apr 2006 toronto hedge fund services 2006 · hedge investment activity. there’s certainly a great...

Major playerscreate globalservicing centre

Investors discoverCanadian hedgefunds

Prime brokerscompete on servicequality

Toronto Hedge FundServices 2006

Apr 2006

TORONTO Hedgeweek Special Report Apr 2006 www.hedgeweek.com | 2

CONTENTS

In this issue…03 Hedge funds market poised fortremendous growthBy James McGovern, Arrow Hedge Partners

05 Canada’s brokers compete on serviceBy Lionel deMercado, TD Securities

06 Toronto joins the global hedge fundindustryBy Simon Gray

09 An emerging hub for hedge fundservices marketBy Mark Fieldhouse, RBC Dexia Investor Services

13 Serving the North American marketfrom TorontoBy Sean Flynn, UBS

14 Resources focus turns the spotlight onCanadian managersBy Simon Gray

17 Global investment made in TorontoBy Jennifer Wood and Mark Purdy, Arrow Hedge Partners

21 Reaching out to start-up managersBy Kevin Beatson and Ronald Landry, Felcom Data Services

Special Report Editor: Simon Gray, [email protected]

Sales Manager: Simon Broch, [email protected]

Publisher/Editor-in-Chief: Sunil Gopalan, [email protected]

Marketing Director: Oliver Bradley, [email protected]

Graphic Design (Special Reports): Siobhan Brownlow at RSB Design

Photographs: Tourism Toronto

Published by: Hedgemedia Limited, 72 New Bond Street, London W1S 1RR

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The Canadian capital markets have beenextremely vibrant over the past few years, asglobal economic growth has led theinternational investment community to“discover” the investment potential ofCanada.

In particular, our resource- andcommodity- related equities have been indemand, but so too have our governmentbonds and our Canadian dollar –affectionately known as the “loonie”.

It may surprise some to know that theToronto Stock Exchange is the seventhlargest exchange in the world with over $1.5trillion in market capitalisation. It boasts morethan 50 per cent of the world’s listed miningcompanies and has the highest number ofoil and gas listings globally.

That said, well over 50 per cent of ourmarket cap is not resource-based, offeringhedge fund managers the benefits ofdiversification into sectors such as financialservices, communicators and technology.Additionally, more than 50 per cent of ourcompanies are considered small to mid cap(C$50-C$500 million in size), offering a goodtrade-off between liquidity and informationalinefficiencies to exploit.

Our debt and currency markets have alsobeen in demand. The Montreal Exchangeprovides equity, debt, interest rate and indexderivatives as means to both leverage andhedge investment activity. There’s certainly agreat deal of life north of the 49th parallel!

The Canadian hedge fund market hasgrown dramatically over the past five years.From barely a few dozen single managerfunds in 1999, there are now some 150hedge funds in operation, and capital hasswelled from C$1.3 billion to more than C$6billion during that time. There is a broad

range of strategies available, but the bulk ofthe capital is opportunistic in nature, withlong/short equity strategies being thedominant category.

In general, performance has been verystrong. In addition, there are a number oflarge funds of funds operators in Canadathat each manage in excess of $1 billion –much of this institutionally focused. Inaggregate, there is well over C$15 billionallocated to hedge funds in Canada.

The majority of hedge fund capital ismanaged from Toronto. All the majorCanadian banks offer prime brokerageservices, and there is a very deep andreliable group of service providers includingmajor accounting, legal and administrationorganisations. Canada has a sound legal andregulatory infrastructure with registrationrequired for all managers. Securitiesregulation however is somewhat burdenedby a provincial (rather than federal) system.The Ontario Securities Commission isconsidered the leading regulatory watchdogin the country.

The Canadian hedge fund market ispoised for tremendous growth going forward.Alternatives generally make up only a smallpercentage of private client portfolios, butthat is starting to change.

International investors, in search ofexposure to new sources of alpha and beta,have been markedly increasing theirexposure to Canadian hedge funds, albeitfrom a low starting base. All of this comesat an opportune time as more talent entersthe industry and substantial capacity isavailable. ■

James L. McGovern

E D I T O R I A L


Hedge funds marketpoised fortremendous growth

James L. McGovern, Presidentof Arrow Hedge Partners Incand Chairman of AIMA Canada

The prime brokerage market in Canada hasenjoyed dramatic growth in response to theinflux of hedge funds that have started upover the past few years. We continue to seenew players coming into the field becausethey realise that potentially, if you do it right,this can be a very profitable segment of themarket.

To a large extent the market is dominatedby the dealer arms of the main Canadianbanks -Toronto-Dominion Bank, Royal Bank ofCanada, Bank of Montreal, Canadian ImperialBank of Commerce and Bank of Nova Scotia,in no particular order. There has been a certainamount of interest from the big internationalinvestment banks, but the hedge fund marketin Canada is not as mature as it isinternationally, and as a result many managersare not yet of a size that would pique theinterest of some of the larger global players.

As the prime brokerage market has grownsubstantially over the past couple of years,the level and range of services provided byTD Securities and other market leaders hasgrown immensely, especially in terms ofclient service and technology.

