How a bad bet sent Phoenix falling

Bond traders call it a "Rio hedge."

It's a black joke. A Rio hedge is when a trader who has lost a lot of money makes one more big bet without the boss's knowledge, but just in case it proves a loser, the trader buys a one-way ticket to some place like Rio de Janeiro.

During the past few months, Steve Duthie secretly took out a Rio hedge at Phoenix Hedge Fund Corp.

Mr. Duthie's bet went awry, and he is nowhere to be found.

Toronto-based Phoenix, which had $250-million in assets going into this disaster, has been forever crippled by a failed play in the U.S. bond market.

Now several hundred angry investors want to know how this trader managed to lose so much of their savings, and 15 Phoenix employees would like to know the whereabouts of a colleague that many had worked with, shoulder to shoulder, for the past eight years.

Yesterday, Phoenix co-founder and head Mark Kassirer said that while no other financial institution lost money on this deal, his firm's losses are substantial. "This is the end of Phoenix as we know it," he said.

Mr. Kassirer said Mr. Duthie is about 37 years old, is married and has no children. "I can't tell you much about his background other than the fact that he's an American citizen, was brought up in Canada, lived in the Toronto area," he said.

Mr. Kassirer last saw the trader on Dec. 31. "I have no idea where he is. We obviously have tried to contact him, unsuccessfully."

Mr. Duthie and his wife occupy a red-brick, semidetached Victorian house they bought for $515,000 last March on Marlborough Avenue in midtown Toronto. The house faces the York Raquets Club, to which they do not belong.

Neighbours described them as a young, attractive, well-dressed couple who came and went on foot, having no car. Except for a light in the basement, the house was dark last night, with all shades drawn. Next-door neighbour Margaret Bates said Mr. Duthie kept to himself but seemed to be at home more often since early December.

"When they moved in, we thought, 'Oh, look, a nice young couple has bought that house,' " another neighbour said. "This is so sad. Poor guy. Poor everybody."

Phoenix, whose funds require a minimum investment of $1-million, has a branch in Hamilton, Bermuda. The man who runs it, Karl Wildi, said he did not know where Mr. Duthie was and did not recall when he last saw him.

Among those seeking answers is the Ontario Securities Commission. "We became aware of this yesterday," the OSC's manager of investigations, Brian Butler, said last night, "and we have staff making the appropriate inquiries."

To understand just what Mr. Duthie did, it helps to know the basic workings of hedge funds.

Phoenix was founded in 1994 by veterans of investment dealer Burns Fry, led by Mr. Kassirer, who had headed up the firm's fixed-income desk and had been chief executive officer at Deutsche Bank Securities' Canadian arm. Mr. Duthie also worked at Burns Fry and also was among Phoenix's founders.

The Phoenix team set up a number of funds that tried to generate steady profits while eliminating market risk. The company takes a fee of 1.5 per cent of assets managed, plus 20 per cent of all returns in excess of what an investor would have made from buying a Treasury bill. Until this week, Phoenix prospered, posting an average annual return of 12 per cent.

Phoenix's specialty is picking up bonds that, for one reason or another, have been mispriced against comparable debt. For example, heavy buying of one government of Canada bond might temporarily drive up its price, with the price drifting back to normal in as little as a few weeks. Phoenix's hedge funds made money betting on this type of move in Canadian, U.S. and European bond markets.

By using its own money as collateral, then borrowing heavily, or leveraging, Phoenix and other hedge funds can increase exposure to the market, which makes the wins sweeter, but increases the pain of losses.

"Phoenix has been a consistent performer, and they are a huge client of most dealers. They might do $800-million of business on a busy day," said a veteran bond trader at one bank.

According to Mr. Kassirer, Mr. Duthie's responsibilities included running the firm's U.S. holdings of what are known as bond "repos," Bay Street slang for repurchase agreements.

In simple terms, the Phoenix trader would borrow U.S. bonds from another financial institution, promising to return the securities at a given date and at a given price, usually within a few days.

Repos are considered a low-risk business with razor-thin profit margins; Phoenix and other players in this game make money by dealing in huge amounts of bonds. It would not be unusual for Mr. Duthie to have $2-billion or more in repo agreements on Phoenix's books.

At some point several months ago -- Phoenix and a forensic accounting team from KPMG are still exploring just when the problem began -- Mr. Duthie stopped playing repos and started buying U.S. government bonds.

"The logical guess is there was a loss here, and he tried to trade his way out of it," said Mr. Kassirer, adding that Phoenix is still trying to work out the extent of the damage.

Unlike repos, holding bonds is a high-risk proposition, as a sharp move in interest rates can lead to major losses.

In the past week, U.S. bond prices plunged on fears of rising interest rates. Mr. Duthie took an enormous hit on his positions, all of which were hidden from the other partners. That changed when the Phoenix employees returned from the New Year's holiday.

"We came in on Tuesday, and we noticed that there were price discrepancies," Mr. Kassirer said. The discrepancies were between what Phoenix's books said the repo holdings were worth, and what the market said they were worth.

Mr. Duthie hadn't come to work, so someone called his house for an explanation. "His wife said he was away on a business trip, and he couldn't be reached. That's when we became concerned."

By midday, Mr. Kassirer knew something was seriously amiss, and began calling clients, regulators and other financial institutions. He can't say just how much Phoenix lost, but it's the bulk of the company's $250-million in assets. The hit to a publiclylisted hedge fund run by Phoenix has already been pegged at $7.4-million, which was 30 per cent of its holdings, and this fund is being wound down.

"We have sophisticated checks and balances in place. But if someone is determined, and deliberately sets out to defy your systems, then any system can be beaten for a time," Mr. Kassirer said. "And this was made all the more difficult to anticipate because this is a fellow some of us had worked with for eight years."

Mr. Duthie has not been heard from since the weekend, but has been the source of much Bay Street gossip. One rival fund manager said Mr. Duthie told his wife "he'd be gone for a long time" when he headed out the door this week on the "business trip."

The Phoenix trader is the latest in a long line of rogues who have brought down their employers by attempting to trade their way out of a bad situation.

The hall of shame would include Nick Leeson, who broke British bank Barings PLC in 1995 when he racked up a $1.4-billion (U.S.) loss on derivatives trades; government bond trader Joseph Jett, who masked $100-million in trading losses at New York's Kidder Peabody & Co. in 1994 with $350-million of fake bond profits, and Len Gaudet, who brought down Canadian brokerage house Osler Inc. in 1987 when he and two colleagues looted the company of $12-million through phony bond trades and accounting.