The Canadian hedge fund industry is estimated to have $35 billion in assets under management. It’s a drop in the ocean compared with the neighbouring US market but participants say its appeal is growing among international investors.
One of the attractions is the quality of managers. Sprott Asset Management runs about $6 billion – $2.6 billion of which is in hedge fund assets. The firm spun out of Canadian broker/dealer Sprott Securities, and its flagship offshore long/short equity fund, which has a bias towards Canada, has had impressive returns. Returns up to the end of October were more than 40%, and returns for 2006 were almost 27%. James Fox, director at the firm, says that managers in the region have been proving their standing in the global hedge fund industry. "The country’s hedge fund industry is still in its infancy compared with other markets, and has been behind the curve, but there are some great managers here," he says. "Talent has not been diluted. And we would like to think we are regarded as a successful hedge fund on a global basis – not just compared with our domestic peers."
Indeed, the performance of Canadian managers as a whole has been impressive. The Scotia Capital Canadian hedge fund index has risen at an annual rate of 18% since its inception in January 2005, compared with 6% for the HFRI index.
Fox speculates that investors are becomingly increasingly attracted to Canadian managers because of their overall views on the market, in addition to good performance. "Some, I would imagine, want more exposure to oil and gas or mining, and global companies in those sectors list on the Toronto Exchange. Toronto is a major world mining finance centre. We are visited every day by at least 10 companies, many that have operations internationally, which update us on their story. Investors incorporating those commodity themes in their portfolios perhaps look to Canadian managers for expertise and exposure in those areas. Exposure to the Canadian currency, I suspect, might play into their speculations also."
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Canada’s hedge fund industry booms |
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Size of Canadian hedge fund industry, assets under management |
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Source: Investor Economics |
The fact that the market is still quite small is an advantage that many investors are realizing. The Canadian market is the sixth largest globally by market capitalization yet is relatively untapped. "Investors have often seen Canada as an oil-based, resource country but there are so many different types of companies listed here," says Dwayne Dreger, director of corporate development at fund of hedge funds group Arrow Hedge. "Analyst coverage is light, and becomes lighter still as you move down the market cap size chain. That gives the managers based here an informational edge."
Arrow Hedge has C$1 billion ($1.01 billion) in assets in four domestic Canadian and four offshore funds of hedge funds. Dreger believes that given that hedge funds in Canada are small and relatively new, they can play a role in portfolios allocating to early-stage managers. "Investors are increasingly realizing that early-stage managers can offer superior returns. There are over 150 hedge fund managers in Canada, of which 45% are under $250 million, and 63% are less than five years old," he explains. Arrow Hedge’s Maple Leaf fund of funds invests primarily in Canadian-based managers that have less than C$150 million and a track record of three years. The fund invests primarily in early-stage long/short, relative value, event-driven and macro manager, and targets annual returns of between 10% and 20%.
Although the confidence of investors was hit by two collapses in the industry, Dreger believes they are gradually coming back. Boaz Manor, co-founder of collapsed hedge fund Portus Alternative Asset Management, returned to Canada from Israel in November to face charges including fraud and money laundering. The other co-founder, Michael Mendelson, was sentenced to two years in jail in November after pleading guilty to fraud. Canadian fund of hedge funds Norshield also made headlines when it suffered from a "run on the fund" by investors and prevented redemptions while it went into liquidation in 2005. A lawsuit is under way that alleges that the fund’s founder, John Xanthoudakis, had been diverting money from the fund to his personal accounts – an accusation strongly contested by Xanthoudakis.
Due diligence
"The events have certainly held the Canadian hedge fund of funds industry back, and it has forced investors – as they have in other global markets – to take a hard look at their due diligence procedures," says Dreger. "Long-only money has dominated the money management industry in Canada but we’re seeing more hedge fund players emerge, as well as early interest of long-only managers to review their ability to leverage and short in limited ways. All in all, the Canadian hedge fund market begs an increased level of investor attention."