Portus fails to taint hedge fund sector: No capital slowdown

Date: Monday, February 20, 2006
Author: Lori McLeod- Financial Post

The Portus Alternative Asset Management Inc. scandal may have put Canada's fledgling hedge fund industry on the global map last year, but not in a way anyone in the business would have liked.

At hedge fund conferences, one can only imagine the "Hey, how about that Portus?" backslaps Canadian managers must have endured with a smile, much the way reputable gold firms became weary of Bre-X nearly a decade ago. But if you think Portus put an irrevocable stain on the industry, think again. There are many signs alternative investment funds in Canada aren't just hanging on, many are thriving.

"I think the Portus thing has gotten to the point where it's such a Gong Show, it has become almost circus-like," said James McGovern, managing director and chief executive of Arrow Hedge Partners, and chairman of the Canadian arm of the Alternative Investment Management Association (AIMA). "People are mildly interested in it ... but I think they are taking it with a grain of salt."

Some of Canada's best hedge funds report no slowdown in bringing in new capital. Take hedge fund Waterfall Investments, a Toronto-based firm headed by Andrew McCreath, a former portfolio manager and founding shareholder at Synergy Mutual Funds.

He founded Waterfall with Dan Rissin, vice-president of risk management, and Lois Marshall, vice-president of administration, after Synergy was scooped up by CI Fund Management in 2003. Waterfall started trading in May, 2004, with $5-million under management.

Funds under management now stand at just less than $200-million. This includes a US$15-million investment from global bank JP Morgan, a significant vote of confidence for a firm that hasn't even reached its second birthday.

Waterfall's staff now numbers 11 and the returns have been strong. For example, the compound annualized return on Waterfall's offshore fund is 27.4%, based on its December data. Mr. McCreath says that since inception, about 98% of Waterfall's returns have been alpha, which in hedge fund terminology means: returns that can't be attributed to the market.

"When a hedge fund is run like a hedge fund, I believe there's lots and lots of proof that the investor can generate a superior risk-adjusted return to traditional forms of investing," Mr. McCreath said. "I feel very strongly about that."

Another gauge of the robustness of the Canadian industry is the number of new funds hitting the market. In this secretive and fast-growing world, it's difficult to get numbers on just how many funds there are, and how much money they manage.

However, Sharon Grosman sees new funds constantly. She is a chartered accountant and partner at Toronto-based hedge fund administrator SGGG Fund Services Inc., which provides fund valuation and record-keeping services for the industry.

"If I'm the barometer, this industry is booming," Ms. Grosman said. "It shows no signs of letting up anytime soon, at least in our office. We just did a count and we have 20 funds that will be launching in the first six months of 2006."

From 35 funds in 2003, SGGG's client base had grown to 130 funds with net assets of about $2-billion as of the end of 2005. SGGG estimates about 85% of Canada's hedge funds are its clients. SGGG is hiring employees at a rate of about one a month, and now has 20 full-time staff to keep up with its growing client volume.

So far, SGGG hasn't seen any of its clients fail and have to close their doors, Ms. Grosman said. While new funds are starting up at a steady pace, it is the larger and more established funds in the country that have the momentum in gathering new assets.

"The larger hedge funds are attracting more capital than the smaller ones," said Gary Ostoich, president of Salida Capital Corp. and legal counsel for AIMA. "It's because a lot of the investors are looking for an infrastructure, a risk committee, governance, and what kind of succession planning there is within a hedge fund."

Colin Bugler, managing director of Scotia Capital's prime brokerage operation, reports that some of the longer-term clients of his department are doing well too. "One nice thing is that the people we brought on board maybe one or two years ago, who have gone through that kind of time of a building up a track record, are starting to see the bigger cheques come through the door for investment now," he said.

So far, Canadian hedge funds have received most of their money from high-net worth individuals in Canada and abroad. Canadian and international institutions, mainly pension funds, still aren't investing much in the Canadian hedge fund scene.

This means one of the keys for fund growth will be to attract more money from institutional investors globally.

"I think that's really going to drive the business forward and get a lot of funds up to much more institution-like size," Mr. Bugler said.