The manager of a small Canadian venture capital fund with a stake in a handful of names in the subprime debacle says he’s holding on.

“We think the market overreacted,” says Geoff Horton, the managing director of VentureLink Financial Services Innovation Fund Inc. of his decision to hold on to the troubled investment. “Time will bear us out whether we’re right or wrong. But we’re still optimistic.”

The fund — one of Ontario’s labour-sponsored investment funds — holds the infamous Coventree Inc. , as well as subprime lenders Xceed Mortgage Corp. and N-Brook Lender Services Inc.

Horton is in a unique position, admittedly with “more exposure than the typical mutual fund” to the Coventree and Xceed — an understatement, possibly. And if the brew wasn’t spicy enough already, the fund is also invested in hedge fund managers SciVest Canadian Holding Inc. , and BluMont Capital Corp.

Toronto-based VentureLink manages four series of the financial services fund, each with the same relative exposure in debt and equity in its holdings. As of Sept. 21, the value of the fund had slipped by about 3.6% to $12.41 since Dec. 31, 2006. The VentureLink Diversified Income Fund, also with equity exposure to Coventree and N-Brook, slipped by 5% to $11.99 in the same period.

As of mid-August, Coventree’s share price had tumbled into a range between $2.50 and $3.50, from more than $14 a share in July because investors started to panic about its line of business. After it announced office closures and job cuts and a restructuring charge at the end of September, its price fell to as low as 76¢ a share.

Coventree has amassed a $16-billion portfolio of asset-backed commercial paper, for which it takes a fee for structuring and managing. About $640 million of that paper is exposed to the subprime mortgage market in the U.S. The rest is Canadian ABCP.

When Coventree’s shares tumbled, it’s partly because the company became “a proxy” for the problems in the ABCP market, says Horton. When the Bank of Canada injected more liquidity into the market, the effect was to widen the spread on the ABCPs, making it difficult for Coventree to make a profit by rolling over its own product.

Horton sees upside in the stock price, however, given that Coventree is trading at less than the value of its cash and equity holdings, which Horton puts at about $3.60 a share. (Coventree also holds a 10% position in Xceed.) A couple of Canadian banks, insurers or U.S. lenders might be interested in acquiring Coventree, Horton says, although as time wears on and as the price continues to drop, the likelihood also declines. Coventree has been mum on its business strategy — and, Horton adds, he is speaking speculatively.

If there is hope for Coventree — and Horton says there may be some — it’s that its line of business may return to normal after the markets calm down. The firm develops relationships with lenders and packages their contracts together into ABCP. This paper is still used in the financing world for short-term financing of between 30 days and a year.

Rather than passing around cash, lenders and borrowers transfer ABCPs. Borrowers will pay a small premium — of about five basis points to 15 bps — on the Bank of Canada’s overnight lending rate to use this product. It’s been done for 20 years in various forms and it’s a viable business that could return, Horton says.

The paper’s underlying assets have varied over the years, but in some form or another, it has always been represented by receivables from paying customers. These days, those receivables are interest and principal payments from clients for mortgages, auto loans and leases, equipment leases and credit card receivables.

“So, it has gotten more complex,” Horton says, “and it has become more difficult for people to assess the risk.”

Coventree has historically earned $25 million-$30 million in annual net income, Horton says, and it could make a good takeout target or partner for the right party. “The best outcome is that banks keep rolling ABCP in the Canadian market. But Coventree would have to be rebranded with someone else’s name — and it’s going to have to be branded with a company that gives investors confidence.”

@page_break@Big “ifs,” admittedly. But it gives Horton some comfort that members of the so-called Montreal accord which are scrutinizing the underlying assets in the ABCPs, say those assets are OK, “for the most part,” he says.

Horton also points out that while there has been only a couple of defaults on the debt issued by the ABCP market in the U.S,, there has never been a single default in Canada.

Toronto-based Xceed Mortgage, another name in the financial services portfolio, is victim of contagion from Coventree because it uses the company to finance its mortgages. But Xceed has two other secure sources for lending — including a financing trust of its own — and it reported a strong second quarter, Horton says.

Mortgage origination during the economic and market turbulence may become harder, and certainly will if interest rates rise. But lenders can try to pass the cost of higher financing to borrowers. “It remains to be seen if their customers will be willing to pay more,” Hprton says. “But I think their options will be more expensive, too. So, I don’t see an impact beyond that.”

Horton hastens to add that among subprime lenders in Canada, N-brook’s loan/value ratio averages 79% and Xceed’s average loan/value ratio is 84%, whereas problem lenders in the subprime market in the U.S. have loan/value rations ranging between 90% and 125%.

“We also think the assessment of Xceed has been more reactionary rather than analytically based, and the economic merits of the company suggest holding onto it,” Horton noted in a conference call to investors in August. “At its current trading price, its dividend yield is close to 10%, too.”

Much of the same argument applies for Mississauga, Ont.-based N-Brook, a private mortgage lender whose debentures VentureLink holds. The risk is with the underlying portfolio of mortgages but the economic outlook for Canada is good. And VentureLink doesn’t believe the real estate market in Canada is overvalued, generally speaking.

Horton is confident about the fund’s debenture investment in BluMont, the hedge fund manufacturer. The debt matures in six months and majority shareholder Toronto-based Integrated Asset Management Corp. recently acquired the portion of BluMont it didn’t already own.

VentureLink’s debenture investment in SciVest is at more risk. Two of its high-leverage funds were affected by the market volatility in August. The values of the two funds have sunk seriously since then.

Many hedge funds are exposed to the U.S. subprime market, and when the markets start to unwind, the effect is contagious. As redemptions start, market-neutral funds such as SciVest’s are forced to sell off their stronger long-term investments to support their leverage guidelines, and they are left with their short-selling stocks, Horton explains.

VentureLink is also invested in Wellington Financial Inc. , a mezzanine lender, and LexFund Inc. , which gives loans to litigation plaintiffs. The lines of business of these two companies aren’t affected by the credit market turmoil, Horton says.

“Lexfund and Wellington could stop adding further loans, if liquidity were to dry up for them,” he says. “And, in each case, it would not impact the value underlying our funds’ investments.” IE