To solve the second problem, O’Leary partnered with Connor O’Brien, who was introduced to him by a consultant. Born in Montreal, O’Brien was a former Olympic skier for both Britain and Estonia, and he had worked on Wall Street in investment banking at Merrill Lynch and Lehman Brothers. O’Brien also had start-up experience, having created a private equity shop, Stanton Capital Corp., in 1995, with his wife, Louise Anne Poirier—who is now chief financial officer of O’Leary Funds—and a colleague in Peru.
Stanton morphed into an asset manager, and in 2004 it launched two hedge funds, managed by O’Brien. The fate of the Stanton International Equity and the Stanton Diversified Strategies funds, which has not been widely reported, may come as a surprise to investors in O’Leary Funds. Stanton’s Diversified Strategies Fund blew up in late 2008, with massive losses amplified by the fund’s use of leverage. Investors who had bought in 2007 or 2008 lost up to 70% of their money, according to a broker who put clients into the fund. Documents obtained by Report on Business magazine show that redemptions were suspended in January, 2009.
O’Brien does not deny that there was a meltdown in 2008 and 2009, but he adds that in the four years prior, investors earned a cumulative return of 30%, plus a significant tax break. He justifies the redemption freeze by saying matters were out of his hands. “We basically passed through, effectively, the policy decision of the bank,” he says.
Turning to his new venture, O’Brien hashed out the division of labour with his partner: O’Leary would market the firm and generate investment ideas, while O’Brien would do the day-to-day portfolio management. O’Leary readily acknowledges that his partner is the “licensed money manager, and I’m just an investor.” The two men split ownership of their joint venture 50-50, and both agreed on a specific investing strategy: “Get Paid While You Wait.” This harked back to the mantra from O’Leary’s mother about buying safe, conservative products and securities that either paid interest or dividends.
On July 30, 2008, O’Leary unveiled his venture with his “pay Daddy” spiel on SqueezePlay. His statement that he wouldn’t grind capital meant the 5% annual yield his first fund promised would come from stellar returns, not from handing investors back their own money.
Early on, the funds flew off the shelves, in part because O’Leary launched closed-end funds, not regular mutual funds. Although the two can have similar management styles, they are sold differently. Mutual funds allow investors to buy from, and sell to, the fund company whenever they choose, but closed-end funds are marketed in one big push. Thereafter, no more units of the funds are issued. In most cases, investors who want to quit their positions must sell to someone else, much like they would a stock. There are opportunities to sell back to the fund company, but only on a few pre-set days each year.
Because all of the fund money is raised during the intense marketing period, investment advisers are enticed to deploy client money through hefty upfront commissions. O’Leary Funds paid 3% commissions—the industry standard—for client money invested in their funds. In about two years, these funds raised $1 billion, which means a whopping $30 million was paid to advisers.
Because early performance from portfolios such as the Global Infrastructure Fund was strong, the company was able to add new funds every two to five months. The offerings got bigger quickly, and each of four funds launched in 2009 raised over $110 million, with distributions that provided investors with annual yields between 6% and 9%. In 2010, O’Leary felt confident enough to float the idea that the company would hit $5 billion in assets within three years—and that it could be taken public. Ecstatic that his funds hit $1 billion in assets under management so quickly, O’Leary celebrated by buying O’Brien a Cartier Roadster watch.
But underlying the success, some questions lurked. Despite their claims that the funds would never touch investors’ principal, O’Leary and O’Brien evidently started doing just that. In 2009, Dan Hallett, vice-president of asset management at Highview Financial Group and a highly regarded expert on mutual funds, wrote a report on the performance of the O’Leary Funds up until that point. Hallett noted that while the fund’s website said investors are “paid by true portfolio yield,” this promise was “over-the-top” given that 81% of the O’Leary Global Equity Income’s 2008 distributions were being paid from return of capital—giving investors their own money.