FORECASTING BEYOND THE CREDIT CRISIS – REVISITED QUARTERLY REVIEW OF HEDGE FUNDS & ALTERNATIVE INVESTING JULY 2010 VOLUME 10 ISSUE 7 CANADIAN INCOME TAX TREATMENT OF DERIVATIVE GAINS AND LOSSES HIGHWATER DIVERSIFIED OPPORTUNITIES FUND PEOPLE ON THE MOVE OLYMPIAN L/S EQUITY FUND, L.P.
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FORECASTING BEYONDTHE CREDIT CRISIS – REVISITED
Q U A R T E R LY R E V I E W O F H E D G E F U N D S & A LT E R N AT I V E I N V E S T I N G JULY 2010 VOLUME 10 ISSUE 7
CANADIAN INCOME TAX TREATMENT OF DERIVATIVE GAINS AND LOSSES
HIGHWATER DIVERSIFIED OPPORTUNITIES FUND
PEOPLE ON THE MOVE OLYMPIAN L/S EQUITY FUND, L.P.
www.canadianhedgewatch.com
Performance SummaryJune2010
YTD
CHW HEDGE FUND INDICES (CHW-HF) % %
CHW-HF Composite Index -1.12 -1.52
CHW-HF Equity Hedged Index -1.33 -1.87
CHW-HF Notes Index 2.92 2.02
CHW-FOHF Index -0.33 0.70
Scotia Capital Canadian Hedge Fund Index
SC CDN HF Index Asset Weighted 0.42 3.90
SC CDN HF Index Equal Weighted -0.60 1.16
CSFB/Tremont Hedge Indices
CSFB/Tremont Hedge Fund Index -0.84 -2.76
Convertible Arbitrage 0.01 -2.51
Dedicated Short Bias 5.45 5.84
Emerging Markets -0.03 -4.28
Equity Market Neutral -0.99 -3.30
Event Driven -1.58 -3.07
Distressed -1.10 -2.50
Event Driven Multi-Strategy -1.97 -3.53
Risk Arbitrage 0.10 -1.52
Fixed Income Arbitrage 0.92 -0.79
Global Macro 0.56 -0.63
Long/Short Equity -2.07 -4.13
Managed Futures 0.42 -4.03
Multi-Strategy -0.81 -2.19
GLOBAL HEDGE FUND INDICES
Hennessee Hedge Fund Index -1.35 0.20
HFRI Fund Weighted Composite Index -0.86 -0.21
HFRI Equity Market Neutral Index -0.71 -0.69
HFRI Fund of Funds Composite Index -0.70 -1.03
MARKET INDICES
MSCI World Index (C$) -1.51 -8.53
MSCI World Index (US$) -3.93 -9.55
MSCI Emerg Markets Free Index (C$) 1.21 -4.97
Dow Jones 30 Industrial Average (US$) -3.58 -6.27
NASDAQ Composite Index (C$) -4.73 -5.99
NASDAQ Composite Index (US$) -6.55 -7.05
S&P 500 Total Return Index (C$) -3.39 -5.59
S&P 500 Total Return Index (US$) -5.24 -6.65
S&P/TSX Composite Index Total Return -3.98 -3.85
Canadian Hedge Watch IntroducesNew Magazine
Canadian Hedge Watch is proud to introduce a new addition toour family of unbiased news and reporting vehicles. We welcomeCanadian ETF Watch magazine, launching soon. Along with thisnew addition we will be incorporating the quarterly newsletteralong with the monthly issue as one comprehensive guide toinvesting and forecasting the trends and environment surroundingthe alternative investment space.
In this month’s CHW issue we explore several key areas of thefinancial sector that are developing within the alternative space.Interviews with two of Highwater Capital Management’s keyplayers; Ara Nalbandian, CFA Portfolio Manager and Matt Manara,Regional Sales Manager, as they walk readers through an in-depthlook into Highwater’s approach to investing in their hedge fund.
An interview with Michael J. Levas from Olympian Capital L.L.C.in Fort Lauderdale, Florida, gives you an account of how theysuccessfully analyse and manage their funds while digging deepinto their investment process and their approach to riskmanagement. Michael further explains his outlook on the marketsand forecasts future trends.
Stan Maj of Ernst & Young LLP looks at the Canadian Income TaxTreatment of Derivative Gains and Losses. Providing guidance totax auditors and digging deeper into the four recent interpretationsfrom Canada Revenue Agency (CRA) will give you an insight intoCRA’s assessing practices regarding derivative financial instruments.
Philip Niles from Butterfield Fulcrum forecasts beyond the creditcrisis, revisiting the four-part series from 2009 concluding thatthere were more difficulties yet to come in the equity markets.He looks into the changes that have occurred since last year andfinds some new evidence suggesting that we may be moving inthe right direction.
Whatever 2010 holds for the industry, fund managers willcontinue to demand ever-more sophisticated services andtechnology from their service providers.
Canadian Hedge Watch appears live onBNN – Business News Network each month.
Tony Sanfelice, PresidentCanadian Hedge Watch Inc.
Volume 10 Issue 7 - July 2010 1
F E A T U R E S
Forecasting Beyond the 2Credit Crisis – RevisitedPhilip Niles, Butterfield Fulcrum
Canadian Income Tax Treatment 4of Derivative Gains and LossesStan Maj, Ernst & Young LLP, Toronto
Highwater Diversified Opportunities Fund 6Ara Nalbandian, Highwater Capital Management
People on the Move 8Matt Manara, Highwater Capital Management
Olympian L/S Equity Fund, L.P. 10Michael J. Levas, Olympian Capital Management LLC.
Around The Hedge 12
2010 Calendar of Events 52
D A T A
Hedge Fund Performance Tables Q2 18
Graphs and Tables Related to Asset Size 28and Distribution of Canadian Hedge Funds
Number of Hedge Funds Reporting 28Number of Hedge Fund Managers Reporting 29Hedge Funds Reporting Assets 30Hedge Funds Assets Under Mngment. (AUM) 31Hedge Fund Asset Change 32Distribution of Canadian Hedge Funds by Asset Size 33Reported Canadian Hedge Fund Assets by Fund Manager 34Average Asset Size of Canadian Hedge Funds Over Time 35Monthly Average Return (Equally Weighted) 36Distribution of Returns in the most recent Quarter 37Distribution of Monthly Average Return 38
(Equally Weighted, since December, 1994)Quarterly Average Returns (Equally Weighted) 4112-month Rolling Standard Deviation (annualized) 42
Performance Comparison: 43Canadian Hedge Funds vs. Major Indices
Commentary 43Comparison of Returns 44Efficiency and Calendar Year Returns 45Correlation Matrices 46
Canadian Hedge Funds Introduced in the Last Quarter 47
Canadian Hedge Fund Indices – June 2010 49
Contact InformationCanadian Hedge Watch Inc.20 Toronto St., Suite 820, Toronto, Ontario M5C 2B8 tel: 416.848.0277 ext. 2269 toll free: 1.877.249.9249 fax: 416.848.0278Editorial, Media & Advertising: [email protected] Subscriptions: [email protected]
Canadian Hedge Watch is published 11 times per year by Canadian Hedge Watch Inc. We welcome articles, suggestions and comments from ourreaders. All submissions become the property of Canadian Hedge Watch Inc., which reserves the right to exercise editorial control in accordance withits policies and educational goals.
DisclaimerCanadian Hedge Watch (CHW) presents news, information and data on both Canadian and Global alternative investment activity. The information presented is not to betaken as an endorsement, investment advice or a promotion for the organizations and individuals whose material and information appears in this CHW publication or onthe Canadian Hedge Watch website.
The material presented, separate from paid advertisements, is for the sole purpose of providing industry-specific information. As with all areas of financial investing, CHWrecommends strongly that readers should exercise due diligence by consulting with their investment advisor or other trusted financial professional before taking any actionbased upon the information presented within these pages.
C O N T E N T S
J U L Y Q U A R T E R L Y
www.canadianhedgewatch.com2
Phil Niles
re-examines where
we currently stand
on credit crisis
Philip NilesButterfield Fulcrum
Forecasting Beyond theCredit Crisis – Revisited
As the keen reader may recall, I did a four-part series in Canadian Hedge Watch approximately oneyear ago which sought to extrapolate beyond the then current market conditions using three keymetrics: the Dow/Gold ratio, the stock market Price/Earnings ratio, and the current level of themoney supply. Given that many seem to feel that we have moved beyond those gloomy days,I thought it would be worth re-examining where we currently stand using these same three metrics.What do these three statistics now indicate, with the benefit of an additional twelve months of dataand a healthy dose of further perspective? We will begin with a quick refresher of those metrics, howthey are to be used, and what they can indicate about the direction our markets are heading.