Prime brokerage surveys consistentlyidentify customer service as the top priority,and it is very difficult to service managers ifyou don’t understand their business. Thismeans that the quality and experience ofstaff is crucial. At TD Securities, for instance,this calls for relationship managers who arevery strong in terms of back officeexperience and have a track record of‘working in the trenches’. It is vital that theyunderstand the challenges that hedge fundsmay experience on a day-to-day basis, whichis why TD Securities insists that itsrelationship managers have knowledge ofthe issues that may arise and that theyunderstand aspects such as corporateactions, settlements and leverage.

The same philosophy applies totechnology, on which clients rely heavily. Theadvantage of having a very strong technicalteam behind the prime brokerage business isthat it makes it possible to providecustomised solutions for clients to help runtheir business more efficiently. TD Securitieshas repeatedly won mandates from clientswith the help of IT specialists who helpanalyse client requirements and enable us toprovide services that other prime brokerscannot.

Canada’s home-grown prime brokers maynot be in a position to compete head-oninternationally with the likes of GoldmanSachs, Bear Stearns and Morgan Stanley,but firms like TD Securities do enjoy anadvantage over the big players when itcomes to large international hedge fundswho manage billions of dollars and have asubstantial amount of capital allocated toCanada. We like to think we know ourmarket better than any of the big players,and certainly we have better access toproduct for short selling.

Another area in which Canadian primebrokers are showing strength is in the areaof capital introduction. Some prime brokersare hosting their own conferences or pairingwith conference organisers as TD Securitiesdid in London earlier this year.

The prime brokerage market in Canadahas changed considerably over the past fiveyears, certainly in terms of the number ofplayers but also in the dramatic growth inlevels of expertise and the range of servicesprovided, and that is set to continue. Morecompetition is good for the market in manyways. New players trying to play catch-upare spending considerable amounts ofmoney, and the original players continue toinvest to keep ahead of the game. Ultimatelythe beneficiaries are the clients! ■

T D S E C U R I T I E S


Canada’s brokerscompete on service

By Lionel deMercado

Lionel deMercado is managingdirector and global head ofequity finance with TDSecurities in Toronto

Its skyscrapers and icy winters might seemat odds with the stereotypical image of anoffshore hedge fund centre, but Toronto isbuilding on a thriving domestic alternativeinvestments market and a well-resourcedfinancial infrastructure to provide a relativelyinexpensive option for administering westernhemisphere hedge fund managers, as theincreasing interest of global service providersattests.

It may not boast the palm-lined beachesand sultry climate of the Cayman Islands, thesheer concentration of French restaurants ofLuxembourg or the pubs of Dublin’s Temple

Bar, but Toronto is emerging as analternative to the hedge fund servicingcentres clustered in the offshore jurisdictionsin and around the Caribbean and in Europe.

The new focus on Toronto is beingboosted by a variety of factors: the existenceof a burgeoning hedge fund managerindustry centred on Canada’s financial capitalthat is also attracting attention abroad, a well-established administration sector catering totraditional long only funds, a low cost basecompared with many other hedge fundservicing centres, and the ready availability ofwell-educated and experienced staff.

O V E R V I E W


Toronto joins theglobal hedge fund

industryBy Simon Gray

Toronto has a long-standing tradition ofhedge fund administration, including StateStreet’s servicing of the Soros funds, datingback to the days when funds that wanted toescape the ambit of US taxation had tosatisfy the authorities of their adherence tothe so-called “10 commandments” specifyingadministrative and marketing functions thathad to be carried out wholly or largelyoutside the United States.

These requirements were relaxed nearly adecade ago, but industry members in Torontosay there remain various practical reasonswhy US-based managers may still find itpreferable to use administrators in Canada.That’s certainly the thinking behind thedecision of UBS, which administers a globaltotal of more than $100bn in hedge fundassets, to set up a Toronto office this year totake on part of its western hemispherebusiness currently handled in Grand Cayman.

The dynamism of the sector is also seenin the recent merger between the fundservices business of Royal Bank of Canadaand the Belgo-French Dexia group, creatinga new industry powerhouse with hedge fundadministration operations in Dublin,Luxembourg, Cayman, Jersey and Guernseyas well as Toronto.

UBS and RBC Dexia Investor Services areamong a mix of domestic and global playersin a keenly contested marketplace, withinternational names including Citigroup andCitco competing alongside specialist localfirms such as Felcom Data Services, which

focuses on start-up and smaller funds thatare often overlooked by the bigger serviceproviders, according to Ron Landry, Felcom’sexecutive vice-president and chief operatingofficer.

He says: “It’s a fairly competitive market,consisting of a handful of very largeAmerican-based service providers likeCitigroup and IFDS, and a number of smallercompanies like ourselves. As well as size,service providers also differ in their approachto the market and who their target client is.Generally you can tell from a client’s focuswhich provider would fit best. If their concernis purely the bottom line of what they’regoing to spend, they may be moreappropriate for one particular provider,whereas if they’re more concerned about theservice quality they’re receiving it might be adifferent one.”

