Canadian hedge funds which boosted short positions outperformed in what was the worst year for the sector since 2011. Focusing on small companies also helped.

Shorting will be key again this year, according to Forge First Asset Management Inc., whose 8.5 per cent return put it first among 67 Canadian hedge funds tracked by Venator Capital Management Ltd.

Forge First was able to hold gains it had in the first nine months of the year through the carnage of the last quarter by shorting the stocks of a diverse portfolio of cash-burning companies, said Andrew McCreath, chief investment officer of the Toronto-based firm, which has $125 million under management.

“We won’t have one of those years when stocks don’t do anything but go up, so alternative investments - such as long and short strategies - are the way to go,” said McCreath, who has a weekly market show on BNN Bloomberg TV.

Hedge funds based in Canada posted an average 5.7 per cent loss in 2018, the worst performance since 2011, according to data compiled by Alternative IQ based on the 127 Canadian hedge funds that report to Fundata. That’s slightly worse than the 4.2 per cent loss in the U.S.

Market Turmoil

Canadian equity hedge strategies dropped 8.7 per cent while credit-focused funds lost 0.5 per cent. Private debt funds were by far the top performers, gaining 8.8 per cent.

The US$40 billion hedge fund sector was buffeted by the same concerns that roiled global markets last year: rising interest rates, a trade war with China, and mounting geopolitical risks. The S&P/TSX Composite index, the country’s benchmark equity gauge, fell almost 12 per cent, its worst year in 11 years.

Last October, Forge First went long gold companies, betting the U.S. dollar was starting to peak amid geopolitical risks and trade tensions. It bought a few Canadian oil stocks at the end of the year and is currently long Air Canada and CI Financial Corp., said McCreath. In the U.S. he’s shorting U.S. credit card companies but remains constructive on Visa Inc., Microsoft Corp. and Alphabet Inc.

New Fund

Shorts also contributed about 80 per cent of NewGen Asset Management Ltd.’s return last year, portfolio manager David Dattels said. Toronto-based NewGen’s $330 million Equity Long-Short Fund returned 7.6 per cent.

“We could liquidate 50 per cent in a day and the balance over the course of a week," Dattels said. “Being nimble and reactive to the market has helped us really preserve capital.”

About 90 per cent of the fund is allocated to Canada, where the firm sees the “greatest inefficiencies.” Its sweet spot is small and mid-cap companies. “We don’t really find much competition when we’re looking at specific event-driven type trades,” Dattels said.

This fund is no longer accepting inflows so the company launched a new vehicle aimed at the wider public: hedge fund strategies wrapped in a mutual fund. The company is aiming for $500 million in assets within three to five years and is searching through the convertible notes and preferred shares space, especially in the U.S., for this second fund.

On the credit side, Brian D’Costa, whose Algonquin Capital debt strategies fund lost 0.1 per cent last year, shifted the portfolio to hold shorter maturity debt and moved up the credit spectrum to BBB+ from BBB-.

The Federal Reserve’s shift to a less aggressive hiking path is a welcome relief though markets will struggle, if the U.S. raises tariffs on China on March 1, he said. So he remains defensive.

“Still, despite expectations for slower global growth this year and next, even if the world slips into recession things won’t be as bad as they were in 2008,” he said.