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By Ray Turchansky
Edmonton Journal
“Your Money” Section
Saturday, June 4, 2005
At first, the problems investors have been facing with hedge funds seemed distant, woes that would affect only the rich and famous.
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "Hedge funds can either make huge money or blow up "in a matter of days, mostly with little or no advance notice.”
But since the beginning of March, I have heard from a number of readers, and some of my income tax clients, who were stung when hedge fund operator Portus Alternative Asset Management Inc. closed shop.
Many of the investors I conversed with were seniors, with $30,000 to $40,000 in annual income, much of it coming from their investments.
Most didn't understand that they were investing in a hedge fund, or the risks involved.
Soon after Portus folded, Montreal-based Norshield Financial Corp. suspended redemptions of three of its hedge funds, after squeamish investors tried to pull their money out.
In hindsight, a convergence of events explains the recipe for hedge fund disaster.
On one hand you had investors leery of equities, due to the bear market from 2000 to 2002, and of mutual funds, due to the market timing and late-trading scandals.
On the other hand you had a hedge fund industry with the allure of having turned in great results during the bear market, suddenly opening itself to retail investors.
Instead of needing $150,000 to invest in a hedge fund, you could now get in for as little as $500.
The result was that retail investment in Canadian hedge funds grew 39 per cent last year to $14.1 billion, with pension funds holding another $11 billion and offshore funds attracting a further $2 billion. Worldwide hedge fund assets are pegged at $1 trillion US.
The major hedge fund operators in Canada include Sprott Asset Management, Front Street Capital Inc., BluMont Capital Corp., and Arrow Hedge Partners Inc.
But hedge funds are difficult to understand because they lack transparency and they can use a grocery list of strategies, including short selling, arbitrage, currency speculation, options and futures trading, leveraging and the purchase of distressed securities.
Being able to sell short allows them to make money when stock markets tank. And being able to leverage their principal greatly inflates their profits, but also their losses.
Hedge funds face much less regulation than mutual funds or equities, and even the usually protective Investment Dealers Association of Canada has released a report calling for a review of regulations to "bring hedge fund products being offered to the retail investor fully within the regulatory process."
What happened was we wound up with the unaware leading the uninformed.
Investors who didn't understand the workings or risk of hedge funds trusted their money in the hands of financial advisers who, in many cases, also didn't grasp the peril they were placing their clients in.
In the case of Manulife Securities International Ltd., advisers earned some $11 million in referral and syndication fees for parent Manulife Financial Corp., which later wound up guaranteeing the $240 million in assets its subsidiary had convinced clients to invest with Portus.
While the investors are getting their principal back, it is taking time, and they are winding up with no return on their investments.
Adrian Mastracci of KCM Wealth Management Inc. in Vancouver cautions that hedge funds can either make huge money or blow up "in a matter of days, mostly with little or no advance notice." He suggests having no more than five per cent of your portfolio in such a high-risk vehicle.
Kelly Rogers of MoneySense magazine warns that with hedge funds, big fees are hidden, performance depends 85 per cent on the fund manager (compared to 15 per cent for a mutual fund), and a sudden rash of redemptions can sink returns.
She noted that 179 hedge funds collapsed in 1998 alone, with U.S.-based Long-Term Capital Management losing $4 billion US. Her advice is that although the $150,000 minimum to invest no longer applies, if you don't have that much to put into a hedge fund, "you should probably steer clear."
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