Says Mark Purdy, chief investment officerwith Toronto-based fund of funds managerArrow Hedge Partners: “There is a legacy ofgood administrative back office business inToronto dating back to the 10 commandmentdays with firms like State Street and Citco,and in addition several of the global playersare strengthening their hedge fundadministration business. From a primebrokerage standpoint, there’s been a bigpush recently from the local banks inresponse to the growth in hedge fundmanagers setting up shop in Canada.”

In contrast to the administration sector,few of the leading global prime brokers havemade a serious push into the Canadianmarket, leaving the field open to the country’sleading domestic banks such as RBC,Toronto Dominion and Scotia. According toLionel deMercado, managing director andglobal head of equity finance with TDSecurities, for the time being the domestichedge fund market is not large or lucrativeenough to justify the kind of investmentrequired for the global players to match themarket experience and insider knowledge ofthe local institutions.

At present the Canadian market targetedby the prime brokers consists of more than200 single-manager funds. Although thecountry’s sizeable community of fund offunds managers have traditionally madesignificant allocations outside Canada,deMercado says they are starting to show

O V E R V I E W


➧ p10

As hedge funds have become a growth areafor the North American marketplace, Torontohas emerged as the Canadian hub for theindustry, thanks to its stable businessenvironment, supportive regulatoryframework and favourable conditions forgrowth.

For its part, the Canadian government hasbeen supportive toward the growth of thehedge fund industry, having done their duediligence to help ensure that investors areprotected and that the right conditionsremain in place to preserve the stability ofthe environment.

Toronto is benefiting in particular from thetrend among institutional investors to adopthedge fund or hedge fund-like strategies.Many of the market’s leading serviceproviders, including RBC Dexia InvestorServices, have undertaken considerableinvestment in this area, demonstrating theircommitment to new markets, investmentstructures and risk management capabilities.This type of investment and commitment willcontinue to be vital as these providers seekto keep pace with the hedge fund communityand service the needs of their clients – notonly today but for years to come.

As the industry becomes moreinstitutionalised, hedge funds will continue tolook for providers who are willing to partnerwith them in terms of development. Forexample, many managers are not planningto develop a full risk management capabilityin-house. Instead, they might opt tooutsource such functions to specialistservice providers, who can offer theinfrastructure necessary to manage theirrisks in the proper fashion. Many institutional

investors these days see tremendous valuein the additional comfort provided by a third-party compliance offering.

In addition to Toronto, RBC Dexia InvestorServices provides hedge fund services inmarkets including rapidly developing offshorehubs such as Dublin, Luxembourg, Caymanand the Channel Islands. Each centre hassome unique advantages for the clients theyare looking to service. The key characteristicsof Toronto are its regulatory framework,proximity to the U.S. and the requirements ofthe underlying investors – including a gradualshift as retail mutual funds move into thealternative investments field.

As regulators become moreaccommodating toward this move by retailasset managers, there will continue to be ablurring of the lines between what used to bequite distinct investment classes. Thisevolution of the client base is also likely todrive a high level of growth within the nextfive years, and together with the increasedinvolvement of institutional investors, this islikely to fuel the development of larger andmore institutional hedge fund managers. Retailand institutional investors alike are looking forthe stability and infrastructure that only a largemarket player can bring to the table.

At the same time, investors such astrustee boards are looking for thereassurance of solid third-party serviceproviders, particularly in critical areas suchas risk management and compliance. Theyalso want to be sure that their providers willbe ready to undertake the kind ofdevelopment and infrastructure build requiredto enable them to deliver as the marketevolves and matures. ■

R B C D E X I A I N V E S T O R S E R V I C E S


An emerging hub forthe hedge fundservices market

By Mark Fieldhouse

Mark Fieldhouse is director oftechnical sales andrelationship for globalproducts with RBC DexiaInvestor Services in Toronto

greater interest in the homegrown market asa result of the success of domesticmanagers over the past few years.

Up to date figures on Canada’s hedge fundindustry are hard to come by, but in June2004 Toronto-based research firm InvestorEconomics estimated conservatively thatassets totalled some C$26.6bn (US$22.7bn),consisting of C$10.9bn in pension planassets, C$14.1bn in domestic hedge fundproducts (of which as much as half consistedof principal-protected structured productsaimed principally at the retail market) andC$1.6bn in offshore funds run by Canadianmanagers, largely targeted at Europeaninvestors. Although modest measured againsta global hedge fund industry whose assetshave been estimated as high at US$1.5trillion, these figures represent rapid growthfor the Canadian market, with domestichedge fund assets growing six-fold between1999 and the end of 2004.

Arrow Hedge chief executive Jim McGoverncautions, however, that because much of thecurrent growth in hedge fund assets isflowing to the offshore vehicles of Canadianmanagers, domestic service providers maynot gain the full benefit. He says: “A lot of thenew capital flows that they’re getting areactually coming from international investorsinvesting in their offshore funds, domiciled inCayman, BVI or Bermuda.”

