Page 18 - Newcom

January 2020 BYB: OUTLOOK 2020 INVESTMENT EXECUTIVE 18
Liquid alts could use troubled waters
A look at how this product category is faring a year after its introduction
dropped by 6.58% due to heightened trade tensions between the U.S. and China, the Scotiabank liquid alt index fared better: dropping by 1.21%.
David Picton, president of Toronto- based Picton Mahoney Asset Manage­ ment, says a market turn in which “riding beta” no longer works could be the biggest catalyst for liquid alt funds. “The ones that deliver on their objective of being different are the ones that [will] really start to pick up some [market] share,” Picton says.
A recent report from Scotiabank states the liquid alts market could reach $20 billion within five years; other estimates put the number as high as $100 billion. As of Nov. 30, 2019, new liquid alt funds had slightly less than $7 billion in reported assets under management, Dorenbush says — a mix of new assets as well as transfers from existing alternative products, which boosted liquid alts in their first year.
Assets held in Canadian products are spread among almost 100 funds and 32 providers, ranging from large asset man- agers (Toronto-based firms such as Bank of Montreal, Canadian Imperial Bank of Commerce [CIBC] and AGF Management Ltd.) to small shops from the alterna- tive space, according to Toronto-based Fundata Canada Inc.
Liquid alts are attracting assets that may previously have gone into hedge-fund offer- ing memorandum (OM) products, as well as attracting investors new to the alternative investments space, Dorenbush says.
However, there’s still apprehension. While fund manufacturers may rate new products as low- to medium-risk, some dealers view them as riskier.
“This is because of the complicated
management style
that many of these
[portfolio] managers
employ, thus forcing
the hand of compli-
ance departments to
default the risk rating
to ‘high risk’,” states a
November report from
Toronto-based Richardson GMP Ltd. “In a way,” the report continues, “this rationale makes sense because of how much latitude there is between a liquid alt in comparison to a traditional mutual fund” — although that means funds with a mandate to reduce volatility could end up classified as “high risk.” The ratings will make growth over the short-term difficult, the report states.
Then there are the fees. In addition to the management expense ratio, many alternative mutual funds charge perform- ance fees based on positive returns above a perpetual high water mark or have “hurdle rates” above which a fee is charged, states a September 2019 report from CIBC.
Claire Van Wyk-Allan, head of Cana- da with the Alternative Investment Man­ agement Association (AIMA), says the average performance fee for alternative mutual funds is around 8%.
Liquid alts’ limited or non-existent track records also are an impediment to landing on dealers’ product lists. Picton says most dealers want to see at least three years of performance. This gives an edge to hedge fund providers with liquid alt funds that match strategies that existed in another form before the new products were introduced.
“The more closely related your product is to what you’ve had in the past, the more
BY MARK BURGESS
while most asset managers are
anxiously hoping to wring out another year of gains from this aging bull market, those in Canada’s new liquid alternative mutual fund market may not mind a little turmoil.
“Liquid alts” — mutual funds that use alternative strategies such as short-selling, leveraging and derivatives — became avail- able to retail investors at the beginning of 2019. Although strategies among the funds differ, last year’s strong markets were chal- lenging for active approaches that aim to remain uncorrelated to the broader market.
The Scotiabank alternative mutual fund index showed year-to-date returns of slightly less than 5% at the end of November 2019. That compares with almost 19% returns for the S&P/TSX composite index and more than 25% for the S&P 500 through the first 11 months of 2019.
“The markets have been on a tear both in Canada and the U.S., and anytime you have a product that hedges, it would be very diffi- cult to keep pace,” says Daniel Dorenbush, managing director and head of Canadian prime services at Toronto-based Bank of Nova Scotia. But the products still are executing their strategies, he says, gener- ating returns while providing downside protection.
In May 2019, when the S&P/TSX com- posite dropped by 3.28% and the S&P 500
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reasonable it is for people to have comfort that you know what you’re doing, and they can see how you’ve done through tests that occurred along the way,” Picton says.
The Richardson GMP report agrees that the “least concerning” products in the market are from portfolio managers whose previous strategy fits within the new liquid alt rules. “However, approach with caution those solutions based on an [OM prod- uct] that had to be drastically modified to meet the new criteria, or others that are novel products launched to ride the early momentum,” the report adds.
The number of new products and the range of strategies offered adds to the con- fusion, Picton says. “We have a plethora of these products coming out promising all kinds of different objectives and they’re all kind of being lumped in to one asset class called ‘alternatives’,” he says.
However, Dorenbush says, progress has been made on educating financial advisors and dealers.
Another potential source of growth for liquid alts is their inclusion in “fund-of- fund” products, the CIBC report states.
