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The Canadian Securities Administrators (CSA) is nearing the end of its multi-year fund regulation review, the Modernization Project, which will introduce comprehensive changes to a number of National Instruments later this year. The biggest development is the introduction of a new class of investment funds called “Alternative funds,” and this is set to open a much wider choice in alternative investments to Canadian investors.
These mutual funds will be able to adopt investment strategies and invest in asset classes that were previously prohibited under the NI 81-102 regulation. Alternative funds are also known as “liquid alternatives” because they offer access to alternative strategies through investment vehicles with daily liquidity, provided through redemptions at net asset value for mutual funds or by trading on an exchange for ETFs.
Following suit
Although this represents new territory for Canada, several other jurisdictions have had access to these products for quite some time, most notably the United States and European Union. First authorized in the 1940 Investment Companies Act in the U.S., the E.U. added a comparable distinction to the UCITS directive in 2002. Despite their legal creation in both jurisdictions, the funds did not really begin to gain popularity until after the 2008 financial crisis. Since then, combined European and United States assets under management (AUM) in this class has exploded from C$174 billion in 2008 to over C$950B in the first quarter of 2017.*
Not only have the European Union and United States experienced rapid growth in alternative funds’ AUM but also in the range of products offered. In Europe, for example, Alix Capital provides the UCITS Alternative Indices, which track a set of 13 broad strategies in the Alternative UCTIS market. Stateside, Strategic Insights maintains 22 distinct categories for alternative funds, while Morningstar supports 31 hedge fund categories.
Especially in the U.S., the categories represent a wide variety of strategies with a high degree of granularity that seems unlikely to translate to the Canadian market, at least in the immediate future. Regardless, if these numbers are any indication, Alternative funds have the potential to become exceptionally popular in Canada and will offer retail investors a wide variety of funds.
A whole new world
The strategies used by Alternative funds will share many similarities with those of Canadian hedge funds, so they are a good place to look for what may become available in the Canadian market. The table below is an overview of strategies developed from existing Fundata hedge fund categories:
For simplicity, the strategies are very broadly classified as “directional” or “non-directional.” Directional strategies involve a net long or short exposure and seek to profit from an anticipated change in price. Non-directional strategies, on the other hand, attempt to capture profit from one or more specific value factors while reducing or eliminating exposure to others.
The list is a brief overview of possibilities and is by no means exhaustive. Strategies in either style can be employed using a variety of assets such as equities, fixed income, currencies, volatility or derivatives, in addition to being further customized or combined with one another.
Some of these investment styles will already be familiar to the average Canadian investor. Leveraged and Inverse ETFs are readily available to Canadians from exchanges on both sides of the border. While it is unclear how much demand there will be for some of the more esoteric fund types, it is likely that the appeal of exposure to new asset classes with low correlation to traditional ones will see their eventual introduction.
Changing times
Alternative funds have been available in other jurisdictions for years but whether they will enjoy the same popularity in Canada as they have with investors in Europe and the United States remains to be seen. What is clear, however, is that the changes coming later this year will forever alter the Canadian investment landscape.
Despite greater complexity, investors are sure to benefit from a wider range of investment options and the opening of opportunities that once were exclusively available to high net worth and institutional investors.
* Source: Franklin Templeton Investments, Lyxor Asset Management
John Krisko, CFA, BBA, is Manager, Analytics & Data, at Fundata Canada Inc., a leading source for investment fund information. He is also Vice-Chair of the Canadian Investment Funds Standards Committee (CIFSC).
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Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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