According to deMercado, the strategyadopted by many managers is to establish atrack record in the domestic market and thento set up an offshore fund to market tointernational investors. He says: “We find thatmany managers who have offshore accountshave a domestic administrator for theironshore business and an offshoreadministrator in somewhere like the CaymanIslands.”

Managers and service providers areunanimous that Toronto can hold its own withthe best in terms of the skills it can providein hedge fund servicing and their cost. AddsdeMercado: “Growth in the services sectorhas benefited not only administrators butfirms offering audit and legal services, andproviding structuring for hedge funds.”

The city’s broad-based financial servicesindustry is a ready source of qualified staffwith many of the skills required by the hedgefund sector. Says Sean Flynn, managing

director and head of UBS Hedge FundServices: “Toronto has a good supply ofqualified and experienced labour for the fundadministration business.

“There are already a number of playerswho have been active for many years in thetraditional fund administration business, aswell as a small but growing number ofhedge fund administrators, but there is alsoa skills pool coming from traditional businesswho can easily be retrained into the hedgefund business. There is a good supply ofaccountants coming out of the Big Fourprofessional services firms.”

According to a local adage, “Americanslove to make money and Canadians love toaudit it”, and McGovern says: “There is avery strong infrastructure here for managingand administering funds.” Mark Fieldhouse,director of technical sales and relationshipfor global products with RBC Dexia InvestorServices, notes that Toronto has one of thehighest levels of new Chartered FinancialAnalyst qualifications of any city in NorthAmerica.

Members of the industry note that whileToronto may look pricey to Canadian eyes, itis certainly competitive on cost with its rivalsfor hedge fund servicing business. SaysFelcom Data’s president and chief executiveKevin Beatson: “Toronto is expensive bycomparison with other Canadian citiesexcept maybe Vancouver, but from a globalperspective it can offer considerable savings.Any administrator in one of the offshore

O V E R V I E W


p7 ➧

island domiciles would find it profitable tooutsource back office work to Toronto.”

Adds McGovern: “Not only is this is a verycompetitive place for recruitment, things likewages and other staff costs, rental costs andoperating expenses are substantially lowerhere than in other jurisdictions. There’s alsoa level of comfort from the fact that there’s abigger infrastructure here in terms of thelegal and accounting professions.”

Toronto offers a very viable alternative toother leading financial centres, Fieldhousesays. “If anything it would be toward the lowend of the cost scale compared withalternatives in the US, although it has probablybeen affected by the strength of the Canadiandollar over the past 18 months to two years,”he says. “RBC Dexia has a global presenceand I would say Toronto is in the middle of thepack when it comes to cost structure.”

These factors are likely to encourage otherservice providers to follow the lead of UBSand look beyond the domestic Canadianmarket to broader opportunities throughoutthe Americas. Says Fieldhouse: “With thetrend on the part of institutional investors toadopt hedge fund or hedge-like strategies andthe overall institutionalisation of the hedgefund market, we can see Toronto growing asa key hub for all of North America. We expectthese trends to produce double-digit growthover the next one to two years.”

Depending on their specialisation andstrategy, providers differ on the importanceof the domestic market in boosting businessgrowth. For instance, it is not currently ahigh priority for UBS, which has alwaysconceived its Toronto operation asinternationally focused. Says Flynn: “At thispoint in time Canada is not a significantmarket. There is a growing hedge fundbusiness, but at the moment the majormarket is clearly the US, and that’s themarket we are looking to service.”

By contrast, the outlook for prime brokerslike TD Securities is rosy, according todeMercado: “We continue to see newbusiness and we’re always in dialogue withnew managers for new mandates,” he says.“We pick up a substantial amount of newbusiness based on our reputation in themarketplace and referrals from other clients,and I see no sign of it stopping any timesoon.”

The new business, he says, is comingfrom a combination of existing managerssetting up offshore funds, the growth inassets of managers that have beenperforming well, and the departure of tradersand analysts from established institutions toset up their own funds. “There’s no questionthat over the next 12 to 18 months we willcontinue to grow and to increase the rangeof services we offer to funds,” de Mercadosays, “and perhaps to a broadergeographical range of funds.”

Beatson believes that increasing numbersof managers outside Canada will add to theflow of business, even for administrators thatare currently focused mainly on the domesticmarket. Arguing that UBS’s decision to setup an administration business “speaks wellfor Toronto and where they see it going”, headds: “One of the great advantages that webring to the table is Toronto’s experiencedand educated workforce.

“We’ve seen that one of the ways we canmove forward in some of these offshoremarkets is providing back office services forsome of the administration companies there.They are dealing with the client directly asthe face of the relationship, but they have ashortage of skilled employees, so they canoutsource the actual work out to us. But wealso expect to see growth from theestablished domestic market too.”

The increasing international spotlight onToronto might bring more competition intothe market from the leading global hedgefund administrators, but Beatson argues thatthey may not have things all their own way.He says: “We’ve seen in the past that USservice providers have come to Canadawith the approach that they can set up asmall shop doing the same thing they doat home.

