After 5 years on the market, advisors are still learning how to use Liquid Alts
JOEL SCHLESINGER – SPECIAL TO THE GLOBE AND MAIL – PUBLISHED MARCH 5, 2024
It’s been five years since liquid alternatives became available to Canadian investors, and advisors continue to learn how the investment products fit in client portfolios.
Learning curve aside, so-called “liquid alts” are increasingly popular, reaching $20.2-billion in assets under management (AUM) among mutual funds and $12.6-billion AUM for exchange-traded funds (ETFs) in 2023, Investment Funds Institute of Canada (IFIC) statistics show.
While still representing a sliver of the total AUM for the fund industry (1 per cent of mutual funds and 3.3 per cent of ETFs), advisors are increasingly discovering these funds’ utility, particularly after 2022 when equities and fixed income fell in tandem.
“That’s a big reason advisors want to use them today – the fact that equities and bonds are moving increasingly in parallel,” says Tiffany Zhang, vice-president of ETFs and financial products research at National Bank Financial Inc. in Toronto.
Still, she notes the understanding of liquid alts’ potential has been slowly evolving after Canadian securities regulators implemented National Instrument 81-102 on Jan. 1, 2019. The change allowed fund companies to offer liquid alts – essentially mutual funds and ETFs using hedge-fund-like strategies involving leverage and short-selling.
Hundreds of liquid alts – mutual funds and ETFs – have come to market over the past five years under the regulation. These include long-short equity and fixed income, market neutral, multi-strategy, cryptocurrency ETFs and levered, enhanced-yield covered call ETFs, Ms. Zhang says.
“The lightly leveraged, enhanced-yield products are mostly used by DIY investors because they like their high yields,” she adds.
“But the ones offering exposure to hedge fund strategies appeal more to advisors because these can be good diversifiers, providing different exposures than they had access to previously.”
Among those seeing the appeal is Kian Ghanei, senior portfolio manager with Caerus Private Wealth at iA Private Wealth Inc. in Vancouver.
“We have used a specific liquid alt over the last three years in addition to the alternative products that we use,” he says, noting the Caerus Private Wealth team has used private market alternatives for more than a decade.
An F-series long-short mutual fund liquid alt now takes up a portion of the fixed-income sleeve in portfolios.
“When yields were extremely low, it was very difficult to get any benefit using fixed-income strategies,” he says. “[Fixed income] was dead in the water, not generating much return.”
The Caerus Private Wealth team looked to the liquid alt market and selected Dynamic Funds’ Dynamic Credit Absolute Return Fund, which employs short positions and leverage to hedge against interest rate risk and provide additional returns in low-yielding environments.
“For our fixed-income exposure, it made sense,” Mr. Ghanei explains, noting the rest of the fixed income allocation is invested in a long-only bond mutual fund managed by iA.
Fidelity Investments Canada ULC has also seen growing use for its liquid alts among advisors, says Andrew Clee, the firm’s vice-president of product.
Since the autumn of 2020, it has offered three mutual funds: Fidelity Long/Short Alternative Fund, Fidelity Global Value Long/Short, and Fidelity Market Neutral Alternative.
Last month it launched Fidelity Canada Long/Short Alternative Fund, along with ETF versions of the aforementioned three mutual funds.
So far, Fidelity’s liquid alts strategies have proven successful demand-wise – with more than $1-billion in AUM – although “a learning curve” is often involved for advisors to position liquid alts in portfolios, Mr. Clee says. “It kind of reminds me of ETFs about 15 years ago.”
Today, the liquid alts market is “growing at a huge clip,” with year-over-year growth of 37 per cent, Mr. Clee says. “It’s really been growing, particularly for use in traditional asset classes – stocks and bonds – with the added ability to generate alpha from short positions.”
Active management strategies, whereby fund managers can short companies they identify as having poor fundamentals, are attractive to many advisors, he adds.
“It kind of highlights what a lot of us have been doing for decades for stock picking,” Mr. Clee explains. “Only now, we have more tools to reduce volatility and for even more diversified exposure.”
Recent Canadian Association of Alternative Strategies & Assets data for Canadian liquid alt mutual funds reveals robust demand for long-short equity and credit funds, accounting for 72 per cent of AUM. In contrast, only 16 per cent of investor capital is allocated to multi-asset strategies, with another 7 per cent in market-neutral funds.
“The market is still sleeping a bit” on market-neutral funds, Mr. Clee notes, adding these liquid alts are arguably the best decorrelation tools for portfolios.
“The whole thesis for market neutral is the direction of stocks and bonds doesn’t really matter.”
He points to the performance of the Fidelity market-neutral fund (series F) in 2022 and 2023, up 5.34 per cent and 6.62 per cent, respectively. In contrast, the S&P 500 fell about 18 per cent in 2022 and gained 26 per cent in 2023, while the S&P 500 Bond Index fell about 15 per cent in 2022 while increasing about 8 per cent in 2023.
“It’s kind of an all-weather strategy,” Mr. Clee says, noting market-neutral funds fit between fixed income and equity as a stabilizer in a portfolio.
Fidelity Canada’s resources for advisors suggest liquid alts could take up about 20 per cent of a portfolio, with 50 per cent in equities and 30 per cent in bonds.
Mr. Clee predicts market-neutral fund demand will only grow in the coming years, along with demand for long-short equity and credit offerings. Those latter fund types potentially could replace traditional active mutual funds entirely for many advisors.
“I believe you’ll see a lot more adoption going forward in previously traditional portfolios,” he says.
For Mr. Ghanei, the credit long/short alt’s performance has proven its value, providing a 1.8 per cent return in 2022, when most bond allocations were down in value. As well, the fund provided additional yield in preceding years when interest rates were at historic lows, and it will continue to play a key role in his clients’ portfolios.
As for adding more liquid alts to portfolios, these investments will remain on Mr. Ghanei’s radar.
“If there’s something that makes sense, we certainly will be looking at it.
This information has been prepared by Kian Ghanei and Terry Fay who are Portfolio Managers for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The [Investment Advisor/Portfolio Manager] can open accounts only in the provinces in which they are registered.
iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.