Hallett now says this was too narrow a snapshot to gauge the funds’ distribution policy or performance. But he says that although there have been good years and bad, if one examines O’Leary’s Global Equity Income Fund (OGE) and its successor mutual fund from 2008 to the present, original investors will have seen their investments decline in value. “One-quarter of OGE’s distributions have been return of capital,” says Hallett. O’Leary Funds says the real figure is 17%. Hallett’s 2009 analysis also showed that most of O’Leary’s funds would have a hard time sustaining their distribution rates from returns in the portfolios alone. “[O’Leary’s] stated investment philosophy was at odds with what they are doing,” says Hallett. “My basic conclusion was there was a lot more marketing than real investment steak.” When asked whether he would invest with O’Leary Funds today, Hallett said, “There are no funds they have that really jump out at me.”
The returns of capital continue in certain funds today. The Yield Advantaged Convertible Debentures Fund returned $11.1 million of investors’ money in 2011 because the fund couldn’t generate the promised yield on its investments.
O’Leary admits that his firm has paid distributions out of investors’ principal—on occasion. “Nobody wants grind, but it’s something you have to do,” he says.
Regardless of the returns of capital, sales of O’Leary funds continued to skyrocket in 2010, adding over $500 million in new closed-end fund assets that year and launching its first set of mutual funds. Such success had Mark McQueen of Wellington Financial, a $500-million Bay Street venture debt fund, scratching his head. McQueen worries that “the bill of goods O’Leary has sold investors is bad for our industry.” Not only do O’Leary Funds grind capital, he argues, but the high yields promised by the company are unsustainable in the long run.
Yield is a hot topic in the industry. In June, Barry Allan, one of the most venerable bond managers on Bay Street and someone who advises on over $6 billion of debt assets, announced that he had to cut distributions on his flagship fund. The portfolio, he said on a conference call, was set up in 2009 when high-yield bonds paid 14% annually, making it easy to pay investors a targeted 8%. But with interest rates so low, it simply wasn’t possible any more. Allan sounded a warning for the entire market: “People are reaching for yield and taking risks that they don’t want to take.”
If a dean of the industry admits 8% distributions on a high-yield portfolio are hard to deliver, how can O’Leary Funds generate its distributions? O’Brien says that good yield opportunities exist—it’s just a matter of finding them. Asked whether he agrees with Allan’s claims, he would neither support nor refute them. Instead, he said it’s hard to compare between funds, because “every single portfolio [manager] has a different mandate, a different size, a different reality that they live with.”
That answer may not assuage clients who have already spotted oddities in their portfolio mix. Recently, a well-respected adviser noticed that in the Yield Advantaged Convertible Debentures Fund, O’Brien purchased a “convert”—a bond that carries the right to be converted into common shares—for about $160, relative to its starting value of $100. At such a rich premium, these bonds no longer trade like stable investments; they swing like speculative stocks. Back in November, 2010, an industry veteran walked into an O’Leary Funds presentation and heard O’Brien touting his holdings of obscure securities, such as Brazilian bonds that paid 11% interest. Since risk is compensated through yield, a rate of 11% suggests these bonds are very speculative. Asked about these types of investments, O’Brien didn’t deny they were made, but says that his exposure in these areas amounts to “very little, very, very little.”
Some people aren’t buying the official story, including five investment advisers who manage billions of dollars of assets and spoke to Report on Business magazine on the condition of anonymity because they work for Big Six banks that have strict media policies. Worried that O’Brien isn’t doing what O’Leary preaches to retail investors, some of them have dialled the dragon directly to relay their fears. One member of this group recalls, “I said to Kevin, ‘You’re supposed to be the smartest businessman in the world. How’d you end up in this situation?’”