“Some of them have been through verydifficult times coming to terms with thedifferences between the two markets. Youfind that Canadian companies and theprofessionals working in them have,generally speaking, a higher level ofexposure to what’s happening worldwide,and Canadians are generally very wellversed in offshore product and what’shappening in that market. There’s a certainglobal awareness among Canadians that youmight not find in other places.” ■

O V E R V I E W


The opening of a new office in Toronto atthe beginning of March is the latest step byUBS to extend the scope and reach of itsHedge Fund Services division, which alreadyhas more than $108bn in assets underadministration, by complementing the group’sexisting hedge fund administration facilitiesin the Cayman Islands and Dublin and anoffice that is being considered in Asia.

The new office is located within the UBSbuilding in Toronto’s business district, takingadvantage of the bank’s existinginfrastructure alongside its investmentbanking, wealth management and assetmanagement businesses.

The Hedge Fund Services business inToronto has been able to hit the groundrunning, thanks to the presence of a numberof skilled hedge fund administrators involvedfrom the outset – including Canadians whohave been working in UBS’s Cayman officeand who have opted to relocate. That meansthe office is able to draw on an experiencedcore of employees who know how thebusiness model works.

Together with the facility in GrandCayman, which has a staff in excess of 130,the Toronto office offers a full range ofadministration services for hedge fund clientsthroughout the Americas. In addition tooffering an alternative, onshore location forthe administration of funds from the region, itwill also offer full business recovery andcontinuity facilities to cover for any disruptionin Cayman, which lies in the Caribbean’shurricane belt.

Toronto is a leading financial servicescentre in its own right and the centre of

Canada’s fast growing hedge fund industry. Ithas a strong concentration of corporateheadquarters and a full range of professionalservices businesses, and enjoys thewidespread availability of the accounting,audit and legal skills increasingly in demandby the hedge fund industry and the firms thatservice it.

Location of administration services is animportant issue for managers, many ofwhom prefer an onshore provider andappreciate being able to visit theiradministrator in a day’s round trip. Toronto isjust an hour’s flying time from the tri-statearea of New York, Connecticut and NewJersey, the largest single concentration ofhedge fund managers in the US, and closeto other financial centres on the east coast.For the time being most demand for theservices of the Toronto facility will come fromthe US, although in the longer term thedevelopment of the Canadian hedge fundindustry may also be a significant source ofbusiness.

With an established long-only fundadministration industry, a burgeoning hedgefund services sector and a significantpresence on the part of the ‘big four’professional services firms, Toronto is wellsupplied with qualified and experiencedpersonnel, especially in areas such asaccounting. Its cost structure is competitivecompared with other major centres for hedgefund services, and there is not the sameproblem of high staff turnover found in someparts of the US where hedge fundadministrators regularly are lured away bystart-up managers. ■

U B S


Serving the North American

market from TorontoBy Sean Flynn

Sean Flynn is managingdirector and head of HedgeFund Services at UBS

Until recently international investors paid littleattention to Canadian hedge fund managers,despite their impressive returns. Butincreasingly humdrum performance acrossthe border and the realisation that Canadianexpertise in the ever more important area ofresources investing is second to none havefocused the spotlight on alternativemanagers in Toronto and Calgary.

Even Canadians admit that the country’sfledgling hedge fund sector has beenovershadowed for most of its existence bythe alternative investments industry in itsgiant neighbour across the border. But now,just as Toronto is starting to attract attentionas a centre for hedge fund servicing,investors abroad are starting to cotton on tothe merits of the country’s managers.

Not the least of these suddenlydiscovered virtues is Canada’s role as acentre for mining and natural resources – a

characteristic that attracted little notice duringthe commodity price slump of the 1990s, butone that has suddenly assumed hugeproportions as soaring demand, particularlyfrom China, has put a rocket under theprices of both raw materials and thecompanies that produce or extract them.

For that, reason, although Toronto is theprincipal location for hedge fund managersin Canada, the second ranking centre isCalgary, the focal point of the vast country’sresources industry, with Vancouver a littlefurther behind and Montreal trailing in adistant fourth, according to Ronald Landry,executive vice-president and chief operatingofficer of hedge fund administrator andtransfer agent Felcom Data Services.

Says Landry: “Toronto is Canada’sfinancial centre, and because of its proximityto New York, the trends emerging there tendto be followed fairly closely. With the hedge

C A N A D I A N O V E R V I E W


Resources focus turns the spotlight on CanadianmanagersBy Simon Gray

fund market well established in the US,Toronto is leading the way in Canada. Otherprovinces are starting to pick up the pacenow, but they’re not moving forward asrapidly as Ontario.”

Landry says the resources boom hashelped to focus interest on Canadian fundsamong investors from Asia and Europe. Hesays: “We’re seeing investors from HongKong and elsewhere in Asia and to a certaindegree Europe recognising that a certainproportion of their portfolios should be here,and the greatest attention is on alternativeproducts that invest in the resources sector.”

In the case of European investors, it is stilla voyage of discovery, but one that is beingsignposted by a regular stream ofconferences and seminars organised inEurope by members of the Canadian hedgefund industry, especially prime brokers,according to Sarah Caygill, managingdirector of Arrow Hedge Partners (Europe),the Geneva-based arm of a leading Toronto-based fund of funds manager. “Theseconferences are raising awareness ofCanadian managers, Canadian talent, and aCanadian angle on producing high risk-adjusted returns, which they have done,” shesays.

