For the past decade, hedge funds have functioned as the Darth Vaders of the investment world – swathed in mystery and viewed by almost everyone with some measure of distrust.
One reason hedge funds inspire so much fear is a lack of clarity around what precisely they are. “Unfortunately,” says Gary Ostoich, Chair of the Alternative Investment Management Association (AIMA) Canada, “there isn’t a definition that everyone will agree upon.” He freely admits that his suggestion – “managers seeking absolute returns using a variety of strategies and financial instruments that aren’t otherwise available to traditional mutual funds” – is a bit of a mouthful.
Ostoich says that the widespread notion that hedge funds short stock “simply isn’t true.” To illustrate, he points out that one hedge fund strategy – activism – has nothing to do with shorting stocks at all, but is, in fact, an example of a non-traditional method of producing investment returns.
Many corporate access experts believe that the nasty reputation surrounding hedge funds is unjustified – and is holding IROs back from exploring some very deep asset pools.
Mike Westcott, Senior Managing Director and Head of Institutional Sales for Raymond James Ltd. (Canada), understands that IROs “don’t want to spend time with someone who’s going to walk out of a meeting and short their stock.”
That said, he wants IROs to recognize that there are a number of hedge fund managers that don’t short stocks. “A lot of the hedge funds we deal with are very good, loyal and knowledgeable long-term shareholders,” he says. “So I think it’s a big mistake not to go visit them.”
Too Big To Ignore
Just as in the U.S., where hedge funds tend to be headquartered in Connecticut, Canadian hedge funds are clustered in and around Toronto. Beyond this geographical proximity, hedge funds have little in common and can therefore be difficult to identify.
In recent years, says Ostoich, both the number and the average size of hedge funds has grown. He estimates that while hedge funds in Canada had $15-$16 billion in assets under management in 2007, today they have north of $34 billion in assets. He also points out that far more new hedge funds are being created each year than are closing shop. As a ballpark figure, he suggests that there are 160-175 hedge fund managers operating in Canada today.
More importantly, hedge funds are evolving, with more long-only funds emerging. Many major fund families include a hedge fund or two within their umbrellas – yet another sign that the lines between traditional investments and hedge funds are blurring.
“The industry has matured,” says Ostoich. “Ten years ago, the industry was more focused on long-biased resource managers. Today, you see a broad range of strategies, whether it’s activism, quantitative or a credit strategy. You’re seeing a much broader range of strategies.”
For IROs who would prefer to avoid certain types of hedge fund managers, researching them is challenging but not impossible. Ostoich, for instance, recommends googling the name of a hedge fund to see whether there are any news accounts of activism or other strategies that IROs might prefer to avoid.
Another source of information is two recent pieces in IR leader: “Hedging Your Bet – Part I: What Makes a Hedge Fund Tick?” (February 2013) and “Hedging Your Bet – Part II: Tips for Interacting with Hedge Funds” (March 2013).
The IRO’s Perspective
Although some IROs may have softened their stances when it comes to meeting with hedge fund managers, there are still plenty of apprehensions and misgivings swirling around.
One of the first problems for IROs is identifying hedge funds. Marie-Josée Privyk, Director of Investor Relations for Innergex Renewable Energy, Inc., an independent power producer relying solely upon renewable energy resources in Longueuil, Quebec, doesn’t believe that any of her investors are hedge funds, but she doesn’t know for certain. That’s because investors don’t have to go public in Canada if their stakes are smaller than 10%.
“From everything I know of hedge funds, their investment horizon is shorter,” says Privyk. “They are not long-term investors. By definition, hedge funds are looking to exploit market inefficiencies or valuation inefficiencies in a company.”
On the other hand, Anne Plasterer, Executive Director of Investor Relations at Newalta Corporation, points out that her company has a small percentage of hedge fund investors and that this ownership has increased over the past year. Plasterer has not noticed “any significant difference in time horizon for this group,” although she expects that hedge funds’ investment horizons are, in fact, shorter. Nor has she seen any evidence of hedge funds shorting the company’s stock.
