Know the limits in CSA’s alternatives proposal

Average investors will soon be able to use alternative investments, provided CSA’s proposal goes through.

Alts advocates are cheering this expanded access, including Craig Machel, director of wealth management at Richardson GMP in Toronto. But the proposal’s restrictions prompt him to describe it as potentially “hedge fund-light.”

That’s because the regulators aren’t including “private equity and private debt — illiquid investments,” he says. “But they’re […] allowing construction and management of a hedge fund using different tools.”

Those tools — leverage, shorting and derivatives — will be allowed to a lesser degree than a “full-blown offering memorandum hedge fund,” he says.

Read: Avoid pitfalls of alternative strategies

Limits

The proposal has a leverage limit of 300% of assets, including hedging, and a shorting limit of 50% of assets. (Currently, mutual funds can have 20% shorting but no leveraging.)

So you couldn’t have, say, a 300% long/300% short position, explains James Burron, COO of Alternative Investment Management Association. “That’s not zero leverage in [the regulators’] books. That’s 600%.”

Read: Long/short strategies keep correlations down

For shorting, Burron suggests 100% may be approved on exemption. “You could have a true market neutral with 100% long/100% short — you’re still under the 300% leverage max. But you’d have to apply to [the regulators] and say, ‘This is our strategy; this is how we’ve run it; this is why it’s not going to be putting any investor money at undue risk.’”

In Australia, there are no leverage or shorting limits, notes Burron. “They’ve been doing this for 14 years, and they haven’t had any appreciable risk to investors.”

Equal opportunity

Machel hopes firms embrace the proposal and allow their advisors to use it. For their part, advisors are “obligated to put in the time and effort to understand the various products available and do the […] paperwork” and get the potential accreditation, he says.

He says the proposal is about freedom of choice and access for all investors — not about risky behaviour.

“Hedging is about risk management. It’s not about taking on more risk,” he says. Institutional investors such as CPP, teacher pensions, and universities aren’t able to take on undue risk. Yet a significant part of their portfolios are made up of alternative investments — 40% or more, he estimates.

Read: Should average investors use alts?

That institutions and wealthy investors should “formally [be] the only ones allowed to go into this world because they can take on more risk — it’s such a fallacy,” says Machel. He calls the proposal’s equal-opportunity access “a progressive move by the regulators.”

The comment period closes December 22, 2016. The proposed amendments can be found here.