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Short positions key to sidestepping turmoil

Hedge funds are supposed to make money when the markets rise and when they fall. Unfortunately, it’s easier said than done. Andrew Allentuck speaks to three managers of Canadian hedge funds on how they made money in a tough market last month.

Globe and Mail – Tuesday, September 11th 2007


YTD return: 11.2%
1 year: 6.1%
Three year: 14.8%

The Hillsdale Canadian Long/Short Equity Fund took large enough short positions in August to neutralize the funds from market declines.

The $101.9-million fund went into August net 57 per cent short and ended the month with a 1.3-per-cent return, preserving its 11.2-per-cent year-to-date return to the end of August.

Arun Kaul, chief operating officer of Hillsdale Investment Management Inc. in Toronto, said his fund sold short such names as Heritage Oil Corp. which had begun to post negative cash flow, and TriStar Oil and Gas Ltd., which he thought would be unable to maintain earnings momentum.

He held long positions in tree grower Sino-Forest Corp., auto parts maker Linamar Corp., Anvil Mining Ltd. and Manitoba Telecom Services Inc. The fund remains about a third short, a less pessimistic position than it held in August.

At the end of August, Mr. Kaul’s shorts included TSX Group Inc. and Quebecor World Inc. The longs include Suncor Energy Inc. and Westjet Airlines Ltd.

“We took positions fundamentally different from other hedge funds that were long subprime loans,” Mr. Kaul said. “When credit market problems arose, equity markets sank because the investment banks were on the same side as the hedge funds. There was no one left in the market to buy packages of bad loans. Balancing longs with shorts worked in a bad month.”


YTD return: 23.1%
1 year: 19.7%
Three year: n/a (founded 2006)

Otto Spork, who heads Sextant Capital Management Inc. in Toronto, came in at the head of the class of Canadian hedge fund managers in August. His Sextant Strategic Opportunities Fund, a $17-million hedge portfolio, gained 10.3 per cent in August in comparison to the 2.9 per cent loss of the median alternative strategies fund in the month.

What drove Mr. Spork’s return was a series of short positions. The fund sold the Canadian dollar short in mid-July at 96.50 cents, then covered the positions at 92.50 cents, realizing a tidy gain. In July, the fund had also raised cash to as much as 85 per cent of total asset value.

“We were concerned back in May that the markets had had a big run and we believed that we were due for a correction,” Mr. Spork said. “We sold our positions in commodities, taking large profits in uranium, molybdenum, zinc, silver and nickel.”

As of the end of August, the fund had eliminated its short positions, Mr. Spork said. He is back into long positions on commodities. Recently, he bought natural gas at $5.50 (U.S.) per million cubic feet and silver at $11.50 per ounce. As well, the fund has put 30 per cent of total asset value into companies that are in the water cleaning business.


YTD return: 40.4%
1 year: 37.1%
Three year: 14.3%

Anticipating the popping of the credit bubble in the United States helped the $62-million CI Trident Global Opportunities Fund to generate a 12.5 per cent positive return for August, according to a company spokesman (CI noted the fund is not valued daily.)

How did CI Trident do it? By shorting selected areas of the credit markets, said portfolio manager Nandu Narayanan, chief investment officer of the subadviser, Trident Investment Management LLC in New York.

“First, we were short asset backed commercial paper and subprime loans,” he said. “Those shorts produced positive impacts on our net asset value. Second, we were short on credit default swaps [debt insurance that loses value when there are defaults]. Third, we shorted U.S. mortgage insurers such as Radian Group Inc. and MGIC Investment Corp., whose stocks collapsed in the month. Over all, our bets that companies holding debt would see their shares fall generated about 65 per cent of our return in August. Year to date, these strategies have produced a 30-per-cent gain.”

Mr. Narayanan is still holding his shorts, he said. He sees two crises ahead. The first is a continuation of the housing disaster that developed from speculative house flippers who did not even have money for down payments. The second is an unwinding of complex credit derivatives built on other derivatives.

“It is speculative excess on mathematical steroids,” he said. “Asset-backed commercial paper created mismatches on length of loan and length of borrowing. It was a classic case for a collapse.”