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By Ray Turchansky
Edmonton Journal
“Your Money” Section
Saturday, March 5, 2005
People laughed when Warren Buffett ignored the technology stock run-up in the late 1990s, saying that he never invested in anything he didn’t understand. But when the tech bubble burst, Buffett looked like a genius.
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "Hedge funds are still somewhat unregulated, their investment fees should be considered, there are liquidity issues, and the risks are not understood by most investors.”
Fast forward to January 19, 2005, when three Canadian bank CEOs sounded an alarm that hedge funds were getting out of control.
Gordon Nixon of Royal Bank of Canada, Ed Clark of Toronto-Dominion Bank and Richard Waugh of Bank of Nova Scotia noted that hedge funds were growing by 46 percent a year, and now had $26.6 billion in assets.
“We all worry about it because it’s a very complex market;” said Nixon, adding that hedge fund examination by regulators was “something we would very much encourage going forward.”
Their concern was a lack of control over hedge funds, and the idea that the funds were now available to the average investor, who had little understanding of their complexity.
Hedge funds often take both long and short positions (Iooking for a stock to fall in value), use leverage and derivatives, and often take large risks on speculative strategies. Thus, hedge funds tend’ to preserve capital during market downturns, but have limited exposure to large market uptakes.
The hedge fund industry immediately dumped on the banks for “crying wolf.”
But three weeks later, the Ontario Securities Commission led an investigation by eight provincial regulators into Portus Alternative Asset Management Inc., a hedge fund operator which said its principal-protected funds were protected by a bank, but did not disclose any bank as doing so.
What started out like a seemingly contained investigation has turned into the Canadian investment world’s version of Watergate, which grew until it toppled a US president. Here’s what unfolded.
An estimated $730 million in assets with Portus, from 26,000 clients, were frozen.
An e-mail sent nearly a year earlier from consultant Duff Young to Portus executives, warning that a scandal could be brewing, was leaked to the media.
The spotlight turned on financial advisors who had steered their clients into investing in Portus funds.
Portus sent out a memo to clients saying ”client money is safe, secure and principal protected,” which infuriated the Ontario Securities Commission.
The Mutual Fund Dealers Association demanded that all fund dealers who referred clients to Portus provide all documents about their relationship.
Manulife Securites International Ltd., a division of Manulife Financial Corp., was said to have referred $240 million in business to Portus, for which Manulife and its agents collected nearly $11 million in referral and syndication fees.
Portus fired most of its 60 employees.
More than $700 million worth of Portus securities was said to be held by PDP International Bank, in the Caribbean.
Manulife Financial Corp. said it was misled by Portus about the nature of investments it was selling Manulife clients.
This week, some 10,000 Manulife clients filed a class-action lawsuit against Manulife and Manulife Securities, seeking repayment of $240 million in client assets and $10 million in referral fees.
The next day, Manulife Financial Corp. said it would guarantee 100 per cent of the principal invested by clients of Manulife Securities International Ltd. in Portus products.
While many hedge funds have served” investors well, especially during the bear market of 2000-2002, Vancouver investment counsel Adrian Mastracci of KCM Wealth Management Inc. warns that hedge funds are still somewhat unregulated, that investment fees should be considered, that there are liquidity issues, and that the risks are not understood by most investors.
Furthermore, he says that “practically every client says that hedge funds are not suitable for them when they answer the question in the ‘Know Your Client’ form.” As Warren Buffett says, if you don’t understand it, don’t invest in it.
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