Our Metrics Re-IntroducedThe Dow/Gold Ratio – defined simply as the ratio of the Dow Jones Industrial Average to the priceof gold in the spot market. It has long been seen as one of the most sought after indicatorspertaining to relative value in the market. As we have seen over the past year in a variety of theworld’s major currencies, holdings in cash can come in and out of vogue and, by extension, thevalue of the currency can fluctuate as much as stock markets in general. This generally will shiftthe focus in and out of gold.
The Price/Earnings ratio – probably the most famous financial metric, the P/E ratio is arepresentation of what price must be paid per dollar of earnings in the underlying investment. In thisexamination, we will be using the Dow Jones Industrial Average as the underlying proxy for themarket as a whole. Frequently, the level of the stock market’s P/E ratio can be used as a descriptivestatistic pertaining to investor confidence; in good times, investors are willing to pay more for stockmarket earnings based on the perception that the good times will keep on rolling. Of course, theopposite must hold true in down times and hence why the P/E ratio can act is a good proxy formarket exuberance.
The Money Supply – very generally, the money supply is the total amount of money held throughoutan economy at a particular point in time. The basic definition involves two major components: thetotal currency in circulation as well as “demand deposits”, or the amount held in current accounts.In this example, we will be using M1 as the definition of the money supply, given its lengthy trackrecord of calculation as well its simplicity.
Our Examination ReprisedWe begin with the Dow/Gold ratio. From the initial examination, we found that underlying secular bearmarkets usually ended with a Dow/Gold ratio somewhere around 5, with the very bottom in the early1980’s being around 1. At the time of writing last year, the Dow/Gold ratio was calculated as follows:
Closing level of the Dow Jones Industrial Average 9,015.10The Price of Gold (US $/oz) $843.15Dow/Gold Ratio 10.69
If we fast forward to the end of June 2010, we are faced with the following figures:
Closing level of the Dow Jones Industrial Average 10,434.17The Price of Gold (US $/oz) $1,239.74Dow/Gold Ratio 8.42
Volume 10 Issue 7 - July 2010 3
So from the above comparison, we can see that the Dow/Gold ratio hasdropped, and indeed it has dropped by more than two full points to restaround 8.42. Most noticeably, and not unsurprising given the weaknessseen in the currencies of the world, the price of gold has risendramatically. While this revised ratio would certainly lend credence to thenotion that we are nearing the bottom of a secular bear market trend,history would indicate that we are still not quite through. To reach a ratioof 5, we would need to see the Dow Jones Industrial Average drop toaround 6,200 (assuming gold prices hold steady) or see the price perounce of gold rise to more than $2,000 (assuming a similar absence ofchange in the Dow). Even more noticeable changes would have to occurto get us down to the all-time low from the early 1980’s. As mentioned inthe original study, it would likely be a combination of the two that wouldbring about a lower ratio, but regardless of whether you are a stockmarket bear or a commodity bull, history is calling for further change.
The price/earnings ratio of the Dow Jones Industrial Average is similarlytelling. To recap, at the time of writing the initial article, the Dow wassporting a P/E ratio slightly in excess of 13. As of the end of June 2010,the Dow is reflecting a P/E ratio of approximately 15.6. The potentialreasons for this increase in the P/E ratio are many: heightened consumerconfidence in the future of the markets, a return of capital to the marketsfollowing the credit crisis, and a decrease in DJIA earnings are all potentialfactors. The important thing to note is that, regardless of the reasons forthe change, the ratio has actually increased. From our previousexamination from 2009, we found that the bottom of the secular bearmarkets in recent history featured a P/E ratio on the Dow Jones IndustrialAverage that was less than 10, even as low as approximately 5. This is afar cry from where the market currently stands and, to be sure, it is strikingthat the P/E ratio has actually increased over the last year.
The money supply is our third metric for study in this examination and,perhaps, the least understood. If you recall from the study of a year ago,we do not particularly care about the absolute level of M1, but rather theyear-over-year change in the level of M1. Most will not be surprised tolearn that the absolute level of M1 has risen dramatically over the lastyear or so. In an effort to stimulate the economy, the powers that be in theUnited States have released a great deal of cash into the market to easythe liquidity concerns that have been such a plague. But where does thatleave us with respect to the underlying secular market trend? Recall thegraph from 2009:
Figure 1: Change in the Level of the Money Supply (M1) 1959-2008
Source: The Author (2009)
We identified that the secular bull markets began with peaks in M1 whilesecular bear markets began with troughs. As such, if the currentdifficulties in the market were coming to an end, we would expect M1 tobe at a peak. Furthermore, we can see that the annual rate of change atthe end of the examination period was however around 0%, but onecould perceive a general upward shift.
Without further ado, this author can confirm that the US Federal Reservereports the annual change in M1 from May 2009 to May 2010 to be 7.0%.Certainly this is an increase from what was observed last year, but it is notnecessarily at the peak one might expect. The figure of 7.0% isapproximately what was witnessed in the early 2000’s in the effort tocounteract that economic downturn, hardly a standout peak for thestatistic. Early in the 1980’s, at the close of the last secular bear market,the annual change in M1 hit double digits. Though the secular bearmarket before that one featured a high single digit annual change in M1,it would be reasonable to expect a figure higher than 7.0% to signal theend of the current secular bear market.
ConclusionThe four-part series from 2009 concluded that there were more difficultiesyet to come in the equity markets, using the Dow Jones Industrial Averageas a market proxy. Using the same three metrics (the Dow/Gold ratio, thePrice/Earnings ratio of the DJIA, and the change in the level of the moneysupply), the revised examination performed with current data seems toindicate that we are not out of the proverbial woods just yet. All threeratios, when taken together, seem to be indicating a general move in theright direction towards the end of the current secular bear market, howeverthe movement has not been especially pronounced. In fact, as mentioned,the P/E ratio has actually moved in the opposite direction. As a final tellingstatistic, reprinted below is the table from the original study outlining thelast six secular market trends, their average returns, and their durations:
Table 1: Dow Performance During Secular Bull and Bear Markets
Source: The Author (2009)
From the above table, we can see that the average duration of the lastthree secular bear markets has been a lengthy eighteen years. Eighteenyears. Given this fact, and the previously presented statistical analyses,it would seem optimistic to expect the current trend to be alreadyreaching its conclusion. Really, taking this average duration, we would beonly just passing the half-way point of the current secular market trend.Without a doubt, there will be bull markets for equity participants to enjoyover the coming years, but the trend seems to be clear: we have got somedistance to go yet.
Canadian Income TaxTreatment of DerivativeGains and Losses
Four recent Interpretations from the Canada Revenue Agency (the “CRA”) have provided insight intothe CRA’s assessing practices regarding derivative financial instruments.
These internal Interpretations were issued in March and April of 2010 by the Income Tax RulingsDirectorate of the CRA. They provide guidance to tax auditors on assessing practices for gains andlosses arising from settlement of foreign exchange contracts used for hedging purposes. The issueconsidered was whether the gains and losses should be on account of income or on account of capital.
The four Interpretations address similar fact situations, but for different taxpayers. They arenoteworthy because they include a lengthy analysis and discussion of the issues.
Each taxpayer had used short-term foreign exchange contracts to hedge its exposure to foreignexchange fluctuations on its net investment in foreign subsidiaries. The contracts were rolled overregularly as they matured in order to maintain the hedge. The CRA concluded that income treatmentwas appropriate. The guidance summarized in these Interpretations would likely be extended by theCRA to other situations where derivatives are used to hedge foreign exchange risk, such as thatrelated to a foreign currency denominated investment portfolio held in an investment fund.
Several key court decisions that have considered this issue are referred to in the Interpretations.Though different shades of interpretation are always possible, the CRA’s application of thesedecisions to the particular facts appears reasonable.
A widely-accepted principle is that income treatment is appropriate for gains and losses onderivatives. The reason is that these financial instruments are speculative by their very naturebecause they produce no income, and a taxpayer can only profit by resale or settlement. At thesame time, the courts have concluded that the gain or loss from a derivative instrument that is usedto hedge a capital transaction should also be on capital account. The difficult issue is determiningwhen a derivative should be treated as a hedge for these purposes.
Volume 10 Issue 7 - July 2010 5
In order to constitute a hedge there must be sufficient inter-connection orintegration between the derivative instrument and the underlyingtransaction. The CRA states that a requirement for capital treatment is anactual or anticipated sale of capital assets. In other words, there must belinkage between the derivative and an underlying transaction rather thanmere linkage to capital assets and liabilities. In ideal circumstances thederivative instrument would be matched perfectly to the foreign currencyexposure both in terms of amount and timing. In the real world, however,circumstances are rarely ideal. The amount of the exposure typicallychanges more frequently than derivative contracts can practically beadjusted. Timing of crystallization is often either uncertain, or derivativecontracts are not commercially available for the anticipated duration.There is no clear answer to the question, “How close is close enough?”
