Resource bets hit the jackpot

Date: Wednesday, December 7, 2005
Author: David Berman, Financial Post

Rohit Sehgal has guided the Dynamic Power Hedge Fund to a one-year return of 119%. Over the last three years, the fund has generated a 72% annual return, thanks largely to energy and materials.

Published: Wednesday, December 07, 2005

Good hedge fund managers have a reputation for being able to trounce the broader index, but Rohit Sehgal, manager of the Dynamic Power Hedge Fund, certainly stands out from even that group. As of Sept. 30, Mr. Sehgal's fund, (which is restricted to minimum investments of $100,000 to $150,000) had a one-year return of 119%, beating the Standard & Poor's composite index by a whopping 90 percentage points and making it one of the top performing hedge funds in the world. The fund's three-year track record is also impressive, with a 72% annual return. Mr. Sehgal is allowed to use leverage in his fund, which was launched in 2002. But the main reason for his success is his big bet on Canada's energy and materials sectors, which accounts for more than 97% of the fund's assets. The Financial Post's David Berman spoke with Mr. Sehgal about the prospects for this hot area of the market.

- - -

Q. Why have you made such a big bet on just two sectors of the market, energy and materials?

A. One trend that we have taken advantage of is what is happening in China and India. We believe that this trend is so well established that the risk of being wrong is very low.

I mean, you're betting on demographics in India, where 60% of the population is under the age of 30 and there is a huge emerging middle class. That's not going to stop tomorrow. We may have some cyclicality from a stock market point of view, but these are well-established trends.

So we have a very large exposure to the energy sector and other commodities and materials like coal, nickel and copper. We believe that all of these commodities will benefit from what we see as rising demand from emerging economies.

This has been a big theme for all our portfolios, but it has been even more concentrated in this fund because we were able to take positions in very junior stocks [such as Dynatec Corp., Paladin Resources Ltd., Kereco Energy Ltd. and Tenke Mining Corp.] that we can't hold in the very big funds. These stocks are high risk, but the returns can be enormous.

Q. You see China as a good opportunity, and yet its stock market has performed very poorly this year. Is energy a better way to bet on its rising economy?

A. Exactly. We want to invest in products which are in demand in that part of the world. We have not invested in the Chinese market. We have invested in commodities that are in demand, and energy is a big part of it. The same applies to India to some extent, although the Indian market is a little more efficient and liquid.

But to take advantage of the big emerging trends, we're investing mostly in Canadian companies.

Q. Energy stocks have performed spectacularly over the past few years, but the price of oil has come down from its peak. Where do you see this theme headed?

A. We don't want oil to go to US$70 a barrel. That would make us nervous, because it creates too much stress for the world economy -- so we're happy to see oil prices coming down.

We see the price settling somewhere between US$50 and US$60 a barrel, and I think the economies will adjust well to this price range. It will not be good if oil suddenly goes up to US$70 or US$80 because it will slow things down, even in China and India.

So the long-term prospects for the energy sector remain unbelievably positive. I mention oil services because in terms of pricing power and demand for their services it has never been so good. We're focused on the Canadian side, but even globally the demand for oil services companies is going to be strong for years.

Q. How do you view the prospects for the natural gas sector?

A. More recently, we have emphasized natural gas, even though this is more of a North American phenomenon. We see shortages of natural gas within this continent, and Canadian producers -- especially the junior producers -- are well-positioned to take advantage of that.

Alberta still provides enormous opportunities for smaller players to go in and increase production -- even double production -- over the space of one or two years.

Most of these companies are being recycled. They've been spun off from bigger companies, so the management teams are very experienced and most of the exploration they do is low-risk, with success rates often more than 90%. We're finding opportunities that we think will give us returns of 50%, 100% or 200%.

Now that the income trust phenomenon is back, these companies benefit because they can be acquired by income trusts or they can become income trusts.

Natural gas is different because it's not very easy to bring in imports. Eventually we will get more liquefied natural gas, but it will be a very slow process.

It looks as though natural gas prices are going to stay a lot higher than normal. The move has been a lot more pronounced even than oil. From US$1.90, gas is currently about US$12.50 -- that's huge, and we don't see it coming down very much. The level is going to remain between US$9 to US$11.

Q. To what extent are high-priced commodities already built into share prices?

A. The companies that we've been interested in -- such as Kereco Energy -- have been trading between three and four times cash flow, and these are companies where production is going to double next year.

So I think valuations have never been so attractive. These companies are well-funded. And they have good exit strategies because a lot of them will become income trusts or they will be acquired by the bigger income trusts.