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Portfolio allocation to alternative investments could grow larger in 2022 given alternatives often provide stable returns amid downside volatility in equity and bond markets, says one advisor.David L. Nemec/The Associated Press

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Alternative investments are no longer for institutional and high-net-worth investors as advisors serving retail clients are using these products increasingly because of rising risks in the stock market.

Claire Van Wyk-Allan, managing director of the Canadian arm of the Alternative Investment Management Association (AIMA), says with a decade of bull runs on the equity side creating current market conditions and high inflation, alternative investment strategies offer great diversification, volatility protection and risk reduction with non-correlated returns.

Yet, alternative strategies are also shifting increasingly with broader industry trends, offering exposure to themes like environmental, social, and governance (ESG) or digital assets like cryptocurrencies, as noted in a recent AIMA report.

New rules introduced in 2019 allowing hedge fund strategies – largely shorting and leverage – to retail investors through “liquid alternative” mutual funds and exchange-traded funds (ETFs) have certainly fuelled growth, Ms. Van Wyk-Allan says.

“The latest estimate on liquid alt [mutual funds and ETFs] assets under management (AUM) in Canada is more than $18-billion,” she says. That’s an increase from about $12-billion at the start of 2021.

In contrast, the private hedge fund market is estimated at $40-billion in Canada – although many of the investors in that space remain institutional, Ms. Van Wyk-Allan adds.

Together, the Canadian alternatives industry is a sliver of the global market, with a recent S&P Global Market Intelligence report showing the industry’s estimated worth exceeded US$13-trillion at the end of 2021. It’s expected to grow to US$23-trillion by 2026.

Ms. Van Wyk-Allan says the Canadian market will likely see even stronger growth than it has in recent years, driven by liquid alt funds as many surpass the three-year milestone. That’s because many Investment Industry Regulatory Organization of Canada (IIROC) dealers “wouldn’t consider putting a fund on their recommended list internally without a three-year track record.”

There’s also plenty of room to grow. Fundata Canada Inc. statistics show more than “90 alternative mutual funds and 100 alternative ETFs” are on the market today, but alternatives only make up about 1 per cent of AUM among IIROC-licensed advisors, she says.

Furthermore, growth could accelerate faster now that the Mutual Fund Dealers Association (MFDA) announced proficiency standards in November for the approximately 77,000 mutual fund-licensed advisors in Canada to get the necessary training to sell liquid alts to their clients.

Why advisors prefer alternatives for stable returns

Ms. Van Wyk-Allan says private alternatives sold through offering memorandum (OM) demonstrate the potential in this space. Advisors in Canada who are discretionary portfolio managers and serve high-net-worth clients have about 10 per cent of their AUM in these assets.

Himalaya Jain, senior investment advisor and portfolio manager with the Rosedale Family Office at Wellington-Altus Private Wealth Inc. in Toronto, is among them.

He has long used hedge funds, private debt, and equity among other alternatives, and that portfolio allocation has grown in recent months.

“Starting in the second half of last year, we became more defensive in equities and started raising our exposure,” he says, noting that alternatives make up about 18 per cent of the average portfolio, an increase from 12 per cent two years ago.

Mr. Jain says the allocation could grow larger in 2022 given alternatives often provide stable returns amid downside volatility in equity and bond markets.

Private debt and equity account for key allocations, but equally of use are hedge funds using long-short, and merger arbitrage strategies that historically have “generated high-single-digit returns with fairly low volatility,” he says.

Indeed, Bank of Nova Scotia’s indexes that track hedge funds and alternative mutual funds performance, increased by about 9 per cent last year. Even though that trails broad equity markets, most clients accept the trade-off, says Jillian Bryan, senior investment advisor and senior portfolio manager at TD Wealth Private Investment Advice in Vancouver.

“They’re okay with giving up a bit of return on the upside for more consistent returns,” she says.

Ms. Bryan uses liquid alts more often even for high-net-worth clients in part because of their liquidity. Another reason is their array of long-short strategies, including for fixed income.

“There has been a tremendous amount of choice in that space,” she says.

Critically, these funds offer downside fixed income protection by shorting bonds – a strategy Ms. Bryan says she cannot employ directly as a discretionary advisor.

“Quite frankly, that’s not my skill set. But for hedge funds, it’s their bread and butter.”

Hedge funds meet ESG and crypto demand

Another recent development is ESG-themed hedge funds, which are “a logical step for me and my clients, especially younger ones” who are concerned increasingly about climate risk, Mr. Bryan says.

Toronto-based Waratah Capital Advisors Ltd., an asset manager that specializes in alternative strategies, is among those firms seeing growing demand for ESG.

“What we’re trying to do is add ESG into our investment analysis and allow it to provide incremental return opportunities both on the long and short side,” says Jason Landau, lead portfolio manager of Waratah Alternative ESG Fund, offered as OM and liquid alt products.

Ms. Bryan uses the liquid alt version for clients as it can go long on companies with lower risks from climate change while shorting those with greater risk.

Waratah Alternative ESG Fund has garnered $600-million AUM since its launch in 2020, while targeting about 7 to 9 per cent net of fees, Mr. Landau says.

He notes Waratah has strong demand for all of its alternative strategies since it started in 2010, growing from $25-million in AUM then to $3.3-billion today.

Still, the overall industry in Canada has grown more slowly.

“But that’s changing as more people recognize [alternatives’] value, especially as we see large equity market drawdowns,” he says.

Advisors are likely to see even more choice this year, Ms. Van Wyk-Allan says, as many fund companies that sat on the sidelines over the past three years plan to enter the space.

Private hedge funds are likely to see growth as well because they’re able to offer strategies liquid alts cannot, such as long-short cryptocurrency and similar digital asset strategies, she adds.

Regardless of strategy or format, alternatives offer advisors another way to demonstrate their value-add to clients, she says.

“These are complex investments not necessarily easily understood by investors,” Ms. Van Wyk-Allan adds. “So, this is a competitive advantage.”

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