Liquid Alternatives: “A Must-Have Component” To Weather Volatility
A view from Canadian law firm Borden Ladner Gervais LLP.
An article by Kathryn M. Fuller, Carol E. Derk, Ronald M. Kosonic, and Roma Lotay of Borden Ladner Gervais LLP titled “2020 Spotlight on alternative mutual funds – opportunities ahead” published in LEXOLOGY on September 10. Alternative mutual funds (informally referred to as “liquid alt funds”) may emerge “as a must-have component of a portfolio’s personal protective equipment,” says the article.
Liquid alternatives and the COVID-19 pandemic
Investors looking to shelter from the volatility due to the COVID-19 pandemic, yet not wanting to miss market opportunities, could find value in liquid alts.
Alternative investments may provide these opportunities.
What’s more, amendments to securities laws in January 2019 allow alternative asset funds for distribution to retail investors.
These alt funds are a happy middle road between conventional mutual funds and private hedge funds, according to Borden Ladner Gervais LLP.
Everyday investors may therefore use these funds as useful diversification. They also serve as a defensive mantle against over-bullish or toppy markets.
Status of Canadian liquid alts, post-amendment
As of July 2020, liquid alts in Canada had assets worth approximately $10 billion. These were held across 106 funds under 40 different managers.
As at the start of 2020, according to the Alternative Investment Management Association (AIMA), more than two-thirds of the liquid alts AUM was accounted for by bank-owned and large independent fund companies.
Strategy-wise, equity funds were the most popular. However, investors were not so enthusiastic about funds employing market neutral strategies or fixed-income funds using credit strategies.
Several private hedge funds converted to liquid alt funds as provided by the NI 81-102 amendments in January 2019, observe Borden Ladner Gervais.
These amendments also allowed liquid alts funds considerable leeway, for example, short selling, cash borrowing, and derivative transactions became permissible.
Systemic issues that hobble the growth of liquid alts
According to Borden Ladner Gervais, distributors tend to assign higher risk ratings to liquid alts funds than what is warranted by the prescribed Canadian Securities Administrators (CSA) methodology.
These higher risk ratings often deter conservative investors from investing in liquid alts.
“Even when liquid alt funds are suitable for a client, the higher risk ratings may limit the willingness of a dealer to allocate a large percentage of a client’s portfolio to alternative mutual funds,” says Borden Ladner Gervais.
Another issue is the CSA’s “proficiency requirement” for advisors selling liquid alts funds. It stipulates that advisors must complete one of the following courses: the Canadian Securities Course (CSC); the Derivatives Fundamentals Course; or the Chartered Financial Analyst (CFA) Program.
As a result, the available pool of qualified advisors for liquid alts is effectively restricted to advisors registered with investment dealers that are members of the Investment Industry Regulatory Organization of Canada (IIROC).
Various organizations have proposed amendments to the proficiency requirements, meanwhile.
Despite the above, the Canadian market for liquid alternatives has great growth potential, says Borden Ladner Gervais.
“Current market dynamics will likely contribute to further traction for alternative investments, with liquid alt funds becoming an increasingly attractive option for investors outside of bull market conditions.”
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