Ari Shiff, founder of alternative investment firm Inflection Management Inc., likens good hedge funds to gut bacteria that digest problems such as the subprime-mortgage crisis. You may not like their volatility, but they buy assets in a way that can support economic health.
Not all bacteria are good for you, though, and for the Vancouver-based head of one of the few for-Canadians-by-Canadians funds that invest in global hedge funds, the challenge of identifying the right investment strategies, managers and regions is matched in difficulty by knowing exactly when to deploy capital.
"A lot of funds of hedge funds are samplers that cover the waterfront with a little bit of this and that. We're not like that," Mr. Shiff said in an interview. "We have a definite macroeconomic view of where markets are going and we'll have three or four themes going at a given time."
He strives for an average 10-per-cent return even as the "fund of hedge funds" (FOHFs) investment class shrinks around the world, undercut by high fees, unreliable returns and a growing preference among investors for alternative investment strategies.
Funds of hedge funds let wealthy investors pool their assets to gain access to many different hedge funds. This kind of diversification is meant to reduce the risk of subscribing to any one hedge-fund manager's strategy. Hedge funds usually have high minimum investment levels – typically more than $1-million – which can make investing in more than one prohibitively expensive. Others may be closed to new investment.
FOHFs have yet to recover from the financial crisis. Global net asset flows have been negative for them since 2007, and their number has fallen 25 per cent in the past six years, according to Chicago-based industry watcher Hedge Fund Research Inc.
But Mr. Shiff's track record backs up his confidence in his strategy. In 2012, his Inflection Strategic Opportunities Fund was ranked by HedgeFund Intelligence as the top global performer among U.S.-dollar-denominated funds that use a leveraged global strategy. The fund has a minimum investment of $100,000 (U.S.), deploys $20-million in investments including leverage and is open to accredited Canadians investors only.
Mr. Shiff attributes his strategy's success to his unusual path to the world of finance. He was hired by a merchant bank after finishing a postgraduate degree in architecture from Cambridge University. "I'm a very pattern-oriented guy. If there's a piece out place in a large pattern, I'll see it," he said. "And that's kind of what we do; we look at the markets and say, 'What's wrong with this picture?'"
He began investing his own money in hedge funds in 1995, and in 2004 he opened a FOHF with a partner by pooling his own wealth with that of friends and family. He sold his stake in that fund in 2008 before the crash. "As soon as I got my money out of the fund, it was deployed again towards things I thought were going to make money out of the crash," he said. That included distressed corporate debt and mortgage-backed securities.
In 2009, Mr. Shiff started Inflection and has since expanded the firm's focus to mergers and acquisitions as well as sovereign debt in Italy, Spain, Cyprus and Greece. Now, the firm is looking for investment opportunities amid the chaos in European banking.
How Canadians will embrace funds of hedge funds in the future? "It's something coming to Canada, but why we haven't seen much of it is because the big banks dominate here," Mr. Shiff said.
Canada's major lenders have a great influence over hedge-fund investing in Canada. "Big banks are starting to pick up hedge funds, and things are starting to change," Mr. Shiff said. If you're not owned by a big bank, you're not promoted.
The big banks compete with their own hedge funds, as well as products such as Royal Bank of Canada's ARC Fund Ltd., which has operated since 2000 and has a minimum investment of just $50,000. RBC operates the fund with the help of a New York-based investment adviser called Saguenay Capital.
Other independent players are also competing for investment dollars. Bob Thompson, vice-president of Thompson Investment Partners, isn't running a formal fund of hedge funds, but he says he does "put investor money into individual fund of funds for high-net-worth clients."
But the business has many unique challenges outside of competition. There is the issue of having enough capital to diversify fully, gaining access to exclusive funds, and then finding the right fee structure and liquidity within the hedge fund to make the arrangement profitable.
Mr. Shiff is willing to miss out on a few percentage points of return to wait for the right time to invest. It's a lesson he learned the hard way in 1998 when he jumped into biotechnology too early and lost money.
"You have to be willing to say you weren't the first to get in," he said of what he has learned since then. "You don't want to be sitting on money that has gone to sleep, or catching any falling knives."
Editor's note: This story has been corrected. An earlier version incorrectly characterized Inflection Management Inc.'s $20-million as assets under management. In fact, that is the amount that the fund has deployed in investments including leverage.
(Jacqueline Nelson is a Globe and Mail Financial Services Reporter.)
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