Plasterer notes that because institutional investors, insiders and employees make up about 80% of Newalta’s shareholder base, retail ownership is small and day-to-day trading activity can be sluggish. “As a result,” she says, “I wouldn’t mind seeing a few hedge funds trading our stock, just to improve liquidity.”
Meeting with Hedge Funds
Although many IROs have prejudices about hedge funds, most haven’t penned formal policies about whether or not to fraternize with them. “We wouldn’t refuse a meeting if a hedge fund wanted to speak with us,” says Privyk. “There’s always something to be gained from the dialogue.”
On the other hand, Innergex doesn’t target hedge funds because the company’s sights are set on long-term shareholders. “It’s not that we wouldn’t want to meet with a hedge fund,” she says. “It’s just that when we’re organizing non-deal roadshows, we would prefer to be face-to-face with investors who have a legitimate interest. We’re seeking long-term investors in our company.”
Plasterer, who is more bullish on hedge funds, does acknowledge that they can be a drag on management’s time. For this reason, IR tries to meet with hedge fund managers before setting up a meeting with top executives, in order to conserve management’s time for more strategic conversations.
“When we’re setting up non-deal roadshows,” she says, “we try to make sure we have a balance. We don’t want the roadshow dominated by meetings with hedge funds, but we will meet with a few whom we’ve pre-qualified either through the sell-side bank setting up the meetings, or a pre-meeting call with IR.”
Greg Waller, Vice President of Investor Relations at Vancouver-based Teck Resources, notes that not all hedge funds requesting meetings do so because they’re considering investing in a company: “A lot of the time, hedge funds are clearly just looking for market information that we’re knowledgeable about. They’re just trying to see what they can learn from us and they may have no interest in investing in us.” He continues: “With the bigger fundamental managers, we know that they’ve been invested in the sector in the past and for good reasons they may not be big purchasers at the time. That’s not always the case when you’re dealing with hedge funds.”
“Hedge funds probably seek us out more than we seek them out,” continues Waller. At bank-sponsored conferences, for instance, he notes that a number of meeting requests typically come from hedge funds. “We do meet with some of them,” he says, noting that “hedge funds are not all created equal.” He continues: “There are some that are more influential and more responsible to deal with, and certainly we do meet with some of them.”
What the Future Will Bring
Over time, the breadth of hedge fund strategies has grown. Ostoich suggests that Canadian hedge fund managers are currently employing anywhere from 20-to-30 separate strategies.
In addition, regulations surrounding hedge funds are starting to change. Today, only accredited investors who have a liquid net worth exceeding $1 million or an annual income of $200,000 are eligible to invest in hedge funds. Canadian regulators are, however, looking for ways to allow the average retail investor to invest in hedge funds – depending on the hedge fund strategy a given manager employs, says Ostoich.
This development, known as “retailization,” could mean that even more assets will pour into hedge funds in the not-too-distant future. “Retailization,” says Ostoich, “is why you see some of the larger, long-only managers getting into this space.”
In the European Union, the UCITS (Undertakings for Collective Investment in Transferable Securities) directive cleared the way for alternative investment funds to be formed – at the same time, allowing certain hedge fund strategies to be available to retail investors, explains Ostoich.
“In Canada,” he says, “there’s limited ability to offer a retail hedge fund strategy, but we see changes coming down from the regulator.” Last March, for instance, the Ontario Securities Commission, the regulator responsible for overseeing hedge funds in the Toronto area, gave signals that retail investors might someday be able to invest in hedge funds.
“Hedge funds are not going away. If anything, they’ll continue to grow because there will be larger pools of retail assets going into their strategies,” concludes Ostoich. “I think hedge fund managers are managers you don’t want to ignore. You want to get educated and find ways to reach out to them.”