The courts have found that the taxpayer’s intention when acquiring an assetis a relevant factor when deciding whether income or capital treatment isappropriate. Acquiring a derivative instrument with the intention of hedgingforeign exchange exposure related to a capital asset supports capitaltreatment, but intention alone is not sufficient. If it is found that theacquisition was speculative, or a transaction to dispose of the underlyingcapital asset is not foreseeable, income treatment may be appropriate.
The CRA has an administrative position that permits taxpayers enteringinto foreign currency futures contracts to elect capital treatment as a“speculator” when doing so does not form part of the taxpayer’s businessoperations. Unfortunately, the CRA has decided not to extend thisadministrative position to investment funds.
Generally accepted accounting principles contain rules related to hedgingthat govern when a derivative instrument should be treated as a hedge foraccounting purposes. The CRA stated, and the courts generally agree,that accounting treatment does not determine tax treatment.
Tax uncertainty may be a greater problem for a fund manager than wouldbe posed by either income of capital treatment. From the fund manager’sviewpoint it may not matter whether the derivative contracts generategains or losses, or are on income or capital account, so long as they fulfilltheir purpose of providing a hedge against currency fluctuations. Fromthe CRA’s perspective it is relatively easy to challenge the treatment takenfor a particular fund because there is no bright-line test, and thecircumstances rarely point clearly in only one direction. Of course, it canbe expected that any CRA challenge will be most aggressive when anassessment will yield additional tax revenue for the fisc.
Fund managers need to be aware that this issue is gaining greater profilewithin the Industry and with the CRA. Steps should be taken to reducerisk and uncertainly. Offering documents and other public informationshould clearly state the manager’s intention when derivative instrumentsare used as part of a hedging strategy. The manager may also want towarn investors of the potential risk for reassessment. Finally, properexecution of a hedging strategy is critical. The manager not only has tointend to hedge but also has to execute in an inter-connected andintegrated manner.
Stan Maj focuses on income tax matters related to the financial servicessector, and leads the asset management tax practice in Canada. Stan adviseson tax compliance issues, and tax aspects of structuring and reorganizinginvestment funds. He is experienced with innovative fund structures andderivative instruments.
Stan sits on the Taxation Working Group of the Investment Funds Institute ofCanada and the Industry Regulation & Taxation Committee of the InvestmentCounsel Association of Canada.
Stan’s previous roles include Vice President of Tax for Metropolitan LifeInsurance Company and Vice President of Tax for Royal Bank of Canada.He is a CA, a CPA, a lawyer and a Fellow of the Life Management Institute.
www.canadianhedgewatch.com6
CHW What inspired the launch of the Highwater Diversified Opportunities Fund in 2007?
Ara Nalbandian During my time as Senior Portfolio Manager at a leading Canadian fundcompany, I achieved exceptional positive risk-adjusted returns for investors in the funds I managed.I’ve always believed a contributor to this success was my conviction to investing fully directlyalongside fund investors. Aligning the interests of investors and managers is the best way for theinvestment management industry to evolve. Highwater Capital Management Corp. was establishedin 2007 and, in December of that year, the Highwater Diversified Opportunities Fund was launched.Despite the challenges all managers faced during this period it has significantly outperformed NorthAmerican total return equity benchmarks by 33%. Rewarding performance is at the core ofHighwater Capital Management’s philosophy; delivering investor’s superior risk-adjusted returnswith a modest, highly competitive performance fee structure.
CHW How would you describe your investment management style?
AN Our management style could be described as diversified North American active value.We apply a rigorous and disciplined approach evaluating individual companies from the bottom-upon a fundamental basis. We are determined to generate consistent portfolio income throughdividends, income generating option strategies (i.e. covered call option writing) and active portfoliomanagement. We invest in a diversified portfolio of publicly listed North American securitiespredominantly in mid and large cap equities and to a lesser extent fixed income securities includingpreferred shares and convertible debentures. We maintain a concentrated portfolio of approximately30 to 35 individual securities, however unlike conventional value investing strategies; we are activein managing each of our positions to optimize income and total risk-adjusted returns.
CHW What is your process for unearthing companies/securities to include in your portfolios?How do you create value in your portfolios?
AN We first start with identifying companies that exhibit superior operational metrics,management expertise and shareholder-friendly behaviour. This can be demonstrated throughvarious factors including: a focused strategy, niche or strategic positioning, product innovations,supply chain improvements, effective cost-containment, stable and increasing dividends and cashflows, accretive acquisitions and aggressive share buy-backs. We then review a company’sfundamentals on an absolute basis and relative to its peer group. Our focus is primarily fundamentalvalue-investing, however we do use a tactical approach to asset allocation as we consider themacro-economic backdrop when taking positions in individual securities, sectors and asset classes.Once we have established our estimated intrinsic value and see potential for attractive risk adjustedappreciation, we build out a strategy to maximize the income from that particular security. Wecontinuously manage and adjust our positions to meet absolute return objectives. We use publiclylisted options to fine tune positions, produce tax efficient portfolio cash flow and reduce portfoliovolatility. Remaining disciplined in this process has contributed significantly to the Highwater Funds’consistent outperformance of benchmarks and peers.
Highwater DiversifiedOpportunities Fund
An interview with
Ara Nalbandian, CFA,
Portfolio Manager
- Highwater Capital
Management
Ara Nalbandian CFA FCSI DMS
Portfolio ManagerHighwater Capital Management
CHW Is the buy and hold strategy dead?
AN I wouldn’t go as far as saying that the buy-and-hold strategy isdead, but it has evolved. The discipline of value investing is still relativelyyoung at just over 75 years old. Innovators like Warren Buffett inspired bythe intellectual framework developed by Benjamin Graham in the 1930shelped value-investing develop and popularized the buy-and-holdphilosophy. The one constant in the world is change. The investmentindustry is no stranger to evolution. Given the current range-bound marketwhere investors are hyper-sensitive to periodic updates of economic andearnings data in the wake of the 2007-2008 recession, active managementtends to fare better relative to conventional buy-and-hold strategies. Thatsaid, I would not discount the importance of owning well-run businessesand purchasing them at a discount to their intrinsic value. Our approachtakes value investing to the next level by actively managing positions andusing income generating option strategies. We believe our approach isparticularly suitable for the current market environment.
CHW In current market conditions with the downturn of 2008 stillfresh in investor's minds, why should they consider equities and/orhedge funds? What have you learned from the downturn in 2008 inregards to protecting the portfolio and capital preservation?
AN Dismissing equities and hedge funds altogether appears to bea knee-jerk reaction to the challenges investors faced in 2008. Hedgefunds retain some of the best and brightest asset managers our industryhas to offer and with increasing regulatory requirements thecommunication level between investors and money managers haswitnessed remarkable improvements in recent years. We believe equitiesare a key asset class for generating total returns and at current valuationsare considerably attractive relative to bonds and other securities. In thepast 25 years, there have been only two instances when the spread of theearnings yield on the S&P 500 and the 10-year U.S. treasury has beengreater than the spread on long-term corporate bonds. The first time thishappened was at the end of 2008, and the second is now. We arebecoming increasingly bullish on equities and continue to seek outcompanies with strong balance sheets, recurring revenues andsustainable/growing cash flows.
To answer the second part of the question, 2008 was a challenging yearfor investors and managers alike, and in many ways it was a year ofedification. Money managers who deployed capital in income generatingsecurities and prudently employed leverage tended to insulate theirportfolios from the broader market downturn. What we have learned from2008 is that the severity of black-swan scenarios cannot be under-estimated simply based on the low frequency of occurrence. We took theopportunity to shield a portion of our portfolio by buying put options onthe S&P 500 Index during periods when the Volatility Index (VIX) was lowrelative to its historical average. While we use options on individualsecurities to enhance income, using them to short the index helpsmitigate our risk in the event of a dramatic market decline. Just like buyinginsurance, you don’t look forward to facing the negative outcome, butyou are glad that, if such an unlikely outcome occurs, you are protectedto some degree. Since the priority is to preserve capital, when the costof buying portfolio insurance is low, it doesn’t hurt to have an added levelof market protection.
CHW Are hedge funds synonymous with leverage and/or risk?
AN While investors tend to consider hedge funds as high risk, thedegree of risk can vary depending on the management style, theunderlying securities and use of leverage. Hedge funds are notsynonymous with risk. However, certain fund managers do use leverageto add exposure in any combination of going either long or short themarket. Our use of leverage is modest and we employ it opportunisticallyto enhance our exposure to a diversified income generating portfolio ofsecurities and strategies.
CHW What is the most significant position you will take in a givencompany or sector?
