Canadian hedge fund probe puts advisers in the limelight

Feb 28, 2005 @ 12:01 am

By David Clarke

OTTAWA - Already staggered by a market-timing scandal, the Canadian mutual fund industry is now the target of a probe into Portus Alternative Asset Management Inc., a Toronto-based purveyor of funds of hedge funds. And financial advisers are being questioned to see if firms recommending Portus to clients made sure the investments were suitable.

This is not Canada's version of the Long-Term Capital Management LP fiasco, however.

"There is no sign that Portus has lost any money," said Miklos Nagy, chairman of the Canadian Hedge Watch newsletter and a veteran industry observer.

What eight provincial securities regulators across Canada are investigating is sales and compliance practices at Portus, which has suspended operations until May 17 at the earliest and is precluded from opening new client accounts or making redemptions to customers.

Industry booming up north

Portus was created two years ago as Paradigm Asset Management Inc. and boasted of a relationship with hedge fund guru James Park of New York-based Paradigm Global Advisors LLC. The relationship was terminated in early 2004, which led to the name change.

With $730 million (Canadian) in assets and 26,000 clients, Portus is one of the fastest-growing hedge funds in Canada. The hedge fund industry is booming up north, growing at a rate of 40% annually over the past several years. Assets in Canadian hedge funds totaled about $16 billion in 2004, up from $2.5 billion in 1999.

Rather than sell its funds directly to investors, Portus relies on referrals from independent advisers and financial planners. The due diligence practices of financial advisers in marketing the company's products is key.

The Investment Dealers Association in Toronto has sent out a questionnaire to its members about the due diligence it performed before recommending investment in Portus.

According to internal documents, Portus paid advisers 5% of the assets they referred, plus one-quarter of an 18% annual performance fee. Portus is accused of diverting more than $87.6 million in funds to commissions, referral fees and other expenses.

Greg Monforton and Partners, a class-action litigator based in Windsor, Ontario, has put up a website claiming that "many experts believe the investment firm's policies make it nearly impossible for an investor to make a positive return. It is estimated the fund would require a 15% annual return to cover the various fees and administrative costs incurred by Portus management."

Manulife Securities International Ltd. referrals accounted for more than $200 million of Portus' asset total.

Manulife Securities is a unit of Canada's largest financial company, Toronto-based Manulife Financial Corp., which owns John Hancock Financial Services Inc. of Boston.

According to Manulife spokesman Tom Nunn, despite the "international" in its name, the securities firm does business only in Canada. He would not comment on reports that there is a major shakeup going on at the firm as a result of negative publicity.

Will Portus' woes lead to regulatory shakeup?

"I think it will," Mr. Nagy said, "especially in terms of the principal-protected sector."

Funds of hedge funds have grown in popularity with average retail investors in Canada. For an investment typically of $5,000, or in some cases as low as $1,000, an investor can buy into a basket of hedge funds with the principal protected.

Portus' complicated array of products included a form of principal protection supposedly backed by long-term notes from Soci%E9;t%E9; G%E9;n%E9;rale Canada, a Montreal-based unit of the French banking giant.

But Soci%E9;t%E9; G%E9;n%E9;rale Canada was not mentioned by name on the fund's offering memorandum, contrary to usual industry practice.

Diletta Prando, director of legal affairs for the subsidiary, would confirm only that it has been contacted by regulators and is cooperating with their requests.

"I don't think it much matters," Mr. Nagy said. "Typically, a hedge fund will put most of its assets in government bonds, which carry their own kind of protection.

Regulators have confirmed that the two derivatives in which Portus had been trading were linked to the equity of Precision Drilling Corp. of Calgary, Alberta, and Cognos Inc. of Ottawa.

The Montr%E9;al Exchange dominates derivatives trading in Canada, and works with the Boston Options Exchange. But Mr. Nagy said he doesn't think "the actual derivatives trading is much of an issue to regulators."

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