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Hedging your bets, both long and short

Date: Tuesday, September 12, 2006
Author: Barry Critchley, Financial Post

It's not just long-only investors who are hurting from the continuing fall in the price of oil and natural gas and its effect on the stock prices of energy companies.

Investors who have handed some cash to funds that go both both long and short are also having a tough time, despite their additional investment flexibility.

There are at least three such long/short hedge funds operating in Canada -- all of which require that the individual investors meet the so-called accredited investor rule. That rule requires a net worth and an annual income of a certain size. And the best performer among the three is a touch above flat for the year.

In contrast, for the year to date, the S&P/TSX energy index is down by 2.2%. The sub-sector of the S&P/TSX composite index hit a high of 3,557.74 in April. Since then the sub-sector is off by 15.7, closing yesterday at 2,999.73. Calgary-based Tristone Capital publishes an index on the junior oil and gas companies. To the end of August, the index is off by 15%.

So how have the others done?

Creststreet Energy Hedge Fund LP This fund was formed in April, 2005, and is intended to provide investors with long-term capital growth "by taking both long and short investment positions in equity, debt and derivatives and through strategic trading." According to its Web site, at the end of June the fund was down by more than 20%. Since inception, the fund is up by 14.14%.

The fund requires a minimum investment of $25,000, and comes with a 2% management fee and a 20% performance fee.

DeltaOne Energy Fund LP This fund, which employs "long and short strategies on the basis of intensive fundamental and quantitative research," has been around since the middle of 2003. (At the end of 2005, assets stood at $58.06-million.)

And like the others, it has found the going tough this year. According to its Web site, at the end of July the fund was down 43.38% so far this year. On a longer-term basis, the fund is up by an annualized 18.47% since inception.

DeltaOne also has a long-only fund known as the DeltaOne Strategic Energy Fund. In something of an irony, that fund (to the end of July) is down by 7.37% this year.

Full Cycle Energy LP 1 This fund has been around since September, 2003. Its investment objective is to "generate above average long-term capital appreciation in energy investments through the full business cycle, with a focus on rigorous risk management."

It has $12-million under management and so far this year is up by 0.33%. (So far this year is to the end of August.)

The fund has posted a negative performance over the past one month, and three and six months. Over the past year, the fund is up by 22.37%; since inception it has posted an annualized gain of 16.81%. Henry Cohen, a veteran analyst, is the fund's manager.

Cohen said the fund's ability to engage in relative value trading has helped its performance. "It's not just equities. We trade commodities and derivatives and use that as a risk-management tool," he said. By way of example, he said that earlier in the year, the fund was long heating oil and short natural gas. "That helped us out a lot," he said.

"We will do relative value between stocks, between a stock and its underlying commodity and between commodities," Cohen said. "That's the type of trading we will do when there is essentially no movement but very volatile markets, like where we are now."

Cohen isn't fazed by the current stock and commodity markets. "We have been making money in the sector all through the 1980s and 1990s with flat to down pricing. There is always an opportunity but you need to be long and short," he added.

So, how have the mutual funds done? In general, the funds -- which are restricted to a long-only investment strategy -- have done better. For instance:

Sprott Energy Fund Formed in 2004, this fund was down by 3.47% in the eight months ended Aug. 31, 2004. Over the past year, the fund -- which can invest in all forms of energy, including oil, coal and uranium -- is up by 4.30%. The fund, which requires a minimum investment of $5,000, has about $184-million of assets under management.

Front Street Energy Growth Fund This fund is a partial labour-sponsored fund (partial because there are no provincial tax credits) that has been around since March, 2002. The fund, which requires an investment of $5,000, invests in small to medium-sized companies. It had assets of $97-million as of the end of August. So far this year, the fund is up by 9.50%.