vertex Making Money Even When Markets Are Down

It is one thing to make money in soaring financial markets, another to make it grow when markets are down. Investors who can boast that they've done both over the past five years include those who bet on the three young money managers at the helm of Vancouver's Vertex One Asset Management Inc. Not that Vertex investors go around patting themselves on the back. They tend to be conservative types like West Vancouver's Bob Stewart, the former CEO of Scott Paper. They have made their capital and are primarily interested in protecting it.

Most would subscribe to the wisdom of the legendary Columbia professor Ben Graham, who pointed out that the first rule of investing is: Don't lose money. Graham's second rule is: Don't forget the first rule. That's also the credo of financial analysts Jeff McCord, 43, John Thiessen, 40, and Matt Wood, 38, who quit MK Wong/HSBC in 1998 to launch the Vertex Fund and the Vertex Balanced Fund. The $86-million Vertex Fund is an opportunistic hedge fund or alternative strategies fund -- a category that embraces a vast range of disciplines such as short-selling, leveraging and arbitrage.

Unlike conventional mutual funds, which are considered successful if they lose less than the market, hedge fund managers seek to achieve positive returns all the time, whether the market is moving up, down or sideways. Stewart, 70, says his early investment in Vertex now accounts for about 45 per cent of his portfolio, having "measured up extremely well" against his holdings in blue chip companies where he served as a director -- including Royal Bank, Shell, BC Gas and Fletcher Challenge. Stewart also holds shares in Maple Leaf Foods, where he is still a director.

Of Vertex, he says: "No question about it, these guys really shine. Their mandate is to generate positive returns quarterly without regard to the market, and I think that is something they work very hard at. Certainly, as an investor, I would say they have been on that target pretty much all of the time." As the chart on Page E3 shows, Vertex is one of the top performers among alternative strategies funds with a five-year track record. The Vertex Fund is ranked No. 2 in its category for five years and the $47-million Vertex Balanced Fund is No. 1 over the same period, notes Ian Dixon, a financial planner with Vancouver's Granville West Group.

"These kids are good," Dixon said. "They are bright, they are young, they have huge energy and I think they have a chance to be somebody in Canada." Granville West, a firm serving high net-worth clients, tracked Vertex for 18 months before placing any money with them. While the results have been stellar -- a five-year average annual return of 18.3 per cent -- Dixon is also impressed by the dedication and skills of the fund managers. "I am familiar with the strategies they use, although I can't say I could do it," he said. "For our clients, it means we are able to take risk out of portfolios if they will look at alternative strategies where they can actually prosper through change, whether it is up or down markets, or a difference in prices or currencies, or whatever."

Another unabashed fan is Carrie Lyle, vice-president and portfolio manager with ZLC Private Investment Management, a joint venture formed in 2000 between Vertex and Vancouver's venerable Zlotnik, Lamb & Co. "I think they are wonderful, and that's peer assessing peer," Lyle said. "We think the Vertex fund and the balanced fund are perfect complements to one another. Many of our clients are in both funds in various proportions, depending on their own particular situation."

Hedge funds sprout like dandelions in volatile markets. It is estimated that Canadians hold $3 billion to $4 billion in alternative strategies funds, up from less than $500 million five years ago. The fund rating agency Morningstar Canada lists 83 funds in the alternative strategies category, but only 11 have five-year track records. By their nature, hedge funds do not disclose their holdings, and managers usually don't want to tell you what they are doing at any given time because publicity could undermine their strategies. As a result, one description of a hedge fund is "a blind pool that charges a lot of fees." Typically, they charge a one-per-cent annual management fee, plus 20 per cent of the fund's returns above a hurdle rate. Those fees are defended as necessary to attract top talent. Studies suggest the average mutual fund manager's performance is 85 per cent related to how the market is doing and only 15 per cent to skill, while up to 80 or 85 per cent of a hedge fund's performance is attributable to the ability of the hedge fund manager and the additional tools at his or her disposal.

Performance incentives and being personally invested ensure the hedge fund manager's interests are aligned with those of the investor. The Vertex management group is the fund's largest unitholder. Most hedge funds are structured as private placements and reserved for sophisticated investors because the managers want to avoid the limitations placed on standard mutual funds by regulators. In a falling market, mutual fund managers generally can only own securities or shift to cash. They are not permitted to "gamble" with puts, calls, options, leverage and other complex investment strategies that allow hedge fund managers to make money both when the markets rise and when they fall. McCord says Vertex is distinguished by what it does not do -- excessive use of leverage, futures and index options which have led to spectacular hedge fund failures in the U.S. and elsewhere. "We look for opportunities where, in our view, on a risk-adjusted basis, the probability of a positive return is much higher than a negative return," he said.

"Preservation of capital is the cornerstone of our investment philosophy and that comes from our background managing high net-worth clients at M.K. Wong. These people have made their money and they are not interested in trying to shoot the lights out."


McCord says Vertex makes a lot of money from low-risk merger arbitrage deals -- "we look for friendly deals with a very high probability of closing" -- and by identifying catalysts that will allow value to be recognized in undervalued companies. He says the six-person firm has remained focused by rejecting offers to take on additional fund mandates and by out-sourcing most administration. Quarterly performance reports, for example, are handled by Royal Trust, the funds' custodian and trustee.

"We believe that concentrating on the two mandates that we have will allow us to not only generate superior returns now but even as we become bigger," McCord said. While it takes a minimum of $25,000 for B.C. residents to buy into Vertex -- McCord says $200,000 is the average stake of its 350 investors -- hedge funds are accessible to middle-income investors for as little as $1,000 with additional deposits of $250 through insurance products such as National Life's Alternative Investment Strategies. Vancouver's Horizons Mondiale Hedge Fund has a relatively low minimum of $5,000. The fund boasts average annual returns of 10.47 per cent since its launch six years ago. mkane@png.canwest.com

SOURCE: Hedge Funds for Canadians by Peter Beck and Miklos Nagy (Wiley; $26.95)