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Looking beyond the big private equity players

Many investors focus on the big names, but smaller funds could also find a place in their portfolios

FUNDS REPORTER

Private equity is hot. Mega-deals are making headlines, and there are hopes of big returns down the road. Retail investors seeking a piece of the action can invest in stocks of private equity powerhouses such as Onex Corp. in Canada or Blackstone Group LP in the United States.

But there are also smaller public players around that may not be on investors' radar screens. They include Canadian players such as C.A. Bancorp Inc. and Clairvest Group Inc. and so-called business development corporations (BDCs) in the United States.

Fledgling C.A. Bancorp, which raised $48-million in a common share offering last week, targets industrial, real estate, infrastructure and financial service companies. And it also generates revenue from managing publicly traded alternative investment vehicles such as funds.

"We want to model ourselves after Brookfield Asset Management, but in the mid-cap space in Canada," says Mark Gardhouse, president of Toronto-based C.A. Bancorp.

Brookfield, formerly Brascan Corp., is a giant asset manger invested in real estate and other infrastructure assets and gets fees from running various funds.

"We know that alternative assets and private equity is a great place to be, and the returns can be exceptional," Mr. Gardhouse said. "The institutions and pension funds have been playing in this area for a while."

Investing in private equity is risky, but can generate superior returns to public stock markets. Private equity owners can add value to a company through financial and operational engineering, and make a nice profit from selling a firm or taking it public.

With more money chasing and bidding up the same deals these days, C.A. Bancorp says it is not worried about going head to head with rivals.

"There are competitors obviously in the small- to mid-cap space, but not as many as there are in the larger space," said Mark MacDonald, C.A. Bancorp's managing director of private investments and a former private equity specialist at the Ontario Teachers Pension Plan. "The much larger space is typically an auction-driven environment."

C.A. Bancorp, which also raised $38-million through a share offering last fall, has been investing in mid-market, publicly traded income trusts as it sifts through potential deals.

"We have looked at about 38 [private equity] deals since the first of the year, and two will close in about 30 to 60 days," Mr. Gardhouse said.

Because it is a public company, it needs to put money to work right away for shareholders. It has had winners in trust names such as Amtelecom, KCP, Custom Direct, Movie Distribution, Clean Power and Norcast. All were snapped up in takeovers.

Toronto-based Clairvest Group, meanwhile, is a veteran private equity player. The firm, which once only invested its own capital to generate returns, now does so with other investors such as pension fund managers.

"The way we used to raise money was share capital, but now we are raising money through our funds," said Clairvest chief financial officer Cameron Williamson.

And it also gets management fees from running those private equity funds, whose investments include industrial companies and casinos.

The $219-million Clairvest Equity Partners LP has invested in companies such as Integral Orthopedics Inc., which makes the Obus Forme branded back products, and auto parts maker Van-Rob Inc.

Recent winners included Datamark Systems Group Inc., Voxcom Income Fund and Gateway Casinos Income Fund. All have been the target of takeovers.

The company also closed the $300-million Clairvest Equity III LP earlier this year.

"We aren't a very big company, and we like it that way," Mr. Williamson said, echoing that there are fewer rivals in the mid-market space.

In the United States, the smaller public private equity players are structured as BDCs, which make loans and investments in small companies. These corporations get favourable tax treatment, but distribute at least 90 per cent of their taxable income.

Diversified Private Equity Corp., a closed-end fund administered by Scotia Capital Inc. that trades on the Toronto Stock Exchange, has invested in a number of BDCs. They include Nasdaq-listed names such as Capital Southwest Corp., Gladstone Capital Corp., MVC Capital Inc. and Technology Investment Capital Corp.

Adrian Mastracci, a fee-only financial planner who heads KCM Wealth Management Inc. in Vancouver, cautions investors not to put more than 5 to 10 per cent of their portfolios in the private equity space despite the allure.

"Obviously, the smaller players have a potential bigger risk," Mr. Mastracci said. "Every company that they invest in is not going to be a winner. That's the reality of the game."

Private equity options

CLAIRVEST GROUP INC.

The merchant bank (TSX: CVG) was founded in 1987 by Joseph Rotman, whose name graces the business school at the University of Toronto. Its board of directors includes Isadore Sharp, founder of the Four Seasons Hotels chain, and Michael Bregman, CEO of Tailwind Capital Inc. and better known as the entrepreneur who built up the Second Cup coffee chain. Clairvest runs two private equity funds and is an investor in Wellington Financial LP, a bridge lender. Clairvest shares, which are closely held, closed $13.70 last Friday on the TSX.

C.A. BANCORP INC.

The Toronto-based merchant bank and asset manager (TSX: BKP) is the brainchild of its chief executive officer John Driscoll, who also owns investment fund manager Sentry Select Capital Corp. The company, which started as a capital pool company on the TSX Venture Exchange, graduated to the TSX in May. The company, which went public in 2005 at $2 a share adjusted for a 10-to-one share consolidation, closed at $3.25 last Friday on the TSX. C.A. Bancorp also manages Sentry Select Total Strategy Fund (TSX:TSF.UN).

© 2007 The Globe and Mail. All rights reserved.

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