AN While we maintain a concentrated portfolio targeting 30-35companies, the fund’s exposure to any sector is generally capped at20-25% and individual company exposure is limited to 10% of theportfolio. The majority of our holdings are in large cap value, dividendpaying equities while about 20% of the portfolio currently consists of fixedincome securities including preferred shares and corporate bonds. Theresult is a portfolio diversified by sector, asset class and various othersources of risk we monitor.
CHW What other risks should investors consider when investing inhedge funds?
AN Investors should always look for a reputable auditor, an externalfund valuator and custodian as well as be cognizant of exposure toprivate/ illiquid securities or individual sector overconcentration. Weprovide investors transparency of holdings with no private securities anda diversified portfolio. We have also established industry leadingpartnerships with leading Canadian firms in fund audit, valuation andcustody.
CHW Where do you see the fee structure of Hedge Funds going?
AN The typical fee structure for Hedge Funds tends to be a 2%management fee and a 20% performance fee if the manager generatespositive returns in excess of a specified hurdle rate or high water mark.We believe that this typical structure demonstrates the industry’spropensity for excess and, as hedge fund investors become increasinglysavvy, fund managers will need to adjust their base management feestructures lower and place a greater focus on performance. The hedgefund industry is highly competitive, and if the goal is to make money foryour investors, positive risk-adjusted excess returns should be theprimary source of reward. The fee structures for Highwater’s Funds areextremely competitive earning management fees at about half the rate ofits peers and collecting only a 15% performance fee on any positiveexcess returns above our high water mark. In addition, the F-Classversion (available to fee-based investment accounts at leading CanadianInvestment Dealers) of the Highwater Diversified Opportunities Fundcharges a zero base management fee, making it a unique and attractiveinvestment.
CHW Where do you see Highwater Capital Management in five years?AN We would like to continue doing what we do best, and that ismanage assets and consistently produce outstanding risk-adjustedreturns for many years to come. We believe our disciplined strategies fordiversified income through multiple sources and our unparalleled focus onaligning our interests with our investors will continue to produce attractiverisk adjusted returns and an increasing and happy client base.
Ara Nalbandian, CFA FCSI DMS, is a Portfolio Manager for HighwaterCapital Management. He specializes in absolute return strategies investing inNorth American securities.
Ara started his career at Richardson Greenshields / RBC Dominion Securitiesin 1996 and later joined BMO Nesbitt Burns in 1998. He was awarded theChartered Financial Analyst designation in 2000 and Derivatives MarketSpecialist designation in 2002. Mr. Nalbandian was most recently SeniorPortfolio Manager at Sentry Select Capital Corporation, where he achievedtremendous success between 2000 and 2007. Since December 2007, he hasbeen the Portfolio Manager of the Highwater Diversified Opportunities Fund.
7Volume 10 Issue 7 - July 2010
www.canadianhedgewatch.com8
An interview with
Matt Manara,
Regional Sales
Manager - Highwater
Capital Management
Matt ManaraRegional Sales Manager
Highwater Capital Management
Matt Manara was recently appointed Regional Sales Manager with Highwater Capital Management.Canadian Hedge Watch asked Mr. Manara to discuss his role and the changes taking place.
CHW Why did you decide to join Highwater Capital Management?
Matt Manara It was an easy decision. It is an excellent opportunity to be a part of an experiencedteam with a solid track record of integrity and performance. It’s an exciting time to be a part of aninnovative and growing firm that is in the process of communicating our unique value addedapproach to investment advisors across the country.
CHW What is your first priority in the sales department?
MM First priority would be to continue our sales momentum. Getting our story out to advisorsthat appreciate the value we create for their clients. I am very pleased with the tremendous positivereception we’ve had in meetings with advisors. We will continue conducting meetings and gettingreferrals nationwide.
CHW What is your unique value proposition?
MM Our value proposition is simple: proven performance, high level of transparency andattractive low-cost structure. We provide direct access to an experienced and disciplined portfoliomanagement team. We conservatively run unconstrained concentrated portfolios that use optionsto generate income and reduce risk. We give clients a service experience that is second-to-none.
CHW Where does Highwater Capital Management fit in the hedge fund industry?
MM We believe our funds are core holdings. Our strategy is called diversified North Americanactive value, but I tend to think of it like a long/short balanced fund. We are well diversified by assetclass and sector and use sophisticated tools conservatively to enhance risk-adjusted returns.
CHW Where do you see the current opportunity at Highwater Capital Management?
MM The opportunity is created thanks to the current market environment. We are wellpositioned to take advantage of a flat market with a wide trading range. Our value-added optionstrategies that produce income and reduce risk combined with a disciplined value approach put usin a great position to continue to generate absolute returns for our clients.
Matt Manara, is Regional Sales Manager for Highwater Capital Management. As an honours commercedegree graduate, Matt started his career in 2004 working on a senior investment team at CIBC WoodGundy. Through positions of increasing responsibility, he was named VP of Regional Sales at Mavrix FundManagment where he spent the last four years. Mr. Manara was an intricate part of Mavrix FundManagement's exponential growth to a peak of $860 million. Matt has a wealth of knowledge andexperience in building and fostering new and existing relationships.
CHW What is the background to your company and fund?
Michael J. Levas The Company was founded in 2003 and this is our 2nd long/short equity fundthat was launched June 1st of this year.
CHW How and where do you distribute the funds? What is the profile of your current andtargeted client base.
ML The funds distribution is primarily to high net worth and ultra high net worth investors andalso institutional investors i.e. fund of funds, family offices and other institutional investors that arelooking for alpha in their portfolios.
CHW What is your investment process?
ML The investment process is to capture at least 2 1/2% per trade either on the long or shortside. Momentum is also an integral part of the process and hedging instantaneously when a positionis either up or down substantially is also something that we look to capture on a daily basis.
CHW What is your approach to managing risk?
ML Risk is classified and dealt with as a non event. In other words we really don’t use leverageat all, we keep a substantial amount of cash on hand at all times so that we can take advantage ofmarket anomalies that we are able to profit from. We do have 4-1 available to us on an intra daybasis but is seldom, and I repeat, seldom used.
CHW What events do you expect to see in your sector in the year ahead?
ML The rest of the year will be essentially a traders market or continuing to be a traders marketas it has been since the first part of this year. I believe we will continue to see choppiness and/orpossible continued corrections on a fairly regular basis thru the end of the 4th quarter 2010.
CHW Are investors’ expectations shifting between capital preservation and growth?If so, how do you deal with this?
ML Some investors are looking for capital preservation but essentially the investors that cometo Olympian are seeking growth and appreciation of capital and are not really looking for us tominimize or preserve capital as they would in balanced or fixed income portfolios.
CHW What differentiates you from other managers in your sector?
ML The defining characteristic is information and obtaining information from existingrelationships that I have on a worldwide basis in the marketplace. My adherence to riskmanagement and in intolerance for sloppy trading that I believe is something that differentiates mefrom other managers in my style profile. And lastly, my ability to read the tape and my extensive useof options is another defining factor in separating me from the pack.
Olympian L/SEquity Fund, L.P.
Canadian Hedge
Watch speaks with
Michael Levas, CIO,
of Olympian Capital
Management about
their investment
process and
future goals
Michael J. LevasCIO
Olympian Capital Management LLC.
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Volume 10 Issue 7 - July 2010 11
CHW How do you view the environment for fundraising in 2010?And does this affect your fund?
ML There is cash available and there are investors looking to placethat cash. The difference is, this year, they are becoming much more duediligence oriented and looking for communication and transparency fromthe manager. We are continually looking for additional capital into our fundand have been very fortunate this year with our investors and potentialinvestors.
CHW How has investor tolerance for volatility and illiquiditychanged in the last few years??
ML I believe that there is a real lack of intolerance for illiquidity andthat is more prevalent on the investor’s minds then the volatility. Astraders, we enjoy volatility because it gives us the ability to generate alphaon both sides of the market.
CHW Will “green” investing continue? Expand? Accelerate?
ML I think that there will be a certain demand for green investingbut again that will be limited in scope to investors that are sociallyconscious as opposed to those that are seeking pure alpha generationand growth.
CHW What are the key elements that you watch?What shapes Olympian’s thinking and analysis right now?
ML Olympian’s view is more of a macro view of economic andfinancial events that take place in various markets around the world.Obviously since 2008, we have had a remarkable change in the financiallandscape and our thinking continues to be rather short to mid term innature than more long term as some investors would like to see. And thereason for that is that because of the increased volatility and theadditional quantitative trading that is taking place i.e. high frequencytrading we really need to understand the impacts of these traders who arehaving a substantial impact on markets worldwide.
CHW Have there been any trends you are watching closely?
