Retail investors will soon have access to a strategy that has been a mainstay of institutional portfolios, as mutual fund companies get set to launch alternative mutual funds, slated to enter the marketplace on Jan. 3.
Last month, the Canadian Securities Administrators – an umbrella group for all provincial securities commissions – approved the long-awaited changes aimed at developing a more comprehensive regulatory framework for publicly offered “alt funds” – currently known as commodity pools.
While the new rules don’t kick in until the new year, several Canadian fund companies have launched alt funds under “exemptive relief” – where they can offer funds under the proposed rules – in hopes of getting a head start on a market that is expected to be worth tens of billions of dollars over the next five years.
Alt funds (also known as liquid alt funds) are typically hedge fund or private equity strategies designed to maximize returns for investors while providing downside protection in falling markets.
Currently, alternative strategies in Canada are only available to institutional investors or high net worth clients with incomes of more than $200,000 a year or a net worth of $1-million. The introduction of liquid alts into the retail market is a major “game changer” for mutual fund manufacturers and will provide an opportunity to drive new sales, according to Paul Holden, research analyst with CIBC, who estimates the market could grow to between $50-billion and $100-billion within five years.
“We also see this as a win for investors as it opens access to a variety of investment strategies with diversification benefits,” Mr. Holden wrote in a recent research note.
The new rules – which were first proposed in a 2016 CSA report – will allow retail investors access to funds that offer more borrowing, shorting and derivatives strategies. As well, the rules will enable levered investment strategies, similar to what is currently available in the exchange-traded fund industry.
The amendments will see commodity pools officially renamed alternative mutual funds and loosen restrictions to allow greater flexibility with investing strategies such as fund-of-fund investing, an increased ability to borrow cash for investing purposes and changes related to short-selling and the use of derivatives.
The changes will also simplify the prospectus requirements for alt funds by bringing them within the prospectus disclosure regime applicable to other mutual funds in the industry.
Canada’s asset managers didn’t waste any time preparing for the changes, with several fund managers already introducing products under the proposed changes. Over the past several months, five fund companies launched alt funds after obtaining exemptive relief from regulators: Mackenzie Investments, Picton Mahoney, Edgehill Partners, Dynamic Funds and CI Financial.
“The new proposed alternative mutual fund rules expand the investing toolkit that managers have access to, and enable us to offer risk-managed solutions at a time when these strategies are most needed,” said Jason Mann, co-founder and chief investment officer of EdgeHill, which launched six alternatives funds in August. "The change is significant in that it really is the democratization of risk-managed hedge fund strategies for the first time.”
Other fund companies such as AGF Management, Manulife Investments, Fidelity Investments Canada and Franklin Templeton continue to actively monitoring the development of the alternative fund asset class, with plans to launch funds in the future.
For now, the new regime will allow alt funds to be sold by advisers licensed by the Investment Industry Regulatory Organization of Canada with no additional requirements. Mutual fund-licensed advisers, however, will need to take additional proficiency requirements in order to sell them. The Mutual Fund Dealers Association does not include alt funds in its current program.
In the United States, the liquid alt market has grown to more than US$225-billion in assets under management since fund regulations were modernized in 2013, according to a recent report by Bank of Nova Scotia.