“European-based investors are curious butdo not know the specificities of the Canadianhedge fund market, because it has longbeen overlooked. When most people from

Europe think about North America, it is moreor less exclusively US centres like New York,Boston and Chicago. The number of peoplewho will make it up to Toronto, let aloneother centres such as Vancouver or Quebec,is relatively small.

“Canada has a very attractive combinationof being relatively undiscovered anduntapped, but everyone now knows it’s thecentre for resources, which is a theme we’reall getting to grips with and that will be withus for years to come. As investors try tounderstand more about resources, they’rerealising it’s something that Canadians knowvery well, since it’s 30 per cent of theirmarket and mining is also very wellrepresented. Canadians are much moreknowledgeable in this area than the averageEuropean manager or investor.”

This expertise is a useful attribute wheninvesting not only in Canada but beyond –for instance in another resource-basedeconomy, Russia, where Arrow Hedge isalso active. Says Caygill: “In investing incountries like Russia, it’s much morechallenging to do the work and feelcomfortable with the investment, becauseyou’ve got to take on board the political risk,as well as understanding local regulation,which may be not as easy to understand asin Canada.”

She argues that the limited scale of theCanadian economy and market comparedwith the US has given the country’smanagers an additional advantage. “Theindustry is in its infancy in Canada, waybehind the US, although it’s catching up veryfast. There won’t be anything like theplethora of hedge funds in the US becausethe market is not so deep, but manyCanadian managers have an edge becausenot only do they know their own marketinside out, but they automatically have tofollow the US market, as their maincompetitor, very closely.

“US managers have a large enoughdomestic market to be able to focus just onthat. They don’t have that inside edge ofknowing the investment themes and specialfeatures of the Canadian market and sectors.For example, many of our managers can dovery interesting paired trades, by going longon a Canadian group and shorting a UScompetitor, depending on what the



➧ p18

Arrow Hedge Partners Inc. is an investmentmanagement company founded in 1999,specialising in providing hedged fund offunds strategies to high net worth investorsworldwide, and from uniquely regionalperspectives. Arrow Hedge is headquarteredin Toronto, with its research team coveringthe Canadian, US, Latin American and Asianmarkets. Based in Geneva, Sarah Caygillprovides additional research coverage from adistinctively European vantage point.

In addition to its strong global researchcoverage, Arrow Hedge has adopted aninvestment process that has capitalised onsome of the most innovative and dynamicdevelopments in alternative investments:early stage managers and strategies.Investing in early stage managers andstrategies represents the core to Arrow’sapproach.

Arrow Hedge firmly believes that earlystage managers are most compelling due totheir competitive return profiles relative totheir more established peer groups.Additionally, early stage managers havetremendous advantages in focusing on nichemarkets and investment styles.

For example, early stage managers havemuch more flexibility in managing smallerpools of capital, enabling greater tacticalmovement in to and out of their positions.This, in turn, is especially critical to Arrow’sasset allocation decision-making as earlystage platforms provide a means toprudently scale into underlying investments.

As well, the early stage focus alsorepresents a more efficient method – hencelonger-term allocations – in deploying capital,as Arrow’s investments are able to growalongside the underlying manager’s assets.

This focus on early stage investing hasalso compounded the importance of

thorough and rigorous due diligence on allunderlying investments. The due diligenceprocess is perpetual and designed tocapture the dynamics of our managers’investment as well as business ororganisational development.

Additionally, Arrow utilises a number ofproprietary risk tools for determiningindividual and aggregate level exposures andhas supplemented these with solutions fromBear Measurisk, enabling more robust riskmonitoring and measurement.

The investment model constructed byArrow’s research and investmentmanagement team is expressed throughspecific fund of funds portfolios, which aredesigned to suit different investmentobjectives and investor demands. Thesefund of funds are at the centre of Arrow’sbusiness model and are constantlymonitored and re-balanced.

Arrow manages two flagship fund of fundsfor its Canadian investors, one a multi-strategy product, which encompasses abroad spectrum of investment stylesincluding equity hedge, relative value, eventdriven and global macro, the other adedicated global equity long/short strategy.Arrow has mirrored this approach to itsoffshore investors as well through itsCompass and Voyageur funds.

The success of both the onshore andoffshore products is a testament to Arrow’sunique global research coverage andfocused investment process. Since inception,all funds have met their risk-return objectivesand have outperformed their respectiveindustry peer groups. ■

Jennifer Wood is a research analyst and amember of the investment committee andMark Purdy is chief investment officer withArrow Hedge Partners in Toronto.

A R R O W H E D G E PA R T N E R S


Global investmentmade in TorontoBy Jennifer Wood and Mark Purdy

characteristics and valuation are, or viceversa.”