ML The regulatory landscape here in the U.S. has changeddramatically and I believe this well have an effect on the market andmarket participants in the years to come so we really need to familiarizeourselves with the changing dynamics in the regulatory environment bothhere in the U.S. and abroad.
CHW What is in the horizon for Olympian Capital Management?
ML Olympian’s goals and aspirations are to continue to seek outalpha, build our fund and separate our thinking, trading and moneymanagement from those who seek to just merely make returns that areaverage or below average for their investors.
Michael J. Levas, is CIO of Olympian Group of Investment ManagementCompanies. Mr. Levas has been in the investment management business forover twenty years and is the founder, chief investment officer and managingmember of the Olympian Group of Investment Management Companies. Priorto Olympian, he was a VP and Portfolio Manager in the Private Client Groupat Lehman Brothers Inc. Prior to that, he was a VP with SG Cowen, UBSPaineWebber and Bear Stearns where he managed in excess of $250 millionin both institutional and retail portfolios. Michael is the founder and managingmember of Olympian Securities LLC, and is a licensed Series 24 generalsecurities principal, Series 7 general securities representative, and a Series65, 66 investment adviser representative with (FINRA). Mr. Levas is also thefounder and principal of Olympian Futures LLC, an (NFA) registeredintroducing broker, and a licensed Series 3 associated person.
Mr. Levas is a frequent conference speaker and commentator on the financialmarkets and asset management industry, and has been featured in numerouspublications including BusinessWeek, Smart Money, Hedge Fund ManagerWeek, Absolute Return, Euromoney, International Securities Finance, Buy-Side Technology, Securities Industry News, Alternative Investment Review,Advanced Trading, Markets Media Magazine, Waters, Bloomberg andNational Public Radio.(NPR)
www.canadianhedgewatch.com12
Garrison Hill & Redwood AssetManagement to Launch Canada's FirstEuropean Crisis FundToronto - June 24, 2010 – Garrison Hill Capital Management alongwith partnerRedwoodAssetManagement, are pleased to announce thelaunch of Canada's first fund focused on the European financial crisis.
The Garrison Hill European Crisis Fund seeks to provide investorswith the ability to profit and hedge their portfolios from deterioratingpolitical and economic conditions in the Euro Zone.
"Economic and political issues in Europe continue to influenceinvestment returns in other asset classes globally," said Michael Yhip,President and Chief Investment Officer of Garrison Hill. "We believethese are structural issues that will take years to resolve and investorsneed to manage the risk to their portfolios accordingly. The EuropeanCrisis Fund provides investors a unique investment opportunity andrisk management tool."
The Fund will be actively managed and will use long and short strategiesin a broad range of asset classes such as currencies, commodities,fixed income, and equities in order to achieve its investment objective.
The Garrison Hill European Crisis Fund will be available throughRedwood Asset Management. Garrison Hill will act as the solePortfolio Advisor to the Fund. "Redwood is pleased to partner withGarrison Hill as they have demonstrated the ability to understandcomplicated global events and turn them into distinct investableideas" said Peter Shippen, President of Redwood.
The Fund is currently being marketed to accredited investors only withan anticipated launch date of July 12, 2010.
Merlin Securities Expands Footprintto CanadaPrime brokerage firmMerlin Securities is expanding its footprint witha push into Canada. The firm has recently hired Daniel Dorenbush asa partner and chief executive officer of the firm’s Canadian operation,which is slated to open later this year, FINalternatives has learned.
In his new role, Dorenbush will be based in Toronto and will report toRon Suber, senior partner, head of global sales and marketing.Most recently, Dorenbush was a New York-based managing directorand global head of strategic sales and relationship management in thehedge fund services division at RBC Capital Markets. He hadresponsibilities across electronic, professional and futures trading,including prime brokerage, soft dollar services, capital introductionand RBC’s fund of hedge funds. Prior to that, he was global head ofprime brokerage for RBC Capital Markets.
Merlin Securities was founded in 2004 and serves more than 500single- and multi-primed managers, providing them with an openarchitecture suite of solutions including dynamic performanceattribution analytics and reporting, seamless multi-custody services,capital development, 24-hour international trading, securities lendingand access to the Gerson Lehrman Group’s worldwide network ofexperts. In addition to its planned Canadian office, the firm hasoperations in San Francisco and New York.
Manitou Investment Management Acquiresthe Greenrock Global Cleantech L.P.Manitou Investment Management announced an extremely positivedevelopment for the Greenrock Global Cleantech L.P. Manitou hasagreed to acquire the right to manage the LP, from Greenrock AssetManagement, and assume its on-going control. Peter Hofstra willcontinue as the manager of the LP, which will be renamed – theManitou Focus+ L.P. and maintain its commitment to deliveringsuperior results by investing in companies with a sustainable/greenfocus. As well, Peter will become Manitou’s Director of InvestmentManagement & Research. As a benefit of working with a largerorganization, Manitou is reducing the management fee, of the LP, from2% to 1% effective July 1, 2010.
Distinct from the LP, Greenrock Asset Management (“GAM”) willcontinue to operate and focus exclusively on investing in early stagegreen related companies as we did with Zenn Motors and Catch theWind. We have hired Chris Seed, an individual with investmentbanking experience, to support this ongoing endeavour. We continueto believe there is tremendous investment opportunity in this categoryand are thrilled that Peter will continue to act as a Special Advisor toGAM, thereby enabling us to sustain the mutually beneficial dialog thathas developed over the years.
Sprott Steps Down as Chief, Replacedby GrosskopfDate: Thursday, July 15, 2010Author: David Scanlan, Bloomberg
Eric Sprott, whose gold and resource-based hedge funds soared six-fold over nine years, is stepping down as chief executive officer ofSprott Inc. and will be replaced by Peter Grosskopf on Sept. 7.
Sprott, 65, becomes chairman of the company, replacing Jack Lee,and will be chief investment officer of Sprott Asset Management, theToronto-based firm said today in a statement. Grosskopf joins SprottInc.’s board and will serve as president and CEO of Sprott ResourceLending Corp.
The Toronto-based money manager’s Sprott Hedge Fund returnedabout 496 percent in the nine years to the end of 2009 as bets on goldstocks and oil and gas companies paid off.
Sprott founded his current money management firm after divestingSprott Securities, now Cormark Securities Inc., to its employees.Grosskopf is president of Cormark.
Sprott Asset Management’s senior portfolio manager Peter Hodsonwill be stepping down from the board, the firm said. Lee will serve asSprott Inc.’s lead director, the company said.
Sprott Inc. fell 5 cents to C$3.30 at 3:56 p.m. in trading on the TorontoStock Exchange. The stock has plunged from its initial public offeringprice of C$10 in 2008.
A R O U N D T H E H E D G E - A Rev i ew o f Hedge Fund Happen i ngs
>>> Around The Hedge (continued on page 14)
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www.canadianhedgewatch.com14
Q&A: Hedge and Private Equity FundsUnder Financial Reform LawDate: Friday, July 23, 2010Author: Sheri Qualters, law.com
The financial reform law signed into law by President Barack Obamaon July 21 targets a sector that has previously escaped vigorousgovernment scrutiny – hedge funds and private equity funds. ThePrivate Fund Investment Advisers Registration Act of 2010, which wasenacted as part of the financial reform law (officially the Dodd-FrankWall Street Reform and Consumer Protection Act), calls for mosthedge fund and private fund advisers to register with the U.S.Securities and Exchange Commission. The law exempts investmentadvisers who manage only venture capital funds, but it's not clearwhich companies will be exempt from the rules because the SEC hasa year to define what's a venture capital fund for purposes of the law.
More onerously, companies subject to the act will be required to adoptcompliance programs, tap a chief compliance officer, craft a writtencode of ethics and implement policies to curb insider trading. ThomasBeaudoin, a partner in the Boston office of Wilmer Cutler PickeringHale and Dorr who chairs the firm's fund formation practice group,discussed the types of companies that are subject to the law, what itmeans for overseas private advisers and the law's impact onattorneys. The Q&A has been edited for space and clarity.
NLJ The hedge fund and private equity sectors have always beenconsidered lightly regulated compared with other segments of thefinancial services industry. Do you consider this the first significantregulation of these sectors?
Thomas Beaudoin There was an attempt to regulate hedge funds byrequiring them to register back in 2004 or so, but that ultimately failed.This is an attempt to get hedge funds and others, including privateequity funds and non U.S. [investment advisers], to register with theSEC to keep a much closer eye on them. Today, they are very lightlyregulated entities, and soon they will be highly regulated entities.
NLJ The act exempts several categories of advisers, including thosewho solely manage venture capital funds or private funds that haveless than $150 million in assets under management in the U.S. Giventhe exemptions, what kind of companies is the act really targeting?
TB It's really targeting hedge funds and most private equity funds. Ithas that under $150 million [language] to exempt smaller buyoutfunds, but it's fair to say it's looking at virtually all buyout funds.
