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Banking veterans to offer fund with cut-rate fees

Date: Wednesday, June 9, 2010
Author: Globe & Mail

Two of Canada’s most experienced bond market veterans are leaving behind careers in banking to open a hedge fund that they hope will shake up the industry by charging much lower fees.

John Schumacher, former co-chief executive of Scotia Capital, and Mike MacBain, former head of debt capital markets at RBC Dominion Securities, have teamed to open Toronto-based East Coast Fund Management Inc. They are seeking to raise more than $100-million from investors.

The plan is to generate returns of 8 per cent to 12 per cent by investing in debt securities, focusing on preserving capital and reducing risk by hedging using commodities, stocks, foreign currency and derivatives.

That strategy is nothing that remarkable in the world of hedge funds. What is remarkable is the fee structure, which is much cheaper than the industry standard that’s often referred to as “2 and 20.” That’s because most funds charge 2 per cent a year in management fees, plus 20 per cent of any upside.

“We think 2 and 20 is ridiculous,” Mr. Schumacher said.

The fee structure may be key to bringing in capital, because it’s not an easy time to raise money. Investors are wary as markets keep getting hit with shock after shock, most recently the Greek sovereign debt crisis, and that’s made it difficult for many hedge funds to attract capital.

East Coast will charge no management fee for initial investors who put money in before July 1. After that, the fee will rise, but still be “very aggressive” and remain under 2 per cent, Mr. Schumacher said.

East Coast’s performance fee will be the standard 20 per cent of any upside, but with the wrinkle that the fund has to return at least 4 per cent before East Coast can take a cut.

The pair picked that number because most investors should be able to earn 4 per cent in the bond market without paying up to hire hedge-fund managers.

“We are trying to show we have confidence,” said Mr. Schumacher, who resigned from Scotia in 2008 after 11 years with the firm. At the bank, he was in charge of global trading operations.

East Coast also plans to have another feature that it hopes will attract investors displeased with other funds’ fees: a permanent high-water mark. That means the team only charges performance fees if the fund’s value rises to new records each year. Other funds often advertise a high-water mark, but give themselves an out by specifying that the level they have to beat resets every two years.

If investors ever want out, East Coast says it will have fewer barriers to withdrawing money than most rival funds. For example, instead of a two-year lockup period when investors have to leave their cash in the fund, East Coast will have a six-month lockup.

“We don’t want to hold anybody’s money for ransom,” said Mr. MacBain, who prior to RBC was president of TD Securities.

So far, East Coast’s performance numbers are big, though the firm had the advantage of a bull market for bonds. East Coast’s “founders fund,” basically the managers’ own money that they have been running to get a track record in the lead up to raising the main fund, returned 31 per cent in its final 12 months.

“The product really sells itself,” Mr. MacBain said.