Liquid alt funds market set to grow rapidly

Once the purview of well-heeled institutional investors, the nascent market for liquid alternative funds is expected to multiply now that the market has been opened up to Canadian retail investors, a conference was told.

Liquid alts, as they are more commonly known, use strategies like short-selling, borrowing and leveraging in traditional asset classes like stocks and bonds, as well as more non-traditional assets like infrastructure and real estate. The Canadian Securities Administrators (CSA) opened up the market on January 3, 2019, and as of the end of September, there were 16 companies offering a total 42 mutual and exchange-traded funds in the Canadian market, Rob Lemon, executive director of CIBC Capital Markets, told a breakout session at the annual Investment Funds Institute of Canada (IFIC) conference in Toronto.

Some estimates, said Lemon, suggest liquid alts could grow to $20 billion in five years in Canada and as much as $100 billion in 10 years. Currently, most liquid alts are equities, with varying management fees and generally with risks of medium to low.

According to IFIC statistics, alternative fund assets stood at $3.2 billion at the end of June 2019. There were also five alternative ETFs with $110 million in assets.

Not surprisingly, jurisdictions like the United States moved earlier to create a framework and ramped up the liquid alts market there.

Michael Schnitman, senior vice-president, product at Mackenzie Investments, said the growth of liquid alts in Canada is “acceptable [but] it hasn’t been amazing [and] it hasn’t been terrible.”

Schnitman, who came from the United States five years ago to Mackenzie after helping to build the market down south, said the speed of growth in Canada mirrors the American situation.

A slow build

“I would say that the slow build that we’re engaged in here in Canada would be parallel to what happened in the early days [of liquid alts] in the U.S. [There] it ramped up quite quickly. Depending on what source you look at and how you interpret alternative strategies, there are somewhere in the neighbourhood of US$400 billion of alternative strategies today in the United States.”

But education remains a key determinant of future growth, said the speakers.

Some advisors still need to learn more about liquid alternatives before recommending any of them to investors. But Kenneth Sue, senior alternative investments analyst at TD, said all of its advisors are already IIROC-licensed and will be given mandatory training in the first quarter of 2020. Sue said many of the advisors have already taken courses dealing with liquid alts and have the proficiency to work with them.

The CSA noted commenters’ concerns about the lack of advisor training when it released its report on Modernization of Investment Fund Product Regulations relating to alternative mutual funds a year ago. The CSA said some of the issues would be addressed through its Client Focused Reforms Project.

No plans for mandatory training

An IIROC spokesperson said the regulator does not currently have any plans for mandatory training on liquid alts. However, the spokesperson said as with any product, whether mutual fund or ETF, firms and individuals are responsible for ensuring advisors adhere to the know your product rules and regulations.

Lemon said liquid alts can provide a great advantage for the mass market, giving managers more tools to use, such as leveraging and short-selling, to provide investors with income. He noted that risk ratings are important because advisors need to know how liquid alts fit into a client’s portfolio.  At the same time, the investments don’t have much of a track record in Canada as of yet, so advisors need to look at the fund’s manager and how successful they have been in the past, he said. 

Clients themselves also need to be more aware of the product to make sure they’re getting a product they understand, such as the performance capabilities of liquid alts, said Schnitman. He said some investors have difficulties determining some important factors, such as the difference between an absolute and relative return strategy.

Sue also said there are misperceptions about liquid alts, particularly that they are too risky for retail investors.