Hedge funds fastest-growing segment of the Canadian financial market

Date: Thursday, October 27, 2005
Author: TAVIA GRANT- Globeinvestor.com

On Tuesday, outgoing EnCana Corp. chief executive officer Gwyn Morgan blamed hedge fund managers -- with their obsession for short-term returns -- for spreading the takeover rumours that whipsawed his company's stock.

Yesterday, it emerged that hedge funds may own as much as three-quarters of Algoma Steel Inc., and the company rejected a demand from one that it reorganize.

What percentage of Canadian equities are currently held by hedge funds? It seems a simple question. Yet after posing the question to dozens of North American hedge fund managers, industry associations, regulators and research groups, no one appears to have the foggiest idea.

In Germany, hedge funds now control as much as a quarter of the country's largest publicly traded companies, raising consternation among regulators and politicians that the fate of many of its firms is determined by an opaque, unregulated industry.

In Canada, one thing is clear: Hedge funds' influence in the equity market is exploding.

It's not surprising the numbers are difficult to track -- hedge funds are still in their infancy in Canada, many with Canadian holdings are based outside the country and a lack of regulation means the industry remains, for the most part, shrouded in secrecy.

What is known is that hedge funds are the fastest-growing segment of the Canadian financial market. In the past five years, the Canadian hedge fund industry has jumped more than sixfold to $15.4-billion in assets under management, while the number of funds has ballooned to 200 from 46, according to a report from Investor Economics.

"They'll only become a lot more powerful," said Bob Thompson, alternative investment strategist at Canaccord Capital Corp. in Vancouver. "A lot of money has gone into hedge funds in the last few years, so a lot of these managers have very big amounts of cash that they can then go take a position in the company or on the board."

Which is great news if you're a shareholder intent on boosting short-term returns. Not so great if you're an embattled CEO trying to establish a long-term plan for growth and stable returns to stakeholders.

In the past five years, they've doubled to become a $1-trillion (U.S.) global industry as investors sought to spread their risk and generate higher returns from lacklustre equity markets.

With that has come some severe growing pains, both in Canada and abroad. In the U.S., Long-Term Capital Management, whose co-founders included Nobel Prize winners, collapsed in 1998, consuming $4.6-billion of investor money.

In Canada, the list of failed and scandalized hedgies is growing, capped recently by Norshield Financial Group, once one of Canada's largest hedge fund companies, put into receivership by the Ontario Securities Commission amid concern about mounting redemptions and a lack of co-operation with regulators.

Most industry experts acknowledge that a Canadian industry that's added between four and 10 new hedge funds every month since 2000, is ripe for consolidation.

Still, their influence on equity markets has some positives. They "plug holes," as Canaccord's Mr. Thompson puts it. In other words, they can improve liquidity.

"They increase the depth and the breadth of markets and create new strategies where others would not be available," said Pierre Saint-Laurent, president of Asset Counsel Inc. in Montreal. "It just makes the market more efficient -- there's a market opportunity and it's being seized quickly."

As well, hedge funds have successfully pressured underperforming companies to boost shareholder value, analysts said.

Earlier this month, Geac Computer Corp. Ltd. named Eric Rosenfeld, CEO of hedge fund Crescendo Partners LP, to its board after he had tried to oust the company's board with claims that Geac was in danger of overpaying the next time it wanted to make a deal.

Canadian regulators are growing antsy. The OSC, which has been studying hedge funds' power in the markets this year, wouldn't comment for this article, saying it will discuss the matter further on Nov. 17. The Investment Dealers Association of Canada, meantime, has called for laws to regulate retail-oriented hedge fund products.


Hedges overgrown?

While it's emerged that hedge funds may own as much as three-quarters of Algoma Steel, how much of the total Canadian equity market is controlled by hedge funds remains a mystery that is increasingly irksome to regulators, CEOs and buy-and-hold investors alike.

Canadian Hedge Fund Assets

Assets in $billion

Dec. 19992.5
Dec. 20003.9
Dec. 20016.2
Dec. 20028.6
Dec. 200312
June 200414.1
Dec. 200415.4


Number of hedge funds

Dec. 199946
Dec. 2002151
Dec. 2003181
Dec. 2004200