Capricious markets have given only headaches to investors the world over, but one group of financial wizards makes important famous this volatility: Canadian hedge fund managers.
This country’s hedge funds happen to be strongly outperforming the broader market previously year. The increased volatility has been embraced by managers, a lot of whom see their strategies perform better when the market is less predictable.
The recently released figures for that Scotiabank Canadian Hedge Fund Index Asset Weighted index shows hedge funds returned an average of 6.21 per cent in 2015, while the broader S&P/TSX Composite Index posted fell 11.09 percent during the same period.
Canadian hedge funds are smaller and more nimble
Canada’s success contrasts starkly with the situation in the United States, where a greater quantity of funds and more competition for investor cash, combined with weak returns, has resulted in a rash of closures. The HFRI Fund Weighted Composite index, which tracks hedge fund performance, closed down 0.85 percent in 2015, only the fourth time since 1990 the index recorded a loss. Since 2009, U.S. hedge funds have trailed the S&P 500’s performance each year by a typical 10 percentage points.
While it’s not easy to compare the 2 markets, given the different regulatory environments, fund managers say what is giving Canada an advantage now’s a far more boutique market.
“Canadian hedge funds are smaller and more nimble,” said Gary Ostoich, president of Spartan Fund Management Inc. in Toronto. There’s also less competition and more opportunities for managers to face out.
That isn’t to say Canada’s hedge fund industry is not without its challenges. The little size of the makes it difficult for smaller funds to obtain capital – especially since hedge fund investing is restricted to wealthy accredited investors, which will make up only one percent of people.
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For a while, Canadian hedge funds also have needed to deal with American funds eating their lunch. A number of Canada’s biggest investors, like the $272 billion Canadian Type of pension Investment Board, choose to allocate their money into U.S. hedge funds because there are more options and large name managers.
Unsurprisingly, in terms of dollars and cents, Canada’s hedge fund market is small compared to the U.S., even if the population difference is drawn in account. Domestic hedge funds have about $35 billion in assets under management.
To put that in perspective, a single fund in the U.S. – the Bridgewater Associates’ Pure Alpha II Fund – has roughly US$81 billion in assets. Canada’s $35 billion AUM is divided up among roughly 140 hedge fund managers, and according to data from AIMA, 58 percent of hedge funds have AUM of under $100 million.
“What you do find in Canada is we’re much smaller, relative to the U.S., being an industry, with a much smaller asset base,” Ostoich said. “In the United States, you have quite a few hedge funds which are north of the $20 billion mark, whereas within the Canadian market I am not aware of any which are over $3 billion.”
But as the U.S. boasts big funds, last year they also boasted big losses. John A. Paulson’s Paulson & Co., Bill Ackman’s Pershing Square Capital Management and David Einhorn’s Greenlight Capital saw some of their funds recording double-digit losses for that year.
The smaller, less competitive nature of the Canadian industry, combined with strong returns in 2015, implies that new hedge money is opening here, whereas closures and liquidations are a issue in the U.S.
“It’s a fascinating divorce because the story here is we’re hearing in Canada is much more and more funds coming out,” said James Burron, chief operating officer of the Alternative Investment Management Association of Canada.
Latest data from HFR implies that the number of American hedge funds liquidated in the third quarter climbed to 257, a jump from from 200 in second quarter. That brought closures within the first nine months of 2015 to 674, in contrast to 661 in the first three quarters of 2014.
“[Liquidations rose] as investor risk tolerance fell sharply, and commodities and equities posted sharp declines, resulting in net capital outflows, wider performance dispersion and meaningful differentiation between hedge funds,” said Kenneth Heinz, president of HFR, in a release.
In Canada, the possible lack of over-saturation of the market means new funds are opening as investors seek alternative investments to diversify. Hedge money is naturally in demand because of their low correlation to the broader market, given that they invest in a wider number of assets and strategies, such as shorting, derivatives and currency moves.
“The market dynamics definitely have changed,” said Jim McGovern, managing director and CEO of Arrow Capital Management Inc. in Toronto. “The greater things go down and also the more volatility associated in the market and the less correlation, generally speaking, is good for alternatives. However, you need to marry the market opportunity with the manager skill, and that’s where I believe things have gotten better here.”
Managers are hoping stronger returns keep attracting more funds, as performance hasn’t always been a certainty. Canadian hedge funds sorely disappointed this year, once the asset-weighted Scotiabank Canadian Hedge Fund Index fell nearly five percent. The Toronto Stock Exchange’s S&P/TSX composite index for the reason that year eked out a four percent return.
There’s even the issue of fees. Hedge funds typically charge 2 % for management and they commonly tack on an additional 20 percent performance fees when net asset value increases. So that as liquidation shows in the U.S., those performance fees aren’t returned when the fund loses out on its bets.
But the strong performance recently is garnering some attention. Research led by Peter Klein at Simon Fraser University entitled the The Canadian Hedge Fund Industry: Performance and Market Timing, found that that Canadian hedge funds have higher risk\adjusted performance relative to the worldwide hedge fund indices.
McGovern of Arrow Capital isn’t surprised, saying that the hedge fund industry in Canada has become leaner and more efficient because the economic crisis.
“Overall, the amount of quality and class from the operators is much, higher than it has been in the past 10 years,” he said.