But market conditions could still be the vital factor. “The space has a lot of runway to grow,” AIMA chair Belle Kaura says. “As investors prepare for a downturn, there is tremendous opportunity.” IE
Regulators to focus on big projects
With the concept of a national regulator in limbo, the CSA plans to review the self-regulatory structure
The review also will consider the evo- lution of the investment industry since the current structure was put in place. More than 20 years have passed since the provincial regulators decided to launch a fund dealer SRO as a separate organiza- tion rather than giving that responsibil- ity to IIROC’s predecessor, the Investment Dealers Association of Canada (IDA). The investment business has evolved and changed dramatically since then.
Throughout that period, there has been a good deal of consolidation, both among dealers and between fund companies and dealers. Other industry categories have grown significantly — particularly the exempt market. More recently, the emer- gence of fintech innovation has given rise to previously unimagined business models.
At the same time, the SRO landscape has evolved, with the IDA spinning off its trade association function and mer- ging its dealer oversight arm with Market Regulation Services Inc. in 2008 to form IIROC. That’s a significant difference from the inherently conflicted SRO/lobby group that existed before.
The CSA’s forthcoming comprehensive review of the SRO environment will take place against this backdrop. Where that will lead is far from certain, but one possibility is an MFDA/IIROC merger; another is a redis- tribution of responsibilities. Alternatively, policy-makers may conclude that self- regulation should be scrapped altogether — as other jurisdictions have decided.
Given the significance of the issues, the review is not likely to be resolved this year, especially considering that the review won’t begin until mid-year. But the review
will be a headline topic for the regulatory community in the year ahead.
At the same time, the Government of Ontario announced it will launch a task force to undertake a review of that prov- ince’s securities law. Reviews are supposed to be routinely carried out every five years, but in reality, only one has ever taken place, and that final report was handed down in 2003. So, a comprehensive review is long overdue. Again, while the heavy lifting will begin this year, the task force is not likely to be in a position to recommend reforms within the next 12 months.
At the same time as these two funda- mental reviews are taking place, there’s critical policy work on the agenda.
Most notably, the CSA finalized its client-focused reforms (CFRs) in late 2019. And while the changes to an array of rules — including suitability, know-your- client, know-your-product, disclosure and conflict-of-interest rules — took effect at the end of 2019, the implementation of new requirements is scheduled to occur over the next two years, with all changes adopted by the end of 2021.
So, in the year ahead, there will be a good deal of work to be done in inter- preting the rules and assimilating them into firms’ processes and practices. At the same time, IIROC and the MFDA will be developing their own amendments to conform with the new CSA requirements, ensuring that the SRO rules match the CSA rules and that SRO-member firms will have to comply with only one set of rules.
Yet, if the experience of implementing the client relationship model reforms — which followed a similar approach — serves as a guide, then implementing the CFRs
could be a time- and resources-intensive chore for the SRO-member firms over the next couple of years.
In the meantime, the industry awaits key policy decisions from the regula- tors this year. For example, the Ontario Securities Commission (OSC) still is mulling what to do about mutual fund deferred sales charges after the CSA banned the charges in the rest of Canada.
There’s also the question of advisor title reform in Ontario, which is in the hands of the new provincial regulator, the Financial Services Regulatory Authority of Ontario. These two long-standing and historically contentious policy debates hopefully will reach some kind of conclu- sion in 2020.
The regulators’ other big project over the past year has been eradicating need- less regulatory burdens. This issue will remain a focus for the year ahead too. The OSC’s Burden Reduction Task Force report, released in November 2019, fea- tures 107 recommendations for reform.
Those recommendations range from rule changes to reduce outdated or redun- dant requirements to commitments to improve the regulator’s service to the industry. According to the report, while some of its proposals require legislative changes or the involvement of other mem- ber organizations within the CSA, many proposals under the OSC’s exclusive con- trol can be completed this year.
So, even as policy-makers begin turn- ing their attention to big-picture issues, such as SRO structure and a legislative review, the work of burden reduction is sure to be an ongoing preoccupation this year. IE
BY JAMES LANGTON
regulators faced a fundamental
rethink in 2019, as policy-makers shifted from enhancing investor protection to reducing compliance costs. In the year ahead, an array of bigger-picture issues is on the horizon.
For the past few years, regulatory trans- formation on the national level appeared imminent, with the Capital Markets Regulatory Authority (CMRA) finally get- ting off the ground. That project remains in the works, but with little progress to show for it over the past year — beyond Nova Scotia joining the effort in 2019.
Looking through 2020, with the fate of the CMRA still up in the air, the Canadian Securities Administrators (CSA) plans to launch a review of the other big com- ponent of the regulatory architecture: the self-regulatory structure.
The CSA promises to publish a con- sultation paper in mid-2020 that will kick off a review of the current self-regula- tory organization (SRO) framework. That paper will include the justification for the prevailing configuration, which divides oversight of the two main dealer categor- ies between the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA).
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Funds with mandates to reduce volatility could end up classified as “high risk”