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Dale Jackson

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Having it both ways

Dale Jackson


TORONTO (GlobeinvestorGOLD) — If the creed of the contrarian investor is "zig when they zag", the battle cry for market neutral investors is "zig and zag". A market neutral investor aims to turn a profit from any momentum in the market — up or down — by holding simultaneous long and short positions. Although it may seem risky, a good manager can target a modest return while drastically reducing risk.

Quite a few market neutral or long/short funds trade on equity exchanges and some are sold as mutual funds. Long/short funds are normally considered "hedge" or "alternative strategies" funds, which are usually associated with a high degree of risk. Managing director and CEO of Arrow Hedge Partners, Jim McGovern says having his market neutral fund lumped in with riskier hedge funds is misleading. "Right now there's less risk on our long/short fund than the average global equity long fund," he says.

His fund is Arrow Global Long/Short. Actually, it's a fund of funds that includes the funds of 17 different managers with their own long/short portfolios and an estimated 12,500 positions in total. Those portfolios include the Arrow Japan long/short fund, as well as U.S., Asian, Emerging Markets, Canadian and European portfolios. In an attempt to boost returns the fund even holds a U.S distressed securities fund.

So far this year the Arrow Global Long/Short fund has returned 8.5 per cent and is has managed to grow and average 14.4 per cent annually over the past three years. Lately Arrow Hedge partners has beaten the underlying MSCI World index, but over that three year period is has lagged by 8 per cent. The difference, according to McGovern, is that the index is 100 per cent long and his fund has half the volatility. "The real risk in long/short funds comes from management. The fact that we have 17 different managers reduces the risk," he says.

One risk all hedge funds have is their relative lack of disclosure. Unlike most mutual funds, hedge fund managers are not required to release details about strategy and holdings. McGovern says including leverage, his fund is 105 per cent long and 40 per cent short, for a total of 145 per cent invested. Only 65 per cent of the fund is invested in the market right now but that is subject to change at any time at the discretion of the manager.

He says the Arrow Global Long/Short fund holds long positions in several resource companies like Inco and HudBay Minerals, but some of the profits are starting to flow into technology.

Short positions include General Motors, Ford and tech giants like Google, EBay and Softbank.

The Arrow Global Long/Short fund is priced in Canadian or U.S. dollars but McGovern says he has the option to hedge if he feels there's a currency risk.

Such a heavily managed fund has its price. The management expense ratio (MER) for the fund is 2.5 per cent plus a 20 per cent performance fee if the fund does well. The minimum initial investment is $25,000 — a bit pricey for the average investor but McGovern says it's all retail investors need for the global weighting in their portfolios. "At the end of the day we want to beat the market and manage volatility," he says.

The Arrow Global Long/Short fund is the top performing long/short fund over the past year with a return of 14.4 per cent, but over the past three years it takes second place. The top three year performer is the BluMont Hirsch Long/Short fund with an average annual return of 15.4 per cent.

The fund's $75.5-million in assets is fully invested in 162 positions in Canadian equity holdings. Manager Veronika Hirsch holds long and short positions mostly in the energy, financial services and materials sector. The fund has returned 7.3 per cent so far this year.

Like the Arrow long/short fund the minimum initial investment for "accredited investors" is $25,000. The MER is 3.15 per cent plus a performance fee when the fund does well.

Trying to compare the risk of these two funds is like trying to hit a moving target. Managers have the option of adjusting the risk level on a dime, and the investor does not need to be informed.

The most common measurement of risk in standard mutual funds is "beta". Beta measures the volatility of a mutual fund relative to the overall market, usually the corresponding index. A beta above 1 is more volatile than the overall market, while a beta below 1 is less volatile.

Using the S&P/TSX Total Return as a benchmark, the 3-year beta for The Arrow Global Long/Short fund is 0.3 versus 0.57 for the BluMont Hirsch Long/Short fund. The higher beta for the BluMont Hirsch fund implies greater risk but the measurement is flawed when you consider the risk level on both funds is constantly subject to change.

Long/short funds have been growing in popularity despite the recent follies of some high profile hedge funds. But the true purpose of a hedge is to reduce risk and it's up to individual investors to find a manager they're comfortable with.

Dale Jackson has been a producer at Report on Business Television since its launch in September 1999.

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