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'We're back from the abyss' Salida Capital and its high-octane hedge funds were flying high - until last fall's perfect storm. Now it's aiming to pick up where it left off. By Joanna Pachner SALIDA BACK ON ASXVBJJKL BXV BB AJSX A

Salida Capital and its high-octane hedge funds were flying high - until last fall's perfect storm. Now it's aiming to pick up where it left off

Special to The Globe and Mail

TORONTO -- When Salida Capital Corp. beat all other bidders in a charity auction last month to score lunch with Warren Buffett, the $1.68-million (U.S.) win sent a signal to Bay Street: Salida is back.

Salida, the once high-flying, resource-focused hedge fund manager known for its appetite for risk, became one of Canada's high-profile victims of last year's market meltdown when its flagship Multi Strategy Fund plunged 67 per cent and three of its hedge funds got locked up in the Lehman Brothers Holdings Inc. bankruptcy.

That was followed by a rapid exodus of key staffers and by dwindling assets under management.

What had been a spunky success story gave way to rumours of the money manager's imminent demise.

Yet here was Salida paying a whack of cash for the right to introduce its most patient and stalwart clients to the Oracle of Omaha, in order to, in the words of president and chief executive officer Courtenay Wolfe, "thank some of the big people who've been our supporters over the years."

Although Ms. Wolfe insists the auction bid wasn't a marketing tactic, the media spotlight highlighted Salida's recent spectacular performance.

The Multi Strategy Fund, with total assets currently at about $85-million (Canadian), is up 100 per cent in the first seven months (recovering about half its losses).

Salida's offshore BTR Global Energy Fund has bounced back even more, returning 136 per cent in that period. Few Canadian hedge funds can boast such lofty stats.

How did they do it? In a word: China

Looking ahead

Ms. Wolfe says Salida owes its comeback to sticking with its "opportunistic, aggressive and active investment management style," which means making significant bets on often small resource companies. Seeing triple-digit annual returns again, investors may well write off the second half of 2008 as a blip.

By last spring, the company was down to about 18 staff from 24, and was managing some $300-million in capital - a 75-per-cent drop from its mid-2008 peak. That's ballooned over the summer to about $400-million now.

Ms. Wolfe, who was elevated earlier this year to the post of president and CEO, emphasized that 2008 was a temporary setback from which the firm was quickly recovering.

By mid-summer, the signs of a performance turnaround were indisputable. The BTR Global Energy Fund had made the Top 10 in the Barclay Hedge index three months in a row. The new offshore Strategic Growth Fund - a successor to the Global Opportunity Fund whose assets remain frozen at Lehman - was up 120 per cent year to date. At the end of July, the total returns since inception for the Multi Strategy and Global Energy funds were 179 per cent and 118 per cent, respectively. Not bad for a firm being written off as a market meltdown casualty.

Brad White and Danny Guy, the two founders who are now Salida's sole portfolio managers, say Salida's investment strategy is based on a fundamental belief that the world is headed into an era of deflation, where hard assets and commodities will fare strongly. The duo have been rebuilding, using a similar strategy to what worked so well before: buying into companies they expect to get snapped up.

"We believe you have 10 really good ideas a year, and we take significant positions," says Ms. Wolfe, adding that those 10 holdings represent about 50 per cent of the Salida portfolio. "We look for catalyst events or special situations; takeouts or mergers based on consolidation of the resource space."

As Mr. White explained during a July webcast, China has been driving this trend in the resource arena, "moving out of dollars and storing them in the ground." Although the Chinese government was tightening the taps on stimulus lending, its actions in the first half of the year "helped clean up the commodity market," he said.

"The Chinese are aggressive buyers of energy, commodities and hard assets, and we strongly believe this will continue," he said.

China is at the table for every oil deal, he added. "We expect their acquisitions to be even more aggressive than the Japanese in the '70s and '80s," he told investors. "With over $2-trillion (U.S.) in foreign reserves, they're in the right position to do it."

Canadian companies stand to benefit because Chinese buyers have been shut out of the American resource market, and Canada is the next natural target. In June, for instance, Sinopec bought TSX-listed Addax Petroleum Corp. for $7.2-billion. Salida owned a chunk of Addax. Mr. White sees potential for similar deals involving Argentina's Repsol YPF SA and the Jubilee offshore field in Ghana.

The start of the fall

The past year and a half has been a stomach-churning roller-coaster ride for the eight-year-old firm.

In the spring of 2008, Salida had amassed some $1.3-billion (Canadian) in assets and a solid track record, but it remained little known beyond Bay Street. It was ready to take its business up a notch.