NLJ What legal questions will these types of companies face goingforward?
TB [First], registering under the act. It's not a difficult process, but it'sa process nonetheless. Also, developing rules and procedures arounddifferent aspects of your operations. [Companies now] might not haveas robust a code of ethics or document-retention, conflicts-of-interestor insider-trading policy as will be required.
>>> Around The Hedge (continued from page 12) They also need to appoint someone to be a chief compliance officer.That could be the [chief financial officer] or internal general counsel.[But if] it is a very complex organization that is not yet registered, thatmay mean they need to hire someone for that role.
NLJ What does it mean for lawyers who advise these types ofcompanies?
TB Lawyers who represent hedge funds and private funds will have,at least at the outset, a significant amount of legal work to get theirclients registered. On an ongoing basis, compliance is less intensive.Venture capital is a mystery as to how [the SEC is] going to definethat. [But] many funds don't have narrowly defined investmentstrategies; they have more broadly defined strategies that may enablethem to make investments the SEC may not consider venture capitalinvestments. There may be a whole group of what we'd considerventure capital [companies that] will be required to register. The SECseems inclined to have everyone register. They're likely to craft adefinition that is very narrow. Law firms that do venture capital fundformation will have many of their clients being required to register.
NLJ Does the law contain any surprises for the industry?
TB Let's say I'm living in Russia and investing in Russian securities. IfI have U.S. investors with $25 million, I'm going to have to registerunless I come under an exception. That is going to be a real surpriseto [private fund managers] who work outside the U.S. – that the reachof U.S. laws is pretty vast.
NLJWill it be a challenge for the SEC to enforce that?
TB I would think it would be. It will also be a big challenge for any non-U.S. based money manager subject to these requirements to register.
NLJ Do non-U.S. money managers who have U.S. investors typicallywork with U.S. lawyers now?
TB They should be, if they're taking U.S. money, they should be.Theoretically, they are at least interfacing with U.S. lawyers if they'reconducting any kind of sales activity in the U.S. [But] if you're talkingabout someone managing $5 billion and taking in a few [U.S.] people[whose investments] add up to $30 million, there's a tendency onsome of their parts to ignore U.S. law or not to get a U.S. lawyerinvolved.
NLJ Is advising overseas fund managers a growing legal area?
TB The appetite of U.S. investors for [foreign investment] products,whether we're talking a private equity fund that invests in Indiancompanies or a venture capital fund that invests in Chinese startups,there's a very large appetite from U.S. investors for those kinds ofproducts. The role of U.S. lawyers in capital formation projectsmanaged overseas and invested in overseas is becoming much moreprominent than it was, say, 15 years ago.
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TOP 5 HOLDINGS* GENERAL
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Highwater Capital Management Corp.Telephone 905.265.0649Fax 905.265.0646e-mail [email protected] www.highwaterfunds.com *Diversified: Closed-End Arbitrage, ETF & Index
Information contained in this document pertaining to the Highwater Funds is not to be construed as a public offering. The offering of units of each of theFunds is made pursuant to its respective Offering Memorandum only to those investors in jurisdictions of Canada who meet certain eligibility and/orminimum purchase requirements. Important information about each of the Funds is contained in their respective Offering Memoranda. Eligible investorsshould read the Offering Memoranda carefully before investing. Performance data represents past performance and is not indicative of future performance.Please contact your investment advisor to determine suitability of investment.
The fund's objective is to achieve consistent absolute returns throughout various market conditions by investingprimarily in the equity securities of mid and large capitalization entities listed on major securities exchanges in Canadaand the United States. The Manager seeks to maintain a moderate level of risk and reduce the volatility of returns bydiversifying its investments by sector, asset class, strategy and other identified sources of risk and by employingoptions strategies, short positions, arbitrage strategies and seeking special situations with attractive expected riskadjusted return parameters. The Manager will employ a disciplined, fundamental, value biased securities selectionapproach with an emphasis on generating consistent portfolio income through varying sources including dividends,income generating option strategies and active portfolio management. A priority is placed on capital preservationengaging in tactical asset allocation and hedging strategies.
COMPOUNDED RETURNS (CLASS F) as at June 30, 2010YTD
3.2%
3 month
-3.0%
6 month Inception
6.0%
PORTFOLIO MANAGER
Performance figures based on investment since inception December 2007 in Class F units net of all fees and expenses.
CALENDAR AND MONTHLY RETURNS (CLASS F) as at June 30, 2010
FOR MORE INFORMATION CONTACT:
ALLOCATION
HIGHWATER DIVERSIFIED TRUST FUND VALUE OF $100,000 INVESTED
FUND DETAILS
INVESTMENT OBJECTIVE AND STRATEGY
Ara Nalbandian, Portfolio Manager, CFA FCSI DMS Ara Nalbandian specializes in absolute return strategies investing in North American securities. He started his careerat Richardson Greenshields / RBC Dominion Securities in 1996 and later joined BMO Nesbitt Burns in 1998. He wasawarded the Chartered Financial Analyst designation in 2000 and Derivatives Market Specialist designation in 2002.He was most recently Senior Portfolio Manager at Sentry Select Capital Corp. where he achieved tremendous success between 2000 and 2007. Since December 2007, he has been the Portfolio Manager of the HIGHWATER DiversifiedOpportunities Fund.
Highwater Diversified Opportunities Fund (Class F)S&P/TSX Composite Total Return IndexS&P 500 Total Return Index (C$)
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
Tech
nolo
gy
Hea
lthC
are
Con
sum
erS
tapl
es
Tele
com
Fina
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ervi
ces
Ene
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Rea
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e
Mat
eria
ls
Con
sum
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al
Bon
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Pre
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hare
s
Div
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Long ShortLong (long call option) Short (long put option)
Volume 10 Issue 7 - July 2010 21
HIGHWATER DIVERSIFIED OPPORTUNITIES FUND
HIGHWATER DIVERSIFIED TRUST FUND
FUND COMMENTARY
The Highwater Diversified Opportunities Fund was essentially flat for the month up 0.1% while our benchmark index was down 4.2%.Our benchmark is comprised of the S&P/TSX Total Return Index and the S&P 500 Total Return Index of which half is currency hedgedtoward the Canadian dollar.
Since inception the fund has outperformed its benchmark by over 33% and year-to-date the fund has produced positive returns of3.2% while the benchmark lost 4.2% during the same period.
STRATEGY SNAPSHOT
Since the end of the first quarter, we had been increasingly defensive throughout the recent equity market rally, gradually reducingpositions as they exceeded our valuation targets, adding to fixed income positions and hedging portfolio exposure.
More recently though, we are seeing attractive opportunities to accumulate positions focusing on large cap, high quality, free cash flowgenerating, dividend paying companies with strong balance sheet characteristics.
OPTION MARKET REVIEW
Our hedging strategy was predominantly executed by accumulating laddered positions in index put options during the recentoverbought market conditions at relatively low index implied volatility levels (inexpensive portfolio insurance). We have since reducedour hedging by approximately half during recent periods of market decline and elevated index implied volatility levels.
This environment has presented opportunities to accumulate equities at a reasonable discount to our estimated intrinsic value targets.One of the ways we have initiated positions is by increasing our option writing activity as premiums are elevated on individual securities.This process effectively reduces our purchase price.
FIXED INCOME REVIEW
Recently, the yield curve on the long-end has experienced a significant flattening resulting in the 10-year U.S. Treasury yield droppingfrom 4% to 3%, and the 2-year U.S. treasury reaching a record low of 0.59%. During this period we have been taking advantage ofwider credit spreads strategically adding to our fixed income positions that continue to exhibit an improving credit story.
OUTLOOK
Our strategies remain consistent with our thesis that equity markets are attractively valued, yet likely to remain range bound in thenear term within a wide trading band. We are seeing increasingly attractive valuations in the large cap tech sector with multinationaltechnology companies trading at about 13 times forward earnings. We continue to be very selective in our approach strategicallyadding positions in companies that demonstrate compelling operating metrics, proven management strategy and shareholder-friendlybehaviour. Consequently, we expect the combination of dividends, income generating option strategies and disciplined activemanagement will produce attractive returns in our portfolio over the balance of the year. Highwater Capital Management’s disciplinedapproach has resulted in a significant outperformance of equity benchmarks since inception in December 2007 on an absolute and riskadjusted return basis.
