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Silvercreek latest hedge fund to feel sting of market downturn


Date: Wednesday, February 4, 2009
Author: Andrew Willis, Globe and Mail

The market meltdown has claimed another hedge fund, with Silvercreek Management into workout mode on a convertible bond fund that featured a who's who of Canadian finance backers.

Silvercreek oversees an estimated $300-million, and ran into trouble in November when the wheels came off the convertible bond market. This debt, which can be flipped into equity, constituted the single worst performing asset class for hedge funds in 2008. That makes converts, as they are known on the Street, the baddest of a very bad lot.

Convertible funds were down an average of 26 per cent last year, according to the U.S. bible for the industry, Absolute Return. The average performance was a loss of just 6.9 per cent.

Silvercreek is run by Louise Morwick, who co-founded the fund in 1996 after a successful career in corporate finance. She attracted personal support up and down Bay Street, with investors who include top executives at a number of investment dealers and banks, and major players in the LBO world and money management.

Ms. Morwick declined to comment on the situation, but a number of investors in the fund said Silvercreek has put forward plans to recapitalize the fund, with support from long-time backers. However, the more likely scenario is that the fund slowly gets wound down, with very little left for investors. Silvercreek is still running two other funds, only one of which holds convertible debt.

Silvercreek's problems are commonplace in the hedge fund world, in large part because these money managers used leverage to pump up results from what were supposed to be low-risk strategies. Sources say Silvercreek borrowed $10 from bankers for every $1 of investor assets, a typical amount of turbo-charging .

In good times, Silvercreek routinely turned in double-digit returns by buying convertible bonds, then short selling stock in the underlying company. In a presentation two years ago, Ms. Morwick boasted that her flagship fund had a 12.6-per-cent annual return over five years.

These results, which are not linked to the performance of equity markets, made Silvercreek an appealing investment for the finance crowd, whose paycheques do reflect the ups and downs of the S&P/TSX benchmark.

However, leverage came back to bite hedge funds late last year, when the credit crisis took hold. Think about the way these funds work: With leverage at 10 times assets, a 10-per-cent swoon can wipe out all the capital put up by a hedge fund's backers. The market for convertible debentures fell apart in November, as buyers steered clear of corporate debt in any form, and the few bonds that did change hands traded at distressed prices.

Silvercreek is now working with its prime broker, RBC Dominion Securities, to manage the portfolio. Obviously, a recovery in convertible bonds, and another shot of capital from loyal supporters, would go a long way toward getting the fund back on its feet.

However, Silvercreek is having trouble enticing new money into a rescue plan in part because some investors see the November downturn as the team's third strike. The fund took a hit back in 2000 when one of its co-founders inflated the price of holdings, and subsequently left the firm, and Silvercreek also lost money on a position in Enron back in 2002.

See Andrew Willis's Streetwise Blog at ReportonBusiness.com

awillis@globeandmail.com