2004-08-01 Canadian Investors Embrace Alternatives Profit & Loss Although Canada rarely features as one of the world?s major markets ? its proximity to the US would appear to preclude such a perception ? there are areas of the financial industry that are leading the world in its forward thinking. One such area is investing in the alternative investment industry, where funds such as Ontario Teachers? Pension Plan (OTPP) and Caisse de Depot et Placement du Quebec (Caisse) have led the way in embracing the hedge fund industry. Certainly the viewpoint from both within and without Canada is that the country remains an area of opportunity for the hedge fund community. "In many regards ? when it comes to investing in alternatives ? the big pension plans in Canada have led the way," suggests Ted Parkhill, vice president, marketing at Florida-based John W Henry & Company, Inc. (JWH), one of the largest and oldest managed futures advisors. "Certainly these plans have been far in front of their equivalents in the UK and even some in the US, where only a few pension funds have exposure to this sector." JWH is one of the few offshore managers to gain official registration as a commodity trading manager (effectively an investment advisor) in Canada, becoming registered under the Ontario Commodities Futures Act in April 2004. It has been something of a long drawn out process to gain registration, but Parkhill stresses the firm?s commitment to Canada. "We have existing Canadian business and demand continues to grow from there," he says. "We are still defining our marketing strategy and approach because it remains early days, therefore we have not leveraged our status, but we are very committed to Canada and committed to working with local firms to develop business and offer Canadian clients alternative products. "We see this move as an opportunity to expand our product and geographical spread and if you are going down this road it makes sense to be officially registered," he adds. JWH?s move is not the only indication of the level of interest in the hedge fund industry. The growing interest in alternatives in Canada led in March 2003 to the formation of a Canada chapter of the Alternative Investment Management Association (AIMA). Gary Ostoich, partner in the hedge fund group of McMillan Binch and a member of the executive committee of AIMA Canada, explains that the chapter was formed (initial planning and implementation of the chapter by Ostoich along with Jim McGovern at Arrow Hedge and David Jarvis at Blair Franklin) with the idea of bringing forward the alternative industry in Canada. "We started with 12 founding members and the ambition to educate the investment community of the value that a portion of an investment portfolio in alternatives can offer," he explains. "We now have over 50 corporate members, which makes us one of the bigger chapters in AIMA globally with a good representation of managers, institutional investors and service practitioners. " AIMA Canada?s membership reflects the wide interest in the alternative industry, boasting committed institutions, meaning that in its educational role it can offer a wide programme. Ostoich explains that the education committee holds a series of seminars at which leading luminaries from the investment industry from within and outside Canada address members. "Our events have helped drive interest in the industry and raise awareness of issues on all sides and have been very well supported," he says. "We have also supported these seminars with written educational material such as our Sound Practices guide, in which we effectively Canadianized AIMA?s European document, as well as the Hedge Fund Primer which was issued in June (see sidebar). " Comparisons and Opportunities Although on the face of it, a diversification into alternative investments would appear prudent, clearly there are many real money managers in the world who do not see it that way. As noted earlier, managers in the UK are proving slow to adopt hedge funds, as are many in the US. Parkhill suggests that this is mainly a result of culture, as well as the fact that unlike the Canadian firms, these managers have not experienced the benefit of improved performance results by being exposed to alternatives during a bear market. "The problem in the US is very much about consultant control ? the pension funds employ consultants who are reluctant to embrace alternatives for a variety of reasons, primarily that they see volatility as risk," he argues. "In Canada and the US, the big plans have employed internal staff who have conducted due diligence and understood that allocation to managed futures programmes and volatility products creates an effective asset allocation mix," he continues, reinforcing the point. "This is not the case with many consultants ? possibly due to perceived fiduciary responsibilities ? but once investors understand the nuances, as they did in Canada, they come around in a big way and the potential result is enhanced performance for all concerned." There is another factor involved in JWH?s decision to move to offer its programs in Canada, one that also plays a role in the work conducted by AIMA Canada. "A big part of our product distribution in the US is effectively retail," explains Parkhill. "We advise funds who deliver product to brokers, who in turn market these to their retail base of investors. We believe that in Canada there exists tremendous potential for similar retail business and our registration means we have the potential to create solutions specifically aimed at the Canadian market place. We will take these products, and, working with local institutions, build upon the success we have had in the US." As far as AIMA is concerned, the retail approach can be split into two areas ? the ?real? retail, those who would normally buy mutual fund products, as Ostoich terms it ? and high net-worth retail. "There are a lot of firms bringing product into Canada aimed at the high net-worth individual," he points out. "But the big issue for many firms is cracking the ?real? retail. The biggest progress to date has been through the issuance of principal-protected notes, but when it comes to offering a mutual fund type service for alternatives, problems arise." These problems primarily revolve around prohibitions put in place by the provincial authorities (Canada does not have a Federal system of oversight) over issues such as short selling and the use of derivatives. "Normally investors have to get relief from these restrictions, which can be a difficult and time-consuming process," Ostoich explains. "This is an area where AIMA Canada is working hard to deliver educational resources and material that will hopefully help to deliver a solution." There would appear to be a lot that can be learned from Canada?s experience thus far in embracing alternative investments ? and many in the industry are firmly of the belief that even Canada has barely dipped its toe in the water. Parkhill points out that Canada?s population is roughly equivalent to an economic powerhouse ? the state of California ? and as such, a huge potential investment pool remains largely untapped by the industry. Ostoich says that the institutional side of the market has been for the most part going down the fund of funds route in terms of their initial investments in alternatives, something that is very much a matter of testing the waters. "We see great potential for this process to expand to include multi-strategy managers and investment in a basket of single strategy managers," he says. "However progress will be cautious because the investors have to convince and educate the oversight committees of the approach?s value." Evidence of the forward thinking approach to alternative investments on the part of Canada?s big pension plans was provided by Daniel MacDonald, portfolio manager, alternative investments, for OTPP, recently at the Managed Funds Association Forum 2004 conference in New York. MacDonald told delegates that OTPP learned many lessons from its eight years of investing in hedge funds ? initially in fund of funds but then directly into hedge funds in 1998. Chief among these lessons, he said, was the value of diversification into areas such as managed futures which provided a long volatility exposure that tends to kick in when the fund most needs it ? to cover losses in its more traditional long-only investments. MacDonald also explained that OTPP works closely with its selected managers. "We guide managers as to where we feel we are under/over weight, and view all direct investments as a strategic partnership," he said. "This requires good two-way information flow which means that the managers themselves ask us about us ? which is very good as it raises transparency and understanding." There is much debate in the US about the real/leveraged money divide, specifically whether it is, or should, narrow to the point of extinction. Many of the answers, it seems, can be found north of the border in Canada, where the alternative industry is enjoying a boom. That firms such as JWH are determined to move into Canada demonstrates the country?s potential and this initial trickle of interest could develop into a torrent if the initial signs are good. Allied to this is a burgeoning domestic hedge fund industry. "At McMillan Binch we are seeing two to three Canadian hedge fund firms opening up per month," says Ostoich. "This is a reflection of an industry that is experiencing good growth, not only in Ontario, but in places such as Quebec and British Columbia also."