Cue an ambitious growth strategy: more hedge funds, greater diversification, a high-profile new president, a whole new sales force and a major marketing push.

Just as the firm was about to press Enter on these plans, the entire financial system crashed. As one former Salida insider puts it, "We got caught by a once-in-a-lifetime tsunami."

Though officially born in 2001, Salida actually emerged out of Banfield Capital International Ltd. Mr. Guy, a seasoned oil and gas analyst, and Mr. White took over the renamed firm when founder Jeff Banfield left following a settlement with the Ontario Securities Commission of insider-trading allegations. (Salida means "exit" in Spanish.)

In 2004, with assets surpassing $400-million, Salida launched the Multi Strategy Fund as its flagship Canadian fund. The firm was garnering the reputation as an aggressive investor in junior resource stocks. Its thesis was that the developing world's growing middle class wanted the basics of life, and commodities were the most basic of all.

Its managers sometimes took activist stands and would play matchmaker, for instance pointing Yamana Gold Inc. toward Viceroy Exploration (Salida had stakes in both).

Through the mid-2000s, Salida roared ahead, with some of its funds posting high-double-digit gains.

"It was a performance-driven shop," recalls Jason Russell, formerly of CIBC Wood Gundy, who was hired in January, 2005, to run the new Global Macro Fund. He brought a different element to Salida. Mr. Russell methodically traded currencies and commodities, wrote his own computer code, and believed that the only true hedge was liquidity - being able to get out if things turned south.

"In my mind, I was putting up good returns - 15 per cent, 18 per cent. Relative to my space, I was doing great. Relative to them, I was a peashooter."

Despite its success, Salida's heavy resource exposure made it vulnerable to market swings. The principals decided to raise the volume on self-promotion.

In April, 2008, Salida hired David Fleck, a high-profile veteran of Big Bank trading floors, as co-president. It also brought in Ms. Wolfe, who had headed sales at Tricycle Asset Management.

Ms. Wolfe's plan last summer was to aggressively market Salida's funds to institutional investors and wealthy individuals in Canada and the United States. She never got the chance.

Economic volatility turned into a sudden rout in July, as the oncoming bear market mauled commodities first. Junior resource stocks were punished as investors fled to large-capitalization stocks.

Most Salida funds were hit hard, averaging 25-per-cent drops for the month. People were stunned. "It was beyond any level of comprehension," says a former staffer who requested anonymity.

While, on average, hedge funds outperformed most asset classes, their roughly 20-per-cent loss in 2008 belied the underlying principle that they could deliver profits in any market.

Some hedge funds' losses were stunning. Salida's were among them.

Mr. White tried to stanch the bleeding in Salida's flagship fund by reducing leverage and shifting to larger, easier-to-sell equities while holding on to core positions. He, and his peers, had been shorting financial stocks assuming the subprime credit crisis would continue to hurt. But financial stocks outperformed miners and oil producers, making his bets wrong on both sides.

Since many of Salida's investments were in small resource companies whose shares no one dared to buy, the managers were "handcuffed," says Al Kellett, a Morningstar Canada fund analyst specializing in alternative investments.

To keep redemptions at bay, Salida launched an outreach program to its investors, holding monthly conference calls. It seemed to work: As of early September, 2008, the company reported that "there has been no up-tick in redemption flows whatsoever."

Then, on Sept. 15, Lehman Brothers filed for bankruptcy.

Many people date the full-out financial crisis to the Lehman wreck.

"Unlike with Bear Stearns, where the government said, 'Common-equity guys, you're wiped out, but we'll guarantee agreements on default swaps,' they didn't do that with Lehman," says Jim McGovern, former chair of Canada's Alternative Investment Management Association and CEO of Arrow Hedge Partners Inc. in Toronto. "That directly caused the crash."

The beginning of the end

It was the subsequent U.S. ban on short-selling major stocks, aimed at protecting the financial sector, that really started hedge funds' collapse, Mr. McGovern says, because the funds no longer had their most trusty tool for hedging investments. The only way for funds like Salida's to cover those positions was to sell commodities, which tend to be illiquid. "You saw an industry get ravaged," he says.

Salida was in the centre of a financial hurricane.

"It was almost impossible to react," a former insider recalls. "If you had any leverage in your funds, you could never get onside, couldn't sell fast enough." The atmosphere on the trading floor was electric. People were throwing up from the pressure.

Salida employees say there was some disagreement about how to respond.

Shifting away from the resource focus was one option. "When you've been down one track, to reverse course is very difficult," one former employee says. For many, the decisions were personal since historically, 25 per cent of assets came from company insiders.

