Canadian hedge fund collapse hits confidence

Date: Tuesday, April 26, 2005
Author: By Bernard Simon FT.com

The collapse of a high-flying Canadian hedge fund has dealt a setback to an industry struggling to convince retail investors that its products are reputable and safe.

Toronto-based Portus Alternative Asset Management went into receivership two months ago, leaving 26,000 clients unsure whether they would see their money again. The receiver, KPMG, has yet to account for C$730m (£309m) in assets garnered by Portus during its two-year lifespan. One of the hedge fund’s co-founders flew to Israel this month, days before KPMG officials were due to interview him.

In some ways, Portus’ rise and fall is the classic story of smooth-talking salesmen seducing naive investors with promises of sky-high returns at zero risk.

However, dismissing Portus as a single rotten apple in an otherwise reputable industry is complicated by the close ties the hedge-fund operator forged with a handful of prominent Canadian financial service companies.

“There’s some degree of concern on the due diligence that people have done on hedge funds and funds of funds,” says Jim McGovern, chief executive of Arrow Hedge Partners, a Toronto-based fund of funds manager. Mr McGovern is also chairman of the Canadian branch of the Alternative Investment Management Association, which represents hedge fund managers.

Canada’s hedge fund market is relatively small and unsophisticated. Mr McGovern estimates that the market has attracted $20bn in capital, split almost equally between the institutions and retail investors. By contrast, Canadian mutual fund assets stood at C$513bn at the end of March.

Portus became a sizeable player during its short life. Many clients appear to have been swayed by its promise that a leading bank had guaranteed the principal of its “fund of funds” products. As in many other countries, Canadian hedge funds typically protect their structured products through notes issued by two big French banks, BNP Paribas and Société Générale.

Portus sold its funds through referrals from financial planners and insurance brokers. None was more active than those employed by Manulife Financial, one of North America’s top blue chip financial institutions. Manulife bought John Hancock Financial Services of Boston last year.

Manulife financial advisers persuaded 6,300 of their clients to invest in Portus funds. Referrals from Manulife made up no less than a third of Portus’ assets.

The brokers’ motives have been questioned since it emerged that Portus was paying an ultra-generous 5 per cent referral commission, plus a quarter of its 18 per cent annual performance fee. According to a class action suit filed against Manulife, Portus spent almost C$90m on commissions, referral fees and similar expenses.

The high commissions are among several questions raised about Portus’ relationship with Manulife and other institutions with which it did business such as Ontario’s Berkshire Investment Group, which is affiliated to AIC, Canada’s biggest privately owned mutual fund distributor.

“Something broke down in the chain of command at some of these organisations,” Mr McGovern says. “It must have been a pretty slick story.”

Manulife has insisted it reviewed Portus’ products carefully but that Portus misled it by, for instance, failing to disclose affiliates in Caribbean tax havens, and not channelling investors’ money directly into bank-guaranteed notes.

The Ontario Securities Commission is examining Portus’ sales and compliance practices. One question is whether Portus products fell within regulators’ definition of structured funds that can be offered to small, unsophisticated investors. Doubts have also been raised whether the promised bank guarantees existed.

KPMG estimates investors will recover 62 per cent of the C$750m they entrusted to Portus. In a recent report to an Ontario court, KPMG calculated the company liabilities at almost C$1.1bn, including C$238m in funds wired to accounts in the Cayman Islands. KPMG It said its work was complicated by the “deliberate destruction or removal” of company records.

Manulife has sought to limit damage to its reputation by offering to reimburse clients for losses on their Portus investments. It plans to set aside C$40-50m in its next quarterly financial statements to cover the cost.Anyone taking up Manulife’s offer must agree to withdraw from the class action suit.

The insurance group’s securities arm is reviewing Its procedures. “We were obviously a little too casual about these referral arrangements or the processes we had in place,” Dominic D’Alessandro, Manulife’s chief executive, told The Globe and Mail. Mr D’Alessandro has also apologised to clients for “the distress this situation has caused”.

None of the other financial service companies that put their clients into Portus funds has so far followed Manulife’s example.

The fallout from Portus on the rest of the Canadian hedge fund industry is still sinking in.

According to Mr McGovern, Portus’ collapse has had little impact on existing investors in hedge-fund products. However, those pondering such investments are “pausing now”, Mr McGovern says. While Arrow Hedge’s assets doubled last year to C$400m, Mr McGovern expects only a “very modest” increase in 2005. Sorina Givelichian, managing director of Cidel Financial, a Toronto hedge fund manager, says the demise of Portus has blunted a drive to interest Canadian banks and other financial service institutions in “white-label” hedge fund products they can market to their clients. “That market is completely closed,” says Ms Givelichian.

Reza Satchu, a Toronto hedge fund investor, says Portus’ success in wooing investors has exposed some shortcomings in the Canadian market. “There’s a compelling argument for hedge funds but I don’t think the right people are making it.” today,” he says