(June 21, 2004) Hedge funds in Canada are raising their popular and academic profile. Last week, the Canadian chapter of the Alternative Investment Managers Association (AIMA) released a hedge fund primer, and announced an annual prize for the best Canadian research paper on hedge funds.
The primer, compiled by Bernice Miedzinski of institutional advisor York Hedge Fund Strategies, follows from an earlier publication, “Guide to Sound Practices for Canadian Hedge Fund Managers.” “We tried to do hedge fund 101 in plain, simple English,” she says. Although Miedzinski calls the primer “plain vanilla,” it’s a little bit more than that.
The 52-page AIMA Canada Hedge Fund Primer has some interesting data, estimating the size of the Canadian hedge fund universe at $20 billion (US), with about $7 billion of that invested by institutions, $7 billion invested by individual investors and another $8 billion managed on behalf of foreign clients, through offshore funds.
While the primer briefly surveys global trends, the Canadian focus is revealing. Retail investors, the primer suggests, drawing on research from Toronto consultancy Investor Economics, have taken to principal-protected notes structured around hedge funds of funds. Institutional investors have also embraced funds of funds, which, all together, gives funds of funds a one-third market share.
Hedge fund definitions
The primer, in dealing with Canadian legal structures, also goes some way to dispelling hedge fund myths that are largely based on the U.S. experience. In Canada, most managers have to be registered, unless they qualify for an exemption, generally for non-Canadian advisors. Registration requirements impose a number of duties concerning proficiency, record-keeping and minimum capital requirements. Even to manage an exempt product — most Canadian hedge funds are exempt from the rules on prospectuses that apply to mutual funds — the manager is usually registered. Investment managers can sell hedge funds without going through the prospectus offering route, but they generally must still have appropriate offering documents. In addition, sales to private clients in the exempt market must be reported to regulators.
What’s a hedge fund beyond the legalisms? In Toronto for the launch, Thomas Schneeweis, founder of the Center for International Securities and Derivatives Markets at the University of Massachusetts at Amherst, commented that the diversity of strategies means that hedge funds “are really a political or legal structure.” What they offer “is a means of investing in certain return opportunities that don’t exist in the traditional world.” Those return opportunities are important for investors because the old stock-bond tradeoff no longer does the job of diversification. International markets are increasingly correlated, while bonds and stocks often move up at the same time. Equally, the euro has eliminated a major field of diversification among sovereign bond markets.
The primer introduces a variety of hedge fund strategies and illustrates some in detail, including distressed securities, merger arbitrage and long/short investing. It also reproduces Investor Economics data on the distribution of hedge fund strategies in Canada. Most single-strategy managers (41%) are long/short investors, while there is also a significant component allocated to managed futures (17%).
The primer also tries to break down some of the sources of hedge fund risk, which include market and credit risks as well as operational risks. So there’s credit risk, which can be broken down by categories, as well as market risks, such as rising interest rates, volatile commodity prices or illiquid securities. Operational risks, which can be mitigated by diversifying among managers, include valuation risk, human factor risk, regulatory risk and the like.
As many hedge fund guides are, the primer is subdued about appropriate allocations to hedge funds. It does illustrate shifts in the efficient frontier of a portfolio, using a fund of funds, but the primer cautions that “AIMA Canada does not recommend using historical data for either traditional asset classes or hedge funds to forecast future returns.” Still, it does discuss the effect of replacing part of the equity or the bond component in a balanced portfolio with a fund of hedge funds or and equity hedge fund.
Says Miedzinski, hedge funds are “not simply a new product option. It’s a whole new way of managing your portfolio.”
Research awards
Perhaps that “new way” will acquire a more quantifiable basis, using real-life Canadian hedge fund returns. At the same time AIMA Canada released the primer, it announced a $10,000 research award for the best paper on hedge funds.
The award is sponsored by JCClark and RBC Capital Markets and the best paper will be published in Canadian Investment Review. For students, the best paper also promises an internship.
Paul Bates, McMaster University’s new business-school head, will lead the adjudication panel. Now a commissioner at the Ontario Securities Commission, as well as the former head of Charles Schwab Canada, Bates, who started his career in 1975 as a commodities broker, alluded to the increased profile of hedge funds, wryly saying that “If I’d called myself a hedge fund manager, my career might have gone somewhere.” He expects to pull together a panel of adjudicators from Canada’s business schools by October.
Tris Lett, co-chair of AIMA Canada’s education and research committee and director of RBC’s alternative investments group, says the research must either be conducted by a Canadian or be conducted in Canada.
For more information about the awards, click here, or go to www.investmentreview.com. Canadian Investment Review is a sister publication of Advisor’s Edge and Advisor.ca, both properties of Rogers Media.
Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.
(06/21/04)