ABOUT HIGHWATER
Highwater Capital Management is a performance-driven asset management firm specializing in disciplined strategies for diversifiedincome. Founded in 2007, our mission is to achieve consistent absolute returns throughout various market conditions by investingprimarily in mid and large capitalization North American equity securities while maintaining a moderate level of risk using optionstrategies to maximize income in our portfolios.
www.canadianhedgewatch.com18
H E D G E F U N D P E R F O R M A N C E (as of June 30, 2010)
Front Street Canadian Energy Fund 32.369 -1.88 -10.63 -11.33 -11.33 38.77 -10.24 14.29 88.11 -70.16 -72.55 29.51 42.18 0.77 31.95 0.40 0.41 69.50 67.69
Front Street Canadian Hedge Fund Series B 116.511 -5.90 -11.75 -7.02 -7.02 7.80 -11.02 11.46 23.46 -43.30 -47.58 13.11 21.31 0.71 1.51 0.83 0.85 67.16 63.08
To ensure the highest level of accuracy, Hedge Funds are encouraged to directly submitmonthly/quarterly/annual data to: [email protected]
Canadian Hedge Watch receives, tracks and presents the data and results of Canadian funds as a service tothe hedge fund and alternative investment community. Business announcements, key personnel appointments and
press releases are also welcome for publication. Please send to [email protected].
Volume 10 Issue 7 - July 2010 25
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The CompanyCanadian Hedge Watch Inc. (CHW) is a publishing, educational andinformation firm providing timely hedge fund and other alternativeinvestment information to the Canadian marketplace. CHW publishesthe monthly Canadian Hedge Watch monthly report and maintainsthe website www.canadianhedgewatch.com which is designed bothas a core source of Canadian hedge fund and alternative investmentnews and to provide information to investment advisors, institutions,sophisticated investors and other industry participants. The monthlyreport and website provide up-to-date statistical data on Canadianhedge funds, quarterly hedge fund reports, current hedge fund news,links to Canadian hedge fund companies, an archive of previousissues of the newsletter and a library of hedge fund related booksand articles. CHW hosts the annual World Alternative InvestmentSummit Canada (www.waisc.com), a highly successful event which nowattracts over 400 hedge fund and alternative investment professionalsand service providers. CHW has also launched the CHAIP (CharteredAlternative Investment Planner) designation for sellers of hedge funds inCanada. This designation is the only one relating to alternatives that isrecognized by the Canadian investment industry.
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2.1 CommentaryEqually weighted Canadian hedge funds had a quarterly (Q2) loss of-3.17% (refer to chart 2.2 - Comparison of Returns), less than theS&P/TSX which posted a gain of -6.17% for Q2/10. The HFRI FundWeighted Composite Index fell -2.52%, while MSCI World Index lost-8.36%, under-performed the S&P 500 Total Return Index at -7.24%.
On the risk side, (refer to Chart 2.3 – Efficiency and Calendar YearReturns) the annual standard deviation (measured for the period ofDecember, 1994 to June, 2010) of equally weighted Canadian hedgefunds was 8.09% compared to the Canadian market’s TSX of16.45%. The largest drawdown was also significantly lower forCanadian hedge funds with a negative 23.24% loss compared to theS&P/TSX’s negative 45.05% loss. Overall, Canadian hedge fundsperformed efficiently and hedged against the market - TSX since1994, in terms of the annual returns and standard deviations of8.47%, 8.09%, and 6.37%, 16.40%, respectively. Equally weightedCanadian hedge funds had 0.225 beta to the TSX and correlation was0.775 over the last 12 months.
For risk and efficiency parameters of Canadian hedge fundscompared to other major indices, the Canadian hedge funds hadsimilar figures (Chart 2.3 – Efficiency and Calendar Year Returns) interms of annualized standard deviation, percentage of positivemonths, percentage of positive quarters, largest drawdown and alphaagainst TSX compared to the HFRI Fund Weighted Composite Index.Over the past 5 years the correlation between Canadian hedge fundsand the TSX was 0.868 (refer to chart 2.4 – Correlation Matrices); andwas also highly correlated with HFRI fund Weighted Composite Indexof 0.908. The correlations for last 12 months were 0.775 and 0.820for the TSX and HFRI Fund Weighted Composite Index respectively.
2. Performance Comparison: Canadian Hedge Funds vs. Major Indices
www.canadianhedgewatch.com44
Performance Comparison: Canadian Hedge Funds vs. Major Indices
2.2.Comparison of Returns
Equally
Weighted
Average
Canadian
HF Return
S&P/TSX
Composite
Index
S&P 500
Total
Return
Index C$
MSCI
World
Index (C$)
HFRI Fund
Weighted
Composite
Index
-2.84% -3.98% -3.39% -1.51% -0.86%
-3.17% -6.17% -7.24% -8.36% -2.52%
-0.96% -3.85% -5.64% -8.58% -0.02%
-0.96% -3.85% -5.64% -8.58% -0.02%
6.66% 8.86% 4.55% 1.15% 9.63%
-4.09% -6.70% -9.92% -11.04% 0.88%
1.13% 2.66% -3.60% -2.24% 6.04%* annual
1 month
3 month
6 month
YTD
RETURN
1 year
3 year *
5 year *
2.3.Efficiency and Calendar Year Returns
Equally
Weighted
Average
Canadian
HF Return
S&P/TSX
Composite
Index
S&P 500
Total
Return
Index C$
MSCI
World
Index (C$)
HFRI Fund
Weighted
Composite
Index
8.47% 6.37% 5.42% 3.69% 9.92%
8.09% 16.40% 13.83% 12.94% 7.32%
0.92 0.33 0.32 0.21 1.22
63.30% 61.17% 57.45% 57.45% 69.15%
73.02% 68.25% 63.49% 61.90% 76.19%
1.40 1.42 1.71 1.05 5.73
7.06% -97.27% -35.39% -46.50% -63.70%
224.2% 257.74% -15.45% 18.46% 261.08%
-23.24% -45.05% -51.16% -44.31% -19.51%
0.225 - 0.504 0.546 0.382
6.26% - 1.71% -0.24% 6.87%
Equally
Weighted
Average
Canadian
HF Return
S&P/TSX
Composite
Index
S&P 500
Total
Return
Index C$
MSCI
World
Index (C$)
HFRI Fund
Weighted
Composite
Index
11.34% 11.87% 33.92% 18.09% 21.50%
24.85% 25.74% 23.55% 14.54% 21.10%
22.26% 13.03% 39.19% 21.31% 16.79%
1.47% -3.19% 37.82% 33.76% 2.62%
24.60% 29.72% 13.94% 17.98% 31.29%
17.22% 6.18% -5.57% -9.53% 4.98%
4.59% -13.94% -6.41% -11.33% 4.62%
1.43% -13.97% -22.84% -20.31% -1.44%
16.50% 24.28% 5.76% 9.93% 19.54%
7.02% 12.48% 2.80% 6.85% 9.05%
8.82% 21.90% 1.51% 6.45% 9.28%
7.16% 14.52% 16.04% 20.90% 13.01%
5.23% 7.16% -9.80% -6.32% 11.06%
-20.40% -35.03% -23.08% -27.15% -17.25%
11.85% 30.69% 9.17% 12.91% 20.35%
-0.96% -3.85% -5.64% -8.58% -0.02%
2006
2007
2008
2009
2010
2002
2003
2004
2005
1998
1999
2000
2001
1997
Largest Draw dow n:
Beta (S&P/TSX):
Alpha (S&P/TSX):
CALENDAR YEAR RETURNS
% Positive Months:
1995
1996
Skew ness:
Kurtosis:
% Positive Quarters:
Sortino Ratio (1%):
Since December, 1994
Annualized Return:
Annualized Standard Deviation:
Sharpe Ratio (1%):
Volume 10 Issue 7 - July 2010 45
Performance Comparison: Canadian Hedge Funds vs. Major Indices
Calendar Year Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Retu
rn(%
)
Equally Weighted Average Canadian HF Return
Calendar Year Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Retu
rn(%
)
S&P/TSX Composite Index
Calendar Year Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Retu
rn(%
)
HFRI Fund Weighted Composite Index
Calendar Year Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Retu
rn(%
)
MSCI World Index (C$)
Calendar Year Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Retu
rn(%
)
S&P 500 Total Return Index C$
www.canadianhedgewatch.com46
2.4. Correlation Matrices
1 0.775 0.710 0.656 0.820
0.775 1 0.694 0.593 0.821
0.710 0.694 1 0.928 0.771
0.656 0.593 0.928 1 0.811
0.820 0.821 0.771 0.811 1
1 0.892 0.493 0.626 0.927
0.892 1 0.640 0.748 0.933
0.493 0.640 1 0.943 0.535
0.626 0.748 0.943 1 0.714
0.927 0.933 0.535 0.714 1
1 0.868 0.284 0.472 0.904
0.868 1 0.520 0.661 0.922
0.284 0.520 1 0.939 0.393
0.472 0.661 0.939 1 0.601
0.904 0.922 0.393 0.601 1
1 0.868 0.290 0.493 0.908
0.868 1 0.503 0.656 0.917
0.290 0.503 1 0.934 0.402
0.493 0.656 0.934 1 0.614
0.908 0.917 0.402 0.614 1
HFRI Fund
Weighted
Composite
Index
HFRI Fund Weighted Composite Index
HFRI Fund
Weighted
Composite
Index
HFRI Fund Weighted Composite Index
HFRI Fund
Weighted
Composite
Index
Equally
Weighted
Average
Canadian HF
Return
Correlation (1 year)
HFRI Fund
Weighted
Composite
Index
HFRI Fund Weighted Composite Index
S&P/TSX Composite Index
S&P 500 Total Return Index C$
MSCI World Index (C$)
S&P/TSX
Composite
Index
S&P 500
Total
Return
Index C$
MSCI World
Index (C$)
Equally Weighted Avg. Cdn. HF Return
Equally
Weighted
Average
Canadian HF
S&P/TSX
Composite
Index
MSCI World
Index (C$)
S&P 500
Total
Return
Index C$
S&P 500
Total
Return
Index C$
MSCI World
Index (C$)
Equally Weighted Avg. Cdn. HF Return
S&P/TSX Composite Index
S&P/TSX
Composite
Index
S&P 500 Total Return Index C$
MSCI World Index (C$)
Correlation (5 year)
Equally
Weighted
Avg. Cdn.