For Salida, Lehman's collapse was disastrous because it used Lehman as prime broker for three of its offshore funds. When the brokerage filed for bankruptcy, those funds' assets were frozen and the hedge funds became unsecured creditors - at the bottom of the pile. It's unclear whether Salida investors will get any money back.

By October, the firm was deeply wounded. The Multi Strategy Fund was down 34 per cent that month, 63 per cent for the year.

Expansion was out of the question; the focus was survival. Mr. Fleck was gone by October. Others followed.

Mr. Russell, whose Global Macro Fund ended 2008 up 20 per cent, the one bright spot amid losses, met with the remaining top staff - Ms. Wolfe, Mr. White and Mr. Guy - and proposed a strategic shift closer to his more risk-averse approach. "I wanted to see [Salida] take a more systematic approach. But it was unlikely to happen."

To Mr. Russell - who left last November and has since started his own hedge fund manager, Acorn Global Investment - it was fundamentally a disagreement about risk management.

Perhaps it was impossible for Salida's founders to change their stripes. "You live and die by the sword," the insider says. After an extraordinary run, "they hit a bear market that took them all the way down in three months."

Tweaks to the formula

When asked during a July webcast how Salida would protect itself from another period like the fall of 2008, Mr. White said the firm is putting more capital into larger-cap, more liquid stocks.

"Our hedges are higher and stronger. And we have less capital deployed, so we can make adjustments much faster. We have a smaller asset base - not that I'm cheering about that."

And economic troubles are over, he stressed. He sees a W-shaped market, with more bounces and drops to come.

As for Salida's future, he was conservative. "We have more than adequate capital. We're back from the abyss, but no one should be overly confident. And we're not."

Ms. Wolfe isn't so modest. She says the firm plans to add new funds this fall, reaching out to retail investors and boosting marketing. As for diversification beyond resources as a protection against market swings, that seems to be on the back burner.

"We can't change the events of last year," Ms. Wolfe says. "The best thing we can do is keep moving. People often get defeated not by the external environment but by stopping moving forward. You can't just all stare at the screen. You can't get paralyzed."

Bob Thompson, an alternative investment analyst at Canaccord Capital Corp., points out that Salida's investing focus has paralleled that of some of the most successful investment managers around, all of whom were sideswiped by the meltdown.

"These people - Eric Sprott, Rohit Sehgal, Jim Rogers, Salida - they didn't suddenly get dumb," he says.

He notes that at the Berkshire Hathaway annual meeting in May, Mr. Buffett was asked how his money managers performed during the market crash. "He said, 'They did equally or worse than the market. And I'm not worried about it.' He said that 2008 was a year in which you could be right on everything you're doing and your performance would have been as bad as those who were wrong."

Salida's principals can only hope that when its investors sit down for steaks and a chat with Mr. Buffett, he repeats that message.

The firm's high-octane, high-risk investing style, essentially unchanged by the events of 2008, may bear little resemblance to Mr. Buffett's buy-and-hold philosophy, but Ms. Wolfe stresses the theme of long-range thinking.

Mr. Buffett has proven, she says, that you can be successful through ups and downs when your trajectory stretches over decades. "We plan to be around and doing this for a long time going forward."

She may be right. Provided another financial tsunami doesn't emerge on the horizon.

*****

By the numbers

67%

Decline of Salida Capital's flagship Multi Strategy fund in 2008.

100%

Growth of Multi Strategy fund from January to July, 2009.

179%

Growth of Multi Strategy fund from inception to end of July.

$1.3-billion

Salida's mid-2008 peak of assets under management.

$400-million

Approximate value of Salida's

assets under management now.

Company reports; staff

*****

At a glance

Salida Capital

Emerged in 2001 out of Banfield Capital International Ltd.

Brad White and Danny Guy took over the firm at that time.

Has a reputation as an aggressive hedge fund manager focused on the resource sector.

Top guns

Courtenay Wolfe

Hired in April, 2008, to ramp up sales and marketing.

Promoted to president and CEO in early 2009.

Intends to push ahead with plans - derailed by the market meltdown - to launch new funds, reach out to retail investors.

Previously head of sales at Tricycle Asset Management.

Brad White

Founder and managing director.

Portfolio manager of the firm's flagship Multi Strategy Fund and the BTR Global Energy Fund.

Previously worked at Burns Fry, TD Securities, Morgan Stanley Canada and Banfield Capital.

Danny Guy

Founder and portfolio manager of the BTR Strategic Growth Fund.

A seasoned oil and gas analyst previously at Banfield Capital, Richardson Greenshields and First Marathon. Staff

© 2007 The Globe and Mail. All rights reserved.

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