Andrew McCreath runs a hedge fund in a country he says is afraid of hedge funds.
McCreath, who is CEO, president and CIO of Toronto-based Forge First Asset Management, says investors north of the 49th parallel were spooked by the high-profile implosions of some early Canadian hedge funds, most of which “proved themselves...to be leveraged beta.”
As a result, he says, “Little question, Canada’s a tougher environment to raise money in.”
But Forge First, which started out with $6 million in partner capital in August 2012, now manages $37 million in a pair of funds—a multi-strategy fund and a long/short—operating under a deceptively simple mandate:
“We're focused on not losing money,” McCreath told FINalternatives in a recent phone interview. “That's the number one and that's the number two goal of our product. And then the number three goal is to make money.”
Since launching in August 2012, the funds have achieved those goals: the long/short strategy, which accounts for 46% of Forge's AUM, has produced an annualized return of 39.36% while the multi-strategy fund, which accounts for the other 54% of assets, is up 29.31%. Year to date (as of May 31) the long/short fund is up 9.80% and the multi-strategy fund up 5.60%. Since inception the long/short fund is up 83.77% and the multi-strategy fund up 60.20%.
“We target low adjusted beta,” said McCreath. “The beta of the market is 1 and the beta of our long/short fund is 0.27 and 0.05 for our multi-strategy, so the volatility of the funds is considerably lower than [that of] the market.”
The long/short fund has a Sharpe Ratio of 4.66 while the multi-strategy's is 4.20, all of which leads McCreath to say of Forge First's track record to date:
“So far, so good.”
Startup, Buildup & Sale
McCreath—who, in addition to running his funds hosts Weekly with Andrew McCreath on Canada's Business News Network—started his career as a sell-side analyst with Gordon Capital before moving to the buy side where he's been ever since.
“I've been a portfolio manager for 16 years,” he said. “I have been involved in the startup, buildup and successful sale of two money management businesses.”
The first of these, Synergy Mutual Funds, he founded with partners in January 1998 and sold to Toronto's CI Financial in October 2003.
McCreath launched the second business, a hedge fund firm called Waterfall Investments, in 2004. His head of operations at the new firm was Fatima Hirani, whom he'd poached from his prime broker, CIBC. He sold Waterfall to Sentry Select (now Sentry Investments) in 2008 and shortly after, Hirani returned to CIBC.
McCreath stayed on at Sentry until 2011 when he “got the itch” to start another business and convinced Hirani to join him a second time. That itch became Forge First Asset Management which McCreath and Hirani—along with portfolio manager Ashley Kennedy whom he'd hired at Sentry—launched in 2012. They've since been joined by trader/analyst Andrew Parks and most recently by Emma Querengesser as director of business development.
As mentioned above, capital preservation is Forge First's prime goal, one McCreath said is achieved through its portfolio construction, which is guided by five rules:
“We run a very diversified portfolio,” said McCreath, “We have more than 300 names in the portfolio. We do not buy any private securities, we always run with a big short book...Take the multi-strategy fund...since inception our gross short exposure in the MS fund has always been 50 to 100%...There's no big bets—we don't have big fat weights in stocks and we don't have dogmatic exposures to sectors—you know, 'Oh, McCreath is bullish on gold, let's be 25% long.' We just don't do that...
“Those five [rules] imply that we're going to have losing months. We've made money 19 out of 22 straight months now, but we're going to have losing months, but I think it's going to be difficult for us to have a big drawdown.”
In constructing their portfolio, Forge First draws ideas from three buckets: stocks they like and don't like, themes and sectors.
The first is self-explanatory, the second, 'themes,' said McCreath generates about half the names in the portfolio, and comes from the top—he gives Kennedy and Parks an idea and they execute:
“So, January 2013, I say to the guys, 'I don't like basic materials.'...That's a thematic trade and that thematic trade gets executed by...identifying 25, 30 names that we can take modest short positions in—10, 15 basis points—so that we're 2.5% to 3% short the space. We really can't get our butts bit, because we don't have big weights in individual names.”
Bucket number three is a sector trade, said McCreath, “like an energy bucket, where we'll have a lot of names...we'll have 80 names in our services bucket and it will be split between services and E&P. Occasionally you'll find a good alpha short, but I call it a sector bucket because most of the stocks in that sector are highly correlated to the price changes of the commodities themselves, so you tend to be shorting two or three crappy beta names for a long position.”
As for Forge First's use of leverage, McCreath said it depends how you define leverage:
“Our OM says that we will never be more than 100% net long, but...let's say you're 170% gross and you're 105% long and 65% short—is that leverage? I think most people would call that leverage too. We will never be more than 100% net long. And when you look at our multi-strategy fund, our net exposure since inception has ranged between 5% net long and 40% net long...”
Exposure tends to be 70-75% Canada, 25-30% U.S. and McCreath doesn't envision this changing any time soon.
McCreath believes his process is reliable and scalable to “a few hundred million,” and to get there, he doesn't rule out the possibility of a seed investor. His target investor, at this stage, is a high-net-worth individual, a fund of funds or a smaller pension.
Properly Run Hedge Funds
As for his pitch, he makes his case for looking at “a properly run hedge fund” based largely on what's currently happening in the United States economy which, he said, is “healing,” with respectable private sector demand at the end of Q1 2014, the beginnings of wage growth and a pickup in loan growth.
Combined with that, he predicts a flattening of the yield curve over the next three to 15 months as rates at the short end of the curve rise faster than those at the long end.
“The Federal Reserve,” said McCreath, “owns about 5% of the 2-5 year part of the curve, about one third of the 10-year part and about 75% of the 30-year.” As the yield curve flattens, “I think...the market is going to get concerned about the Fed's exit. And not only does the Fed only own 2-5% of the five-year part of the curve, but the Street, the hedge funds, are leveraged into that space, because with interest rates so low, when I duration match my short sale of a 10 or a 30-year bond with owning the 2-5 year part of the curve, I've got to own $4 of the short end to hedge $1 at the long end, so it's a very crowded trade too.
The P/E multiple, at 16 times forward earnings on the S&P 500 is (excluding the valuation during the tech bubble) is the highest it's been since 1976, convincing McCreath there's “room for a little multiple contraction as the curve flattens, the result of the market forcing rates higher because the Fed's got no control over the 2-5 year part of the curve.”
All of which, for McCreath, illustrates “why you look at a fund that's shown an ability to preserve capital in a down market but also participate in upside.