HF Return
S&P 500
Total
Return
Index C$
MSCI World
Index (C$)
Equally Weighted Avg. Cdn. HF Return
S&P/TSX Composite Index
MSCI World Index (C$)
Correlation (3 year)
Equally
Weighted
Avg. Cdn.
HF Return
S&P/TSX
Composite
Index
HFRI Fund Weighted Composite Index
S&P/TSX Composite Index
S&P 500 Total Return Index C$
MSCI World Index (C$)
S&P 500 Total Return Index C$
Correlation (2 year)
Equally Weighted Avg. Cdn. HF Return
Volume 10 Issue 7 - July 2010 47
3.
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www.canadianhedgewatch.com48
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Volume 10 Issue 7 - July 2010 49
Canada's first non-investible hedge fund indices were created byCanadian Hedge Watch. They include 3 sub indices:
. CHW-HF Equity Hedged Index
. CHW-HF Notes Index
. CHW-FOHF Index
The composite index is the asset weighted CHW-HF CompositeIndex. The most prevalent Canadian hedge fund type is equityhedged as the majority of Canadian hedge funds are followers of thetraditional equity long-short types of hedge funds. Most hedge fundsexhibited negative performance in 2008 but many began to recoverlost ground in 2009. However, a number of hedge funds have takena more defensive position in 2009 and the first half of 2010 by holdingcash and taking short positions in the market. There have been agrowing number of managed futures funds and real estate fundsreporting as well.
The CHW-HF Composite Index is up 6.45% in the last 12 months.Gains derive from the Equity Index of 9.77%. The loss from Fund ofFunds contributed the negative 32.26% in the composite index dueto six of the constituent funds in fund of funds index – Mac AlternativeStrategies posted a large loss during the last 12 months.
CHW Canadian Hedge Indices
www.canadianhedgewatch.com50
Volume 10 Issue 7 - July 2010 51
28 www.canadianhedgewatch.com
2 0 1 0 / 1 1 CALENDAR OF EVENTS
9th Annual World Alternative Investment Summit waisc.comMonday, September 13 to Wednesday, September 15 Niagara FallsWAISC is Canada’s largest annual gathering of alternative investmentprofessionals and service providers. Featuring panel discussions withtop-level international speakers, fund manager showcases and leadingservice providers, WAISC brings together over 400 delegates to exploreevery side of the alternative investment space.
9th AnnualWorld Alternative Investment Summit Canada
ETF's, ETN's, Indexing, Structured Products, Closed End FundsThis inaugural conference will address the latest trends and developments inthis rapidly changing and growing product environment. The agenda featuresindustry experts sharing their experiences and forecasts in a format designedfor retail and institutional investment professionals.
Canadian Society of Technical Analysts (CSTA) Toronto Annual Conference csta-conference.com
Monday, December 6 & Tuesday, December 7 Toronto
The annual national CSTA Toronto conference brings together over 200 participants,both full and part-time traders, for in-depth information sharing and dialogue on thelatest issues affecting technical analysis in market trading. Some of the foremost namesin both national and international trading analysis present their thoughts and ideas throughinformative presentations and group discussions that are open to both CSTA membersand the general public.
Coming in May 2011 TorontoThe Institutional Trading & Technology Summit brings together leading industry professionalsboth from the Buy Side and Sell Side to network as well as hear fascinating discussions ontimely topics such as the latest developments in Canadian trading, new trading technologiesand the rapidly growing Canadian marketplace. A must attend event for Trading professionals,IT professionals, Risk Managers and Portfolio Managers.
Coming in May 2011Niagara Institutional Dialogue is an exchange of ideas, knowledge and practicesfor Canadian Institutional Investors. Approximately 50 senior representativesfrom U.S. & Canadian pensions, will participate in two days of informativediscussions, education and networking.This confidential closed door event is reserved for select industry participants.
Brought to you byradiusfinancialeducation.com
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Volume 10 Issue 7 - July 2010 29
Disclaimer The information contained in Canadian Hedge Watch has been compiled from sources believed to be reliable, however accuracy is not guaranteed. Canadian Hedge Watch provides information asa general source of news and events and should not be considered personal investment advice. Before taking any action all readers are advised and cautioned to consult a certified financial advisor. We haveendeavoured to ensure that the material contained in Canadian Hedge Watch is accurate at time of publication.
Contact InformationCanadian Hedge Watch Inc.20 Toronto Street, Suite 820, Toronto, Ontario M5C 2B8tel: 416.848.0277 ext. 2237 fax: 416.848.0278toll free: 1.877.249.9249Editorial, Media & Advertising: [email protected]: [email protected]
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A M O N T H LY R E V I E W O F H E D G E F U N D S & A LT E R N AT I V E I N V E S T I N GFEBRUARY 2010 VOLUME 10 ISSUE 2
COLLATERALIZED FUND OBLIGATIONS: A FUTURE
ALTERNATIVE TO FUND OF FUNDS?
MAN’S TOREIGH STUART ON MANAGED FUTURES
ARTEMIS GROWING AGAIN
CQS MANAGERS SPEAK AT BSP FUNDS
CHINA AND THE
UNITED STATES:
A LEVER, AND A PLACE TO STAND
A M O N T H LY R E V I E W O F H E D G E F U N D S & A LT E R N AT I V E I N V E S T I N GAPRIL 2010 VOLUME 10 ISSUE 4
AIMA CANADA SPEAKS
OUT ON PROPOSED
EU CHANGESAN INTERVIEW WITH GARY OSTOICH
UCITS – AN OPERATING MODEL FOR TOMORROW?
ROCKING-HORSE WINNER
FINANCIAL SERVICES MAY NO LONGER
BE EXEMPT FROM THE GST/HST
UNDERSTANDING
HUMAN CAPITAL
RISK & RETURN IN CANADIAN
HEDGE FUND INDUSTRY
INTERVIEW WITH ARROW
HEDGE/ AFC FUNDS
CANADIAN CHAIR CFA
BOARD OF GOVERNORS
A M O N T H LY R E V I E W O F H E D G E F U N D S & A LT E R N AT I V E I N V E S T I N G
MAY 2010 VOLUME 10 ISSUE 5
THE NEW CANADIAN
REGISTRATION REGIME:
HOW IT’S WORKING SO FARA M O N T H LY R E V I E W O F H E D G E F U N D S & A LT E R N AT I V E I N V E S T I N G
JUNE 2010 VOLUME 10 ISSUE 6
HOW ‘THE NEW NORMAL’ IS PROVING NOT SO NORMAL
THE SECONDARY PRIVATE EQUITY MARKET
PEOPLE ON THE MOVE
Stay informed with all thelatest hedge fund newsand performance datawith in-depth analyses.
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September 13-15, 2010Niagara Falls, Canadawww.waisc.com
9th Annual World Alternat ive Investment Summit Canada
WAISC2010
When is a ‘hedge fund’ not a hedge fund?Harry Markopolos, a quant working in equities derivatives, was handed a prospectus
outlining Bernie Madoff’s strategy and knew right away it was bogus. But that was just the beginning for Harry...he would spend the next ten years trying to convince the SEC to take action.
Canadian Hedge Watch is pleased to present Madoff whistleblower Harry Markopolos, author ofNo One Would Listen, the fascinating true story of how his team’s investigation uncovered a $65 Billion Ponzi scheme,
in an exclusive appearance atWAISC 2010, September 13-15, Fallsview Casino Resort, Niagara Falls.For more information, go to www.waisc.com