Alternative investing strategies and assets, once the domain of hedge funds, large institutions and the ultra-wealthy, are becoming increasingly available to ordinary retail investors through mutual funds and ETFs. New regulations in the works could increase that accessibility.
These alternative investments span a diverse spectrum. They encompass strategies often used by hedge funds, including short-selling, use of derivatives, leverage and investments in private debt and equity. Options also include physical assets with low correlation to financial markets, such as commodities, real estate, infrastructure, timber and agriculture.
"Alternatives are moving off the side street and onto Main Street," says Keith Sjögren, senior consultant and managing director, consulting services, at Investor Economics Inc. in Toronto. "Pension funds have had big allocations [of alternative investments] for some time, but financial advisors and investors are becoming more comfortable in this area. Clearly, there has been an increase in the size of the alternative asset base overall, but one of the challenges is to determine what fits and what doesn't on the retail side."
According to Investor Economics, Canadian-managed investments in alternative assets more than doubled to $188 billion as of June 30, 2016, from $84 billion as of yearend 2011.
Alternatives can be yet another arrow in the quiver of a well-diversified portfolio. Alternatives with low correlation to traditional stocks and bonds can provide a better risk/return experience by increasing portfolio diversification, lowering volatility and enhancing returns, all of which encourage investors to commit to their long-term plan.
Alternatives can "zig when the rest of the portfolio is zagging" says Jaime Purvis, executive vice president, institutional sales and accounts, at Toronto-based Horizons ETFs Management (Canada) Inc. They can also provide "crisis alpha" - like ballast in a portfolio when traditional equities or bond markets hit the skids.
However, looking carefully "under the hood" of individual offerings is important. Some alternatives may pose particular risks, including lack of liquidity, magnification of both positive and negative returns through leverage, and project/business risk. Some offer defensive strategies or downside protection that may bolster a portfolio in bear markets, but cause a drag by limiting full exposure to hot markets or adding to investing costs.
Growth in alternatives could get a further boost if regulators proceed with draft proposals to make these types of investments more accessible to retail investors. Last autumn, the Canadian Securities Administrators (CSA) published proposed rules for offering "alternative funds" - currently known as hedge funds - in the retail market via a prospectus similar to that issued by mutual funds.
Under the proposals, the alternative products could be sold through member firms of both the Mutual Fund Dealers Association of Canada and the Investment Industry Regulatory Organization of Canada. Investment in alternatives would no longer be limited to accredited investors. The CSA solicited industry feedback during a 90-day comment period that ended in December and is reviewing those comments.
"There were voluminous comment letters, and it will take the CSA a while to consider whether to make additions or amendments to its draft proposals," Michael Burns, partner at McMillan LLP and chairman of the Canadian chapter of the Alternative Investment Management Association, told the annual Canadian Funds Summit in Toronto recently. "It's hard to project when the rules will be published in final form. There could be a call for another round of comments before that happens - likely sometime in 2018."
Meanwhile, retail clients can access some alternative strategies employing limited short-selling, options and other derivatives through mutual funds and ETFs without having to qualify as an accredited investor. Some mutual funds offered by firms such as Sprott Inc., LOGiQ Asset Management Ltd., CI Investments Inc., Franklin Templeton Investments Corp. and the Dynamic Funds family of 1832 Asset Management LP (all based in Toronto) offer limited alternative exposure within the boundaries of current mutual fund rules.
Some mutual fund providers are introducing funds labelled as alternative strategy vehicles, including Sentry Alternative Asset Income Fund, offered by Sentry Investments Inc., and Mackenzie Diversified Alternatives Fund, offered by Mackenzie Financial Corp.
For example, Mackenzie Diversified Alternatives Fund provides exposure to a mix of global alternative assets, including options, currencies, commodities, infrastructure, non-traditional fixed-income (such as emerging markets debt) and non-traditional equities (such as micro-cap equities). The investible universe contains 50 asset categories, says Allan Seychuk, senior vice president, product, at Mackenzie. The fund focuses on relatively liquid assets to accommodate daily purchases or redemptions.
"Most Canadians already own a core balanced portfolio of global stocks and bonds," says Seychuk. "We're offering a balanced fund of non-traditional asset classes. We take care of the risk concentration and monitoring. We can't tie up a big percentage of our assets in a bridge or an airport, as a pension fund can; but, through diversification, we can utilize the benefits of a whole host of alternative strategies."
Typically, clients approaching retirement have less tolerance for volatility. But, Seychuk says, even a 20% allocation to diversified alternatives will have a positive effect on risk and return in a globally balanced portfolio that includes traditional assets.
Some ETF manufacturers, such as Auspice Capital Advisors Ltd. of Calgary, Purpose Investments Inc. of Toronto and Horizons ETFs, make emphasizing alternatives a priority. Clients with any size of account can buy ETFs, which trade on an intraday basis and don't have the minimum investment restrictions, limited liquidity or lockup periods associated with some alternative investments.
"One of the challenges of the alternative asset class is that it can be difficult for small investors to access and is normally marketed to the high net-worth [client] segment," says Som Seif, CEO of Purpose. "We bring alternative strategies to the retail investor in a low-cost, transparent product."
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