader, which is the danger from Birchcliff's point of view. When he gets out, the stock really suffers."

This back-and-forthing is unusual in itself. Most fund managers have a psychological aversion to re-entering a stock once they've decided to sell it, especially if the price has risen in the interim. Sehgal doesn't seem to care, and will go in and out enthusiastically. "He doesn't have this burnt-in memory," says rival money manager Eric Sprott, who co-launched a $75-million "all-star" fund in September with Sehgal and Norm Lamarche of Front Street Capital Management. "I think that's quite rare. It is unusual that you can sell things one month and buy it the next. I'm the exact opposite. When he believes in something, he goes in pretty big, fast. And when he doesn't like something, he gets out fast."

In the third week of September, when Treasury Secretary Hank Paulson was devising a $700-billion (U.S.) bailout of the troubled financial industry, and the markets began whipsawing violently, Sehgal and his partner, Priya Patil, who is an investment banker in Toronto, were in Tuscany on vacation.

The previous two weeks had been dreadful for Sehgal. His funds were getting clobbered, and for almost all of the trip, Sehgal was tethered to his phone. "Although Priya would smile and say she was having a good time, she was miserable," he says. "I've got to be honest--I was under duress."

The duress, though, had begun to dissipate as the bailout took shape. Energy prices staged a rally. Commodities began to regain their lustre, and suddenly, one of Dynamic's funds was up 8%.

Sehgal's confidence was up, too: Unlike in August, he seemed more philosophical than wary, dispensing the kind of avuncular wisdom one might expect from a fund manager who has spent three-quarters of his life in the markets. "I've been going through these kinds of episodes every five years," he says. "This time will pass too, my friend. We will survive. My gut says the worst has passed."

His gut was wrong. During the first week of October, the primary commodity index fell into a sickening nosedive, shedding 10% of its value--the worst five-day plunge in more than 50 years. Sehgal, whose Dynamic Power Canadian Growth Fund is comprised of about 70% commodities, had quickly lapsed into a funk, along with the markets. Once again, he found himself unable to look at his monthly performance numbers.

This time, he did not wait for commodities to ride out the storm. In the span of a few days, he cut his commodity exposure to about 50%, and then did something he hadn't done in the past four years--he bought bank stocks, with an emphasis on Goldman Sachs & Co. and J.P. Morgan Chase & Co., two greybeards that have weathered the carnage, and now appear to hold an advantage as the industry begins to lick its wounds. As of mid-October, financials accounted for between 15% and 20% of his portfolio--an unlikely reversal from a few months earlier, when he said he tended to shun the industry, given its lack of durable growth prospects.

"When you start to see the picture changing a little bit, there's a tendency to fight it, because you believe in the secular trends," Sehgal explains from his office, where he is watching the House of Representatives pass its historic rescue package. "But in my whole career, I've never been through a period like this. This week was absolutely horrible."

It could have been a lot worse. Sehgal didn't face the mass redemptions that forced many hedge funds to sell their stock holdings, contributing to the massive slide in commodities. His clients stuck with him. Likewise, his trusted coterie of relations on Bay Street proved loyal.

One of the defining traits of the current crisis has been an evaporation of liquidity: Everyone, from consumers and investors to major banks, has been hoarding cash, making it difficult to unload positions without punishing losses. That is, unless you have loyal trading partners who are determined to help you get rid of the stuff. Sometimes, this means calling in favours from possible buyers. Other times, it means that a brokerage will use its own money to buy its client's stock, and then assume the risk of selling it into the market.

This is called liability trading, and it's a risky proposition at the best of times--never mind in the middle of a crisis. Again, it is a testament to the network Sehgal has cultivated, and his importance as a source of trading fees, that he can call up this resource at this time. "Most of the guys stood by me," says Sehgal. "It was a good test. I think it's always good when the network you have also works under stress."

But how much longer does Sehgal, at 62, want to endure this stress, and measure his self-esteem by the ebbs and flows of market cycles? He recently bought a home in a gated community in Goa, on the west coast of India. He gets to visit a few times a year on business, but would like to spend more time there.

One of his ambitions is to raise money to build a school in Goa for underprivileged children. But DundeeWealth's David Goodman can't envision Sehgal fully extricating himself from the business, despite talk of fatigue and nerves, and the growing burden of responsibility. "I don't think Rohit is ever hanging up the cleats," he says. "Will he change the nature of how he operates? Obviously, he will. But Rohit's an investor, and I think he'll do it for a long time."

Sehgal is a bit more ambivalent. He says he wants to retire at some point, but notes, ruefully, that his net worth has declined in "a big way" over the past few months. There is the matter of how he would handle a withdrawal, market junkie that he is. And, of course, there is pride.

"I still believe that we will come out of it, and that we'll still be one of the best funds. That's my job. Most of the time, that's where I've been positioned. So I'm going to do my darned best to make sure I'm back in there," he says. "Last year we had a huge success, and I was thinking, 'Hey, maybe it's time to exit.' And then I quickly thought--'Exit to what?'"