New rules allowing for the sale of liquid alternative mutual funds have only been in effect in Canada since the beginning of the year, but these products have already proven to be very popular with financial advisors and investors, attracting more than $1-billion in assets under management (AUM) in the first quarter of the year alone, according to data from the Investment Funds Institute of Canada (IFIC).
It’s hardly surprising advisors and investors have gravitated toward these products as “liquid alts,” as they’re known, provide access to alternative strategies that traditional mutual funds cannot, says Dennis Tew, head of national sales at Franklin Templeton Investments Canada.
What’s more, Mr. Tew suggests, liquid alts are potential game-changers for advisors when constructing clients’ portfolios because they “provide increased diversification and, in turn, dampen volatility in a portfolio while enhancing returns to some extent.”
That’s because liquid alts are essentially “hedge funds in a mutual fund wrapper,” says Roy Ratnavel, executive vice-president of sales and marketing and national sales manager at CI Investments Inc., as portfolio managers are able to employ strategies such as short-selling, options trading and leveraging – as well as the ability to invest in physical commodities.
But unlike hedge funds, which are available to accredited investors via an offering memorandum, liquid alts are available by prospectus, have low barriers to entry, are priced daily and are easily tradable – hence the “liquid” moniker, he says.
Already, advisors have plenty of choice as asset-management firms such as Franklin Templeton, CI, Mackenzie Investments, CC&L Funds Inc., and various others have launched a slew of liquid alts. But that choice presents a challenge for advisors to find the suitable products for their clients’ needs.
Some liquid alts offer enhanced fixed-income strategies; others involve long/short equity approaches; while others still use multiple strategies.
In CI’s case, the firm has launched three offerings, one of which is Munro Alternative Global Growth Fund, subadvised by Australia-based Munro Asset Management Ltd.
Munro’s portfolio managers have been running a similar strategy in Australia successfully for about a decade, Mr. Ratnavel says. As an example, he points to how the strategy adeptly avoided much of the pain during the stock market correction last autumn, quickly reallocating its holdings to 60 per cent equities exposure from more than 90 per cent.
“They did lose money, but they didn’t get hammered,” he says. “That kind of flexibility is generally not provided in any traditional, long-only growth fund.”
For Myles Zyblock, chief investment strategist at 1832 Asset Management L.P., which manages Dynamic Funds, choosing liquid alts whose portfolio managers have significant experience running alternative strategies is critical.
“If you’re going into these funds in the early days, you really do need to lean on [portfolio] managers that have a good track record,” he says.
1832 Asset Management offers three liquid alts thus far, including Dynamic Real Estate and Infrastructure Income II Fund, which invests in publicly traded infrastructure, utilities and real estate companies. This fund is not dissimilar to more traditional real estate mutual funds, but unlike those offerings, it can use leverage, trade in derivatives and engage in short-selling.
Although this fund and other liquid alts employ hedge fund strategies, they’re not designed to serve as a pure hedge to equities position, Mr. Zyblock says. Rather liquid alts are meant to “decorrelate” portfolios from long equities and bond positions.
“The point is they act as independent engines in your portfolio,” he says. And this ability to “drum to a different beat than the rest” may prove critical in a climate in which equities and fixed-income are approaching the end of long bull markets.
That said, Mr. Zyblock notes liquid alts are long-term investments. “While during any given short-term period you may not see their rewards,” these approaches should enhance returns over longer stretches.
The fact many institutional investors have increased exposure to hedge funds and related strategies over the past 20 years reflects their effectiveness in diversifying a portfolio, he says.
On average, institutional money managers allocate about 25 per cent of a portfolio’s capital to alternative strategies, Mr. Zyblock adds.
When it comes to retail clients, advisors should consider allocating between 5 per cent and 25 per cent of their portfolios to liquid alts, Mr. Tew says.
Given that many liquid alts funds are classified as “low” to “medium” risk, often requiring an initial minimum investment of $500, they may be suitable for many investors – particularly those who are approaching or already in retirement and need to preserve capital and reduce volatility.
In fact, although several liquid alts focus on one key strategy or asset class, there are others that try to reduce volatility by employing several approaches under one umbrella. This includes Mackenzie Multi-Strategy Absolute Return Fund, which aims to provide an absolute return regardless of market conditions.
Franklin Templeton’s Franklin K2 Alternative Fund has a similar approach, employing three strategies in one basket, including a risk premia sleeve that aims to monetize behavioural and structural anomalies in the markets at “very low cost,” Mr. Tew says.
Indeed, liquid alts are priced competitively relative to other strategies as Series F funds have a management fee of about 90 to 100 basis points (bps). As well, liquid alts charge a performance fee on returns above a high watermark and/or hurdle rate.
For example, for Munro Alternative Global Growth Fund, CI charges a management fee of 90 bps, a 15 per cent performance fee on returns above its high water mark and a hurdle rate of the yield of a 10-year Government of Canada Bond plus 3.5 per cent.
“This fee structure puts the fund manager on the same side as the investor,” Mr. Ratnavel says, because both benefit from enhanced returns. (Also of note, many funds charge additional fees for early redemption.)
Advisors can expect more liquid alts funds to enter the market given their early success and long runway for growth, , Mr. Tew says. According to a recent study from Bank of Nova Scotia, the liquid alts market in the United States has grown to US$225-billion in AUM since becoming available in 2013 – and the report forecasts that Canada’s liquid alts market could reach $20-billion in AUM in five years.
“Clearly, we see this having a lot of room to grow in Canada,” he says.