Arrow Hedge is well placed to assess therelative qualities of Canadian managers andtheir counterparts abroad because the firmoffers investors funds of funds and selectedsingle manager funds drawn from bothgroups. Says director of research KeithTomlinson: “We visit managers globally, sowe don’t have to put any money in Canada,but we find excellent hedge funds here, soabout a third of our number of allocationsare to Canadian managers.”

Adds chief investment officer Mark Purdy:“The increased demand globally forCanadian hedge fund managers probablyhas a lot to do with the returns beingproduced by oil and energy, but anotherimportant factor is that, very much like in theUK, almost all managers are registered withtheir respective provincial securitiescommission. That means there’s a very goodlegal framework to operate within, on top ofthe advantages of a highly educatedworkforce and five big banks that providegood channels for distribution.”

The high degree of regulation and theimportance of bank distribution reflect thespecific characteristics of a market in whichretail sales of hedge products in the form ofprincipal-protected notes accounted foraround 25 per cent of all investment withCanadian managers, including offshore funds,funds of funds and managed accounts forpension schemes, at the end of 2004.

According to Lionel deMercado, managingdirector and global head of equity financewith prime broker TD Securities, the range ofstrategies followed by Canadian managers is

broadly comparable with those in othermarkets and include notably equitylong/short, long-only, convertible arbitrageand risk arbitrage as well as fixed-incomestrategies.

Among individual funds, he says, there area substantial number with assets of betweenC$20m and C$100m, rather fewer in the“bulge bracket” of C$500m-C$1bn, and ahandful with between C$1bn and C$2bn.DeMercado estimates that the industry nowprobably has more than 200 single managerfunds and total assets of around C$18bn,including funds of funds but not managedaccounts.

Arrow Hedge chief executive JimMcGovern, who also founded and heads theCanadian chapter of the AlternativeInvestment Management Association, arguesthat on the institutional investment side thereis a sharp dichotomy between the attitudesof the biggest pension funds, some of whichare experienced and enthusiastic investors inhedge funds and other alternative assetclasses, and smaller schemes that he saysare still reluctant to take the plunge.

He says: “The big government pensionplans and some corporate plans are verystrong in terms of knowledge andacceptance of alternatives in general. Five orsix very substantial plans are big buyers ofalternatives across the board and have longincorporated them into their investmentpolicy. However, the smaller endowment andpension schemes are not as keen on hedgefunds.”

One of the big hitters in the market is theOntario Teachers’ Pension Plan, which hasattracted headlines in recent weeks for itsforays into the private equity market and isone of the biggest allocators to hedge fundmanagers. Says Purdy: “One advantage ofToronto from an allocator’s standpoint is thatyou’ve got the Ontario Teachers’ Plan up theroad which has 150 hedge fund managers.You often get a lot of managers coming uphere from New York and London or evenAsia looking for capital.”

Managers and service providers agreethat two high-profile hedge fund collapseslast year have resulted in a hiccup for theindustry, although there is less consensus ofhow long the impact will be felt. Norshield,once one of Canada’s largest fund of funds



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managers with C$1bn in assets in mid-2004,collapsed into receivership last June, leavinginvestors as much as C$500m out of pocket.

Portus Alternative Asset Management wasplaced in bankruptcy on March 24, just overa year after the firm had its licencewithdrawn by the Ontario SecuritiesCommission following allegations of sales tounauthorised investors and failure to followthe firm’s stated investment policy. However,the firm’s 26,000-odd investors are likely toget much of their money back after thecourt-appointed receiver KPMG said it hadnow recovered all but C$17.6m of the nearlyC$800m placed in the Portus funds.

DeMercado is relatively sanguine aboutthe impact of the Norshield and Portuscases. He says: “Canada is no different fromany other jurisdiction. There’s always goingto be the odd bad apple that’s going tocloud the marketplace. All it does is to makethe regulators take a closer look at theindustry, and makes the big banks treadmore cautiously when offering the product ata retail level.”

Adds Mark Fieldhouse, director oftechnical sales and relationship for globalproducts with RBC Dexia Investor Services:“The impact has been minimal as far asgrowth in the segment is concerned. As withany other investment vehicle, it justunderlines that investors must completeproper due diligence and look at theproviders with which the hedge fund isdealing. Are they getting risk managementand prime brokerage services from areputable institution? This is an importantpoint with any type of investment.”

McGovern believes that the scandals mayhave affected the industry in the short term,especially at the retail level, but it should beable to shrug them off over time. “The solidsingle manager funds and funds of fundshave continued to take in capital from privateclients, so for those that understand what’sgoing on, it wasn’t really a big issue. Itaffected more the pure retail market wherethey were using structured notes to distributehedge funds to retail investors.”

He argues that the inevitable calls forgreater regulation of the industry aresuperfluous, since managers were alreadyregulated more closely than by the new USrules introduced by the Securities and

Exchange Commission in February. “Anyonemanaging money in this country and offeringtheir services to the public has to beregulated, which covers continuous reportingdisclosure regimes, capital requirements,proficiency requirements and so on. We’reahead of the US on a lot of issues.”

