Regulators open door to ‘alternative’ funds

Demand up for ‘liquid alt’ retail investments

TORONTO • Canadian regulators have put final rules in place that will allow retail investors to put their money into funds that share many attributes of a hedge fund — such as employing leverage and short-selling, and investing in illiquid investments.

Some of these so-called liquid alternative — or ‘liquid alt’ — funds are already available, due to exemptions granted earlier this year by the Ontario Securities Commission.

“Sales are going well … We’ve raised about $35 million of assets into the new funds,” said Jason Mann, co-founder and chief investment officer of Edgehill Partners, which launched six funds. Five of them use strategies that mirror the ones that have been employed in Edgehill’s private funds for more than five years.

Hedge funds in Canada have long been the exclusive territory of institutional investors and other sophisticated market players because they were considered too risky for the average retail investor.

The new funds require detailed disclosure in a prospectus, as well as interim and annual financial statements, which is meant to provide a layer of investor protection.

As the new rules for alternative funds made their way through the regulatory process over the past few years, some observers wondered whether more onerous obligations would dampen the enthusiasm for the big banks for distributing nonproprietary products such as alternative funds.

And investor advocacy groups such as the Foundation for the Advancement of Investor Rights (FAIR Canada) opposed the regulatory changes altogether, arguing against granting retail investors “easy access to alternative funds which are traditionally complex, illiquid and higher risk.”

Last year, a report produced by Canadian Imperial Bank of Commerce — which referred to liquid alternative funds as “The Next Market Disruptor” — predicted demand for the product could ultimately top $100 billion.

Mann says Edgehill’s new funds are being distributed through independent dealers and three major banks — Bank of Nova Scotia, Royal Bank of Canada and National Bank of Canada — and talks with others are ongoing.

He said alternative funds are appealing to banks that are looking to provide clients with the option of more “defensive” funds to help weather the next bear market.

“Scotia for example has a recommended list of alternative products … and our market neutral fund is one of them,” he said.

“Ultimately, we think they all will allow for them to be sold given they are regulated products, but if there is no track record some of the banks will treat it as a ‘high risk’ investment,” he said.

Darin Renton, a partner in the financial products and services group at law firm Stikeman Elliott LLP in Toronto, said retail demand for such products is expected to drive widespread distribution.

“But there will be growing pains,” he predicted.

“At the outset, there is a concern that the bank channels of distribution may treat all alternative mutual funds as ‘high risk’ (even though) that may not coincide with a lower investment risk level as calculated by the manager.”

The new Canadian rules come on the heels of the widespread adoption of alternative funds in other jurisdictions, including the United States and Europe.

Renton said there is a “wide consensus” that alternative funds could have a meaningful impact on the Canadian fund market.

“For years, the aggregate market capitalization of the closed-end fund market hovered around the $30 billion mark and based on the experience with liquid alts in the U.S., the early forecast is that the demand for alternative funds will surpass that mark,” he said.