Canada’s hedge fund sector will almost certainly never rival the scale of that of its giant neighbour to the south, but it is currently enjoying striking success on a number of fronts which, indust
Canada’s hedge fund sector will almost certainly never rival the scale of that of its giant neighbour to the south, but it is currently enjoying striking success on a number of fronts which, industry members hope, will help to consolidate its position both within the country’s domestic investment structure and firmly establish it on the global map as a focus of interest for international investors and as a major hedge fund service centre for the Americas.
The surge in commodity and energy prices this decade has helped to awaken the interest of investors worldwide in resourcesrich Canada, and hedge funds have taken advantage of a booming market that has seen extensive merger and acquisition activity. Local hedge fund managers are benefiting from allocations by investors from outside the country, especially in Europe, while managers abroad are increasing their exposure to Canadian assets.
industry is growing from strength to strength, not only in Toronto, where a number of leading international administrators have joined a cluster of firms headed by the top local player, RBC Dexia Investor Services, but also in the newly-discovered financial services centre of Halifax, Nova Scotia, where Olympia Capital, Butterfield Fund Services and Citco have all set up operations in recent months.
Toronto, the home of the country’s leading stock exchange and the main centre for investment banking, remains the principal focus of the hedge fund industry, although Brad Taylor, global head of investment finance and hedge fund services at RBC Dexia, points out that the firm also has administration and custody clients based in Vancouver and Montreal as well as Calgary, the main hub of the natural resources industry.
It also helps that Toronto is easily accessible from the main centres of the US hedge fund industry. Says Taylor: ‘Canada is a stable democracy, well regulated, an hour’s flight from New York and in the same time zone. For institutional investors looking to make bets in different global markets, it is only a short step away from the US. Investing in energy securities in Canada can be more comforting than in securities whose assets are in more volatile regions of the world.’
Jim Buckley, head of global equity finance at Scotia Capital, notes that in some respects the Canadian market is less developed than the US, for example in the degree to which direct market access has taken root, but he acknowledges that Scotia’s ability to win business from European hedge funds is boosted by its expertise in its domestic market and ability to service Canadian shares. ‘As funds are deploying energy and mining strategies, we’re looking to see how we can better service their needs in these areas,’ he says. Buckley believes the Canadian hedge fund industry is poised for significant growth in the coming months and years. ‘Canada has been lagging a number of other capital markets in development, but we’re starting to see a number of mainstream mutual fund managers launch hedge products, an important step in the market’s evolution,’ he says. ‘We’ve already got the independent players that offer solely hedge products, but we’re starting to see more and more people looking to participate in the returns of the hedge space rather than being constrained by long-only strategies.’
Mark Purdy, chief investment officer of Arrow Hedge Partners, a Toronto-based manager of single-manager hedge funds and funds of hedge funds, argues that perceptions abroad of the Canadian hedge fund industry have been assisted by a number of factors, including a series of international conferences and seminars designed to raise the country’s global profile, as well as the development of the Scotia Hedge Fund Index.
Purdy, whose firm has seen its assets under management nearly double from CAD500m to more than CAD900m over the past year, says: ‘The returns that managers have produced, the fact people are monitoring the Scotia index, and a series of events in London, Zurich and Geneva over the past year have really put Canada on the map. The main focus for investors is energy and commodities, which are still the market’s shop window, but there are also special situation investors interested in consolidation opportunities.’
Industry participants acknowledge that the impact of scandals such as Portus and Norshield still weighs to some extent on domestic attitudes toward hedge funds, but they believe a more rounded picture is emerging. Taylor says: ‘Listening to comments made by the governor of the Bank of Canada and the minister of finance, there seems to be an awareness of the role played by hedge funds and the benefits they can provide in the marketplace.’
Purdy notes that while there is plenty of interest in alternatives among larger institutions, hedge fund managers find it more difficult to gain traction with pension schemes in the bracket between CAD500m and CAD3bn. ‘Some of the bigger institutions are looking to bring single managers into their hedge fund portfolios,’ he says, arguing that in the respect Canada is following a pattern set in other markets. ‘The same experience will happen here, it will just take a bit longer. Those institutions that are branching out into single-manager funds tend to do so with managers outside Canada.’
Meanwhile, Toronto is continuing to consolidate its position as a centre for hedge fund administration serving not only the domestic industry but international clients, following the arrival of global banks such as UBS and Citigroup as well as specialist hedge fund administrators like Citco. Notes Taylor: ‘A number of US-based institutions have set up shop in Toronto, where they can access high-quality personnel at a reasonable cost and close to the local market. Some of them are offering services to Canadian clients, while others are servicing a US and offshore-based clientele.’
Toronto, he argues, compares favourably in terms of living and business costs with New York or London – it’s not even the most expensive city in Canada, a title that these days falls to Calgary – yet the city benefits from a very high-quality infrastructure. ‘Because of its geographical location close to major US markets, it benefits from highquality transport links, and its cost base is attractive for service providers used to the tristate area of New York, New Jersey and Connecticut,’ he says.
Raj Kothari, partner and leader of the investment management practice at PricewaterhouseCoopers in Toronto, argues that the administration industry is still essentially focused on the offshore hedge fund industry rather than Canadian managers – a reflection of the fact that many of Canada’s 250-odd funds have less than USD15m in assets and only a handful of players have more than USD1bn. This acts as a brake, he argues, on the development of the kind of infrastructure found in the US, or even in the Cayman Islands.