According to Landry, one importanceconsequence of the scandals is that hedgefunds have embraced a significantly higherdegree of transparency. He says: “Setbackssuch as Portus certainly impacted themarketing side for alternative products,although there still is an appetite for them. It’sdefinitely impacted sales, and it will probablytake a little while before sales of hedge fundsin Canada continue their upward trend.There’s a certain level of confidence thatinvestors need to have restored.

“What you’re seeing as a result ofsituations like Portus is that alternativeproducts are elevating their level ofdisclosure to investors. Investors are movingtoward the greater transparency offered byprospectus-based funds. This includesnotably the history of the principals that areinvolved, to ensure that there isn’t a risk thatmoney will go offshore and never make itback. Managers who are not ready to facethat kind of question will not get theirproduct to market.”

Landry argues that it may take more timebefore the market emerges from its currenthiatus. “The market for domestic consumptionof hedge fund products is in a lull, but that willebb as things are clarified with Portus,” hesays. “Over the next year or so there will begrowth, although it will be slower than in 2004.As people become aware of the increasedtransparency of these products, the market willstart to rebound. It’s just a matter of howeasily confidence can be restored.”

McGovern believes the rebound will befelt as early as this year. “We’re going to seea surprising level of growth,” he says. “Thereis a lot of international interest in the market,and at home the banks, who really are thedrivers of financial services growth, willwarm up to alternatives even more. Inaddition, we expect to get a bounce offPortus and Norshield as the problems fadefrom public attention, and some of thedeferred investment from last year will startto come in. It should be a very good year.” ■



Founded in 1999, Felcom Data Services provides quality Administration, Fund

Accounting and Transfer services.

Over 100 products including many domestic and offshore alternative products

depend on Felcom Data Services for efficient and cost-effective fund services.

With our team’s diverse background, we have the skills and expertise needed

to meet a wide variety of fund services needs.

Call 416.365.4370 to see how Felcom Data Services can help you spend more

time selling.

Your time is money.

SERVICING YOUR FUNDSSHOULD NEVER KEEP YOU FROM SELLING YOUR FUNDS.

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t 416 365 4370

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Québec, QC G2J IE2

t 418 688 2080

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Created to meet a burgeoning need forproviders of third-party fund services to start-up alternative managers, over the past fouryears Felcom Data Services Inc. has carvedout a client base and its own specialistexpertise in a highly competitive Canadianmarket today fought over vigorously by ahandful of very large international companiesand a number of smaller domestically-oriented providers.

Felcom Data, a subsidiary of JovianCapital Corporation, is a third-party providerof fund accounting and transfer agencyservices to fund companies with bothonshore and offshore offerings. Alternativeproducts such as capital protected notes andhedge funds represent the firm’s core activity,accounting for around three-quarters of itsbusiness, although it also handles someplain vanilla mutual funds, pooled funds andprivate accounts.

The services offered by Felcom Data varyaccording to the exact needs of the client.For managers that require a full-serviceprovider, the firm can deliver a range ofmanagement administration services rangingfrom assistance in the writing of offeringdocuments – most of the funds arememorandum-based – to ensuring thatregulatory filings are carried out promptlyand accurately.

At this level of service, Felcom Dataeffectively takes over the administrativefunctions of the firm in order to allow itsprincipals to avoid becoming overwhelmedby the burdens of corporate functions, animportant consideration for start-up fundmanagers whose priorities are likely to be tofocusing on investment management andfund-raising.

This focus on the requirements of start-

ups reflects some of the considerations thatprompted the creation of Felcom Data justover four years ago. The firm was born outof the need for a provider in the Toronto areaspecifically to serve smaller fund managers,who found that many of the existing serviceproviders imposed onerous minimum assetlevels for new managers.

Initially, Felcom Data was conceived as anin-house provider to service a particular setof offshore funds, but the business quicklyevolved into providing similar services forfund managers with close connections oraffiliations. This led to the decision tobecome a completely independent third-partyservice provider. The 2004 acquisition of asimilar service provider in Quebec City hasenabled Felcom Data, which now has a totalof around 35 staff, to expand its business toCanada’s francophone community and itsmaritime provinces.

The growth of Felcom Data has beenboosted by the fact that many larger fundservice providers are unwilling to take onproducts that do not meet their criteria forbeing of a minimum size or very standard intheir design. While such firms often lack theflexibility to accommodate the uniqueness ofeach product they administer, Felcom hasmade it the focus of its business and mostimportant differentiating factor.

This approach has attracted new businessfrom throughout Canada and some leadingoffshore hedge fund centres through referralsfrom within the Jovian group and via word ofmouth through recommendations fromexisting clients and industry contacts. Manynew clients are fresh start-ups whose firstrequirement is to understand the processand potential pitfalls involved in getting aproduct to market. ■

F E L C O M D ATA S E R V I C E S


Reaching out tostart-up managers

By Kevin Beatson and Ronald Landry

Kevin Beatson (above) ispresident and chief executiveofficer and Ronald Landry(below) is executive vice-president and chief operatingofficer with Felcom DataServices in Toronto andQuebec

apr 2006 toronto hedge fund services 2006 · hedge investment activity. there’s certainly a great...

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