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Les Marton, head of hedge fund consulting with Scotia Capital Inc., poses in Toronto on Friday, February 27, 2015.Darren Calabrese/The Globe and Mail

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Canadian hedge funds are on a roll, but not the kind they're likely to brag about. For the third year in a row, hedgies were thumped by long-only Canadian fund managers that passively tracked the S&P/TSX Composite Index.

The Scotiabank Canadian hedge fund asset weighted index, which tracks hedge funds that have been around for at least a year, and have $15-million or more under management, was up 4.1 per cent in 2014, trailing the S&P/TSX Composite Index which returned 7.4 per cent. The performance gap wasn't nearly as pronounced as it was in 2013, when the average Canadian hedge fund was up 1.4 per cent, while the TSX soared 9.5 per cent. In 2012, hedge funds lost 4.7 per cent on average, while the TSX climbed 4 per cent.

Asset classes that historically moved independently of one another have been unusually correlated for an extended period, says Les Marton, head of hedge fund consulting with Scotia Capital Inc. That has given the hedge fund industry a collective migraine.

Titanic amounts of quantitative easing have artificially propped up equities, fixed income, commodities and real estate, Mr. Marton says, and that has made short-selling some of these asset classes a lot trickier. Global macro funds which typically buy or sell securities based on broad themes such as the direction of currencies, interest rates or the yield curve got creamed last year, losing 6.7 per cent on average.

"It's hard to make big macro calls when it is really political will that is deciding, as opposed to market directionality or imbalances between markets," Mr. Marton said. "The central banks have been dictating where the macro changes have been going, as opposed to free market activity. So it's been tough for hedge funds over the last several years as a result."

There were some casualties in the Canadian hedge fund sector late in the year. In December, Toronto-based Red Sky Capital Management closed its two long-short equity hedge funds after a four and a half year run. The decision was prompted by the company's inability to "gain sales traction" with investors, Red Sky founder and chief executive officer Timothy Lazaris wrote in a letter to unit holders.

The collapse in the price of crude oil also hit some funds hard. In December, Calgary-based Kootenay Capital Management Corp. announced it was shutting down its Global Energy Absolute Return Fund citing "a period of challenging investment conditions for natural resource investors."

However, betting against the energy sector worked for other funds. Toronto-based Forge First Asset Management Inc., which has about $50-million under management in two long-short equity funds, took short positions in the energy sector in 2014, which helped power the company's Long Short LP fund to a 15 per cent return.

Forge First invests in small and mid-cap north American businesses "that we know and understand" says CEO Andrew McCreath, adding that the company's portfolio doesn't contain any "high-falutin' biotech stocks or semi-conductor design stocks." Apart from his short position on the energy sector, the company made tidy profits by being long on consumer staples, industrials and healthcare stocks.

The $35-billion Canadian hedge fund industry is still tiny in comparison with the mutual fund industry, which has about $1.1-trillion under management. The hardest aspect of running a hedge fund here is raising new money, says Mr. McCreath, adding that our culture of cautiousness is partly to blame.

"Canadians are more risk averse than Americans," he says, and domestic investors have historically shied away from alternative asset classes such as hedge funds.

Mr. Marton predicts that Canadian hedge funds will have a better year in 2015. He says we are in the midst of the "great decorrelation," with asset classes' respective performance finally decoupling from one another, thanks to the winding down of macro events like quantitative easing in the U.S. Early results are encouraging – the Scotiabank Canadian hedge fund asset weighted index ended up 2 per cent in January, nudging out the TSX which was only up 1 per cent.

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