After the crash

Date: Thursday, August 27, 2009
Author: Joanna Pachner,

Derivatives expert Jason Russell bailed out of a Bay Street high flier when the market went bust. He's back now with his own firm and a new plan.

What Jason Russell is doing seems to defy common sense. Stock markets are still in a trough, investors are stashing money in their mattresses, and many believe so-called alternative investments have been irreparably tarred by the escapades of Bernie Madoff and other financial miscreants. And yet, here is Russell, as he himself says, "launching a hedge fund in the most challenging period many of us in the financial sector ever experienced." It wasn't a big shocker when one colleague opined, "You've got big balls."

But Russell, who in July opened Acorn Global Investments, sees the volatile economy as a perfect opportunity for his style of methodical, risk-averse investing. Hedge funds were originally designed to deliver profits in both bull and bear markets by using tools such as short-selling and leverage (investing with borrowed money), which mutual funds and other, more consumer-focused instruments do not permit. Over time, however, the moniker came to apply to any fund that was loosely regulated, charged high fees and demanded hefty minimum investments. After the recent slew of spectacular flame-outs, hedge funds came under attack for being secretive, reckless and difficult for clients to divest. Russell sympathizes-and hopes his company serves as something of an antidote. "I had a good lesson about risk, and I learned it well," he says.

That lesson came courtesy of Salida Capital, a high-flying Toronto-based hedge fund manager that Russell joined in 2005. Salida's funds posted world-class results through the early and mid-2000s, before plunging in last year's market wipeout. Russell, a trader and portfolio manager who'd spent some 18 years around Bay Street, ran the Global Macro fund that ended 2008 as the only one of Salida's six funds in the black. By late fall, he realized that he wouldn't be able to grow his business the way he wanted at Salida. "I decided to make a clean break," he recalls. "In mid-January, I pulled the trigger: I picked up the phone and called the lawyers."

It was the first step in a six-month legal, accounting and regulatory gauntlet that any new hedge-fund manager has to run. Russell began by registering the fund, along with himself as the fund's manager, with the Ontario Securities Commission. The OSC application process takes several months, as the agency sifts through information about the manager's experience and education. (Russell has a business administration degree and is a CFA.) Meanwhile, he worked with his lawyers on several key documents for the fund: an offering memorandum-a 40-page description of the fund's objectives, strategy and risk profile; and the subscription documents for clients.

Operating a hedge fund requires many external relationships, starting with banks and brokerages-the former to hold the fund's cash assets, the latter to execute trades. Russell investigated potential financial partners, since the failure of Wall Street stalwart Lehman Brothers last fall convinced him that one can no longer put unreserved trust in a brand name. Some brokerages have recently scaled back their services to hedge funds, and Russell wanted to be sure he was in good hands. He also examined companies' range of businesses, looking for any risky sidelines that could affect their health. He opted for Royal Bank and two brokerages, Newedge and Interactive Brokers, that focus on funds that do a lot of electronic trading.

Russell also hired an independent administrator, Commonwealth Fund Services, to calculate his fund's performance, track expenses and handle other accounting on behalf of investors. As well, he enlisted Caledon Trust to serve as an independent trustee of his clients' assets. Caledon essentially hires Russell to manage its money-and could potentially fire him. Such measures are increasingly being adopted by hedge funds as investors demand stricter governance. "I want to give clients more transparency and liquidity than they've seen anywhere else," says Russell. Finally, he has hired KPMG as the auditor.

This preparatory red tape has taken up much of his time since that first phone call. As of mid-June, he'd racked up more than $75,000 in legal, compliance and accounting costs to bring his company into regulatory compliance.

Because Russell's approach is to use preset price targets to constantly buy or sell a wide range of equities, bonds, commodities and currencies around the globe, he relies heavily on technology. Hence, setting up his trading system was an important aspect of pre-launch preparation. While he bought some off-the-shelf software, a good chunk of the code work he did himself, as few contractors have sufficient knowledge of both programming and the trading processes involved.

In March, Russell rented a small office in the Toronto suburb of Oakville, where he lives (the company's name is partly a nod to his hometown). By April, Acorn's website was up, explaining the fund's philosophy. The Web will be his main marketing tool. "We won't spend a lot of money on glossy brochures," he says. He does, however, want to get on FundSERV, an electronic fund-listing system that allows brokers around the country to review and buy various funds on behalf of clients. It's an important distribution channel-most major institutions won't send clients to a non-FundSERV hedge fund-but in the wake of the financial upheaval, new funds have been largely locked out.

Months before he was ready to take orders, Russell sent out feelers to his professional network. But it wasn't until late May that he started to formally pitch the fund, travelling to Vancouver, Montreal and Chicago, and spending much of June doing presentations around Toronto.

In the pre-launch months, Russell had his moments of doubt-his "gut-check times." He was often in the office as early as 4:30, eager to work. But even before Acorn's doors opened, he was heartened by the phone ringing every day with someone asking when he'd be ready to accept money. "My [former] performance numbers get passed around," he says. "And there's a shortage of managers of this style."

Russell now has five staffers and has signed up an independent salesperson to market his fund in Europe. As of July, he'd raised roughly $15 million, waiving his performance fee-the industry-standard 20% of profits, though he still receives a 2.5% management fee-for all founding investors. That's another break with industry practice: Hedge funds typically offer such deals to only one or two major start-up investors, but if one investor whose assets constitute the bulk of the fund chooses to pull out, a fund can be in trouble. Russell has chosen to encourage a broader client base. He also has a no "lock-up" period-clients can withdraw their money with just five days' notice, whereas many hedge funds demand investment commitments of one to three years.

Although happy with the initial client response, the 40-year-old father of three, who's put all his investment money into his fund, is determined to keep his expectations conservative. "I still take any [verbal] commitment [from a client] and divide it by half," he says. He aims to crack $50 million in assets under management by the end of next year (the minimum investment is $10,000). "I'm keeping my focus on a year or two from now," he says. "If I focus on reading the paper every day, all the news about our industry, breaches of confidence and trust..." He trails off pensively. "It may look like I'm either crazy or courageous. But there are times when you need to look through the immediate troubles."


Why do it now

Russell believes his fund's methodical, metric-driven strategy suits investors' cautious attitude after many got burnt on more high-reward and high-loss funds. He also sees market opportunities opening up in such areas as currencies, bonds and soft commodities that his trading system can exploit.


His risk-averse approach might lose its appeal as the markets recover. "Clients could forget the lessons of last year," says Russell. "We're marketing a process rather than a hot story, and they could get wooed into a hot stock tip." By allowing investors to pull their money out on short notice, Russell makes the investing easier to commit to- but also easier to abandon.

Where the money is

So-called family offices-the managers and advisers who run wealthy families' finances. Russell finds they tend to be more sophisticated and disciplined than individual investors, yet are more entrepreneurial, flexible and easier to entice than institutions such as pension funds.




Accounting services $7,500

Regulatory fees $5,000

Insurance $2,700

OSC's capital requirement $35,000

Legal services (offering memorandum, subscription documents, know-your-client form, dealer/ administration agreements, tax opinions, marketing compliance, U.S.and OSC registration) $70,000

Total $120,200



Rent $1,250

Phone and Internet $400

Technology (equipment leases, data services) $2,600

Insurance $250

Travel and entertainment $1,000

Strategic consulting $500

Employment $25,000

Office supplies $500

Legal and accounting $800

Marketing $500

TOTAL $32,800

Total investment assets needed for the fund to break even:$15 million