One of the factors that have made Toronto attractive as a centre for hedge fund servicing is the availability of qualified staff, but industry players say this should not be interpreted as abundance, and staffing raises issues in Canada as much as in other administration centres. Taylor says of RBC Dexia’s competitors: ‘They are not only looking to provide the same services as us but they’re also competing for the same talent pool.’
Kothari adds: ‘In the financial services industry as a whole there is no shortage of skills, but the hedge fund industry is much understands it. Because the industry doesn’t have the critical mass of other financial sectors, to attract the best and the brightest becomes a challenge.’
He notes that while some of the smaller Canadian administration firms are more limited in their capacity to service larger and more sophisticated funds, the influx of big firms like Citco and UBS is bringing skills such as the pricing of hard-to-value instruments into the marketplace, drawing upon the capacity of their offices elsewhere in the world. This process, Kothari believes, is already expanding the range of capabilities available in Canada.
‘Finding high-quality talent is a challenge in any industry,’ Taylor says. ‘This industry has a fairly constant innovation curve, which makes it a challenge to find well versed people to put in any role, but that’s not unique to Toronto, it applies equally to New York, London or any other major centre. But Toronto does benefit from a well-educated workforce, and in my view trying to find people with the requisite skills seems to be a little bit easier in the Canadian marketplace.
‘The specialist skill set involving hedge fund knowledge and awareness is an enhanced challenge we’re constantly dealing with. To find and attract talent, we make sure we offer an opportunity and a workplace environment that will attract the right people, but we also have an ongoing training effort to bring people in the organisation up to speed on new strategies and other developments. We’re constantly educating our people and maintaining their awarenessof innovation in the marketplace.’ The constant search for skills is complemented by judicious deployment of technology. ‘We’re spending a lot of time and effort ensuring that we have very good technology systems,’ Taylor says. ‘We have to develop and reproduce processes very frequently, so we need the scalability to manage a growing number of clients.’ An additional challenge, he notes, is the move toward a shortened settlement cycle agreed by the Canadian Capital Markets Associationand the country’s financial regulators, an initiative much discussed in other countries but that will soon be reality in Canada. A number of fund administrators are seeking to ensure better access to skilled staff and keep costs under control by setting up operations in Nova Scotia. In November Butterfield Fund Services announced plans to establish a new fund administration centre in Halifax, which opened in March. The venture plans to hire up to 60 people by the end of this year and as many as 400 by 2013.
Olympia Capital, another Bermuda-based administrator which opened its Halifax office last August, expects to reach 35 staff in 2007 and is targeting 150 jobs by 2011, Meanwhile Citco, which already employs 350 people in Toronto, plans to add the same number at its operation in Halifax, which will comprise both an administration centre and a training Facility for the group’s employees throughout North America.
Says Kothari: ‘This is an interesting experiment known as nearshoring rather than offshoring. Halifax is being boosted by two factors, a common language in English and understanding of the business model, which makes it more accessible to the US marketplace than, for instance, operations in India. But the challenge in Halifax is resources and skills. They are trumpeting the concept of nearshoring, but the question is whether the skill sets will be available to meet the demand if it becomes a big cluster.’ Financial incentives linked to the number of jobs created have played a role in attracting financial services businesses to Nova Scotia. Says Buckley: ‘Various tax advantages have helped to persuade international administrators to locate there, but the other factor is the availability of accounting talent. There’s a lot of expertise that can be used to provide fund valuations and improved investor reporting.’
Adds Taylor: ‘Halifax is a large city with a very strong and well-educated labour force. It is also in a time zone very close to the US East Coast and the offshore jurisdictions. It isn’t one of the major Canadian financial centres, but some large institutions have back office facilities there, so it offers a skill set and knowledge of fund administration and some other capabilities. The interest is driven in part by access to a highly-skilled workforce at a reasonable price.’
Kothari is convinced that the outlook for Canada’s hedge fund industry is positive, with the prospect of significantly higher levels of investment by both institutions and individuals poised to benefit local managers as well as administrators that can look forward to a more substantial base of domestic business.
‘In the future huge amounts of cash will need to find a home, and hedge funds will become a more important tool for channelling these funds,’ he says. ‘The bad memories of Portus and Norshield are fading away, which can only be positive for the industry. Hedge funds investing in the commodities sector have shown good returns recently, and investors are likely to start looking more closely at these markets if they have a feeling the equity markets have peaked.
"One challenge to the hedge fund industry everywhere in the world but especially here is that Canadians are more prone to examining the cost structure. When returns are huge, no-one minds the cost, but when returns are less stellar, people begin to look at levels of fees. Another challenge is the regulatory process regarding hedge funds sales practices, and the new registration requirements proposed in January that aim to ensure fund managers have appropriate capital and insurance, experience and proficiency qualifications.’
Purdy is not convinced that establishing a nationwide system of regulation for the industry is either desirable or even possible. ‘Hedge fund managers are currently regulated through provincial jurisdictions, and I’m not sure how much national regulation would add from the standpoint of investors, who are currently pretty well protected as it is,’ he says. ‘The efforts to achieve common Canadian standardisation of rules have been going on for a long time, and it’s proved very difficult. We’ll see if they can do it this time.’
