Expanding Your Horizons
Accessing Alternative Investments - A Canadian Retail Investors' Perspective
Disclaimer: This article is only intended to provide you with general information. It is neither an offer to sell nor a solicitation of an offer to purchase any security and does not constitute, and should not be construed as, investment advice. Any statement about a particular investment or company is not an endorsement or recommendation to buy or sell any such security. The article is not intended to provide legal, accounting, financial or tax advice, and should not be relied upon in that regard. You are encouraged to seek independent advice. Every effort has been made to ensure that the article is accurate as of the date of first publication; however, we cannot guarantee that it is accurate, complete, or current at all times. The article may contain forward-looking information that reflects our current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties, and assumptions that could cause actual results to differ materially from those expressed herein.
Come gather 'round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You'll be drenched to the bone
If your time to you is worth savin'
And you better start swimmin'
Or you'll sink like a stone
For the times they are a-changin'
The Times They Are A-changin’ by Bob Dylan
The Times They Are A-Changin
The first half of 2022 has been a rough ride for investors. With the S&P 500 (Ticker: ZSP) down ~18% year to date, the NASDAQ (ticker: XQQ) down nearly 30% and the 60/40 portfolio (ticker: VBAL) down close to 15%, retail investors are getting hit across the board. Rising interest rates, high inflation, a softening real estate market and increased geopolitical uncertainty have combined to create a challenging environment for investors who have gotten used to rising stock markets with low price volatility. Zooming out, the last decade, which has been a fruitful one for investors utilizing the traditional 60/40 investment model (with approximately 60% in stocks and 40% in bonds), was in fact quite anomalous compared to average 60/40 portfolio returns throughout history. According to research by quantitative investment firm, AQR, returns from the 60/40 portfolio were three times higher in the last ten years than anytime between 1900-2011. Only 4% of the time over the past 122 years have risk-adjusted returns for the 60/40 portfolio been as good as they were in the last decade (as cited by Institutional Investor).
This is sobering stuff. Particularly for retail investors who have been sold a narrative that passively investing in the stock and bond markets through low cost ETFs is basically the only way to invest. The reality is that sophisticated investors have been investing in many, many other things with core objectives of preserving capital (risk management), earning a yield (income) to offset current liabilities and safely growing capital (growth) over time. As Canadians, we are directly exposed to some of the most sophisticated investors globally through our contributions to pension plans such as the Canadian Pension Plan (CPP), the Ontario Teachers Pension Plan (OTPP), the Caisse de dépôt et placement du Québec (CDPQ) amongst others. As a group, the Canadian pensions share many common attributes, however, one I want to highlight is their ongoing and consistent exposure to alternative investments. The reason being that alternative investments have been central to the healthy and consistent investment performance of many public pension plans in Canada. According to a study conducted by the Financial Services Regulatory Authority of Ontario (FSRA), seven of the largest public pensions in Ontario who manage a combined ~$500 Billion, have exposure to alternative investments, which range from 25%-50% of their portfolios as of the end of 2020. This compares to retail investors, who are estimated to have 1%-5% (if that) allocated to alternative investments within their portfolios (excluding primary residences).
So why do smart investors allocate to alternative investments and what are alternative investments? Investment Research database, Preqin, explains that alternative investments are essentially any investments that fall outside of traditional asset classes (stocks, bonds and cash). The large categories of alternative investments include:
Private Equity
Venture Capital
Hedge Funds
Private Debt
Real Estate
Infrastructure
Natural Resources
Each of these categories of alternative investments contain different risks and benefits to investors, however, the most common reasons why large investors, such as the Canadian pensions, allocate to alternatives include:
Bit of a tough chart to read but basically large investors use alternative investments to satisfy many of the same investment challenges and objectives retail investors grapple with. There are important differences between retail investors and large institutional investors such as investment time horizons, liquidity requirements and tax considerations, however, the bottom line is that retail investors have to expand their horizons to include alternative investments in order to benefit from better expected investment outcomes, particularly in the current and forward looking market environment.
Okay, so pretty long winded lead up to the purpose of this writeup; how do retail investors access alternative investments in Canada and what are the go to platforms and services? Well, the good news is that accessing alternative investments for retail investors is better now than ever before. The bad news is that accessing alternative investments for retail investors is still far from easy and, more importantly, the quality of alternative investments available to retail investors is not always the same as the quality available to large institutional and HNW investors. This is changing but much work remains. Before we dive into the landscape as it stands today, a few important definitions:
Accredited Investor: In Canada, accessing certain investment offerings may require you to qualify as an accredited investor. Most (but not all) alternative investments are limited to accredited investors because they are perceived as inherently riskier when compared to buying an ETF or a stock in a publicly traded company. This view is evolving and it’s not outside the realm of possibility that non-accredited investors may have broader access to alternatives sometime in the near future.
The basic qualification criteria for individual accredited investors all revolve around financial tests, which include:
Has your annual income exceeded $200K in the last two years or;
Has your household income (you and your spouse) exceeded $300k in the last two years;
Do your financial assets (stocks, funds, bonds, cash, etc.) exceed $1M either individually or jointly with a spouse
With that said, there are certain instances where non-accredited investors can invest in alternatives up to a certain dollar threshold per year. We’ll explore this more later in this post.
Managed Accounts: A managed account is a form of investing where you as the individual investor give authority to an investment/wealth manager to manage your money. This is typical when a financial advisor is steering your savings into investment opportunities but also when you put your money to work through a robo-advisor portfolio
Direct Investing: When an investor chooses to allocate their own capital into a given investment opportunity. Examples include buying stocks through an online/discount brokerage platforms like Questrade or Wealthsimple Trade or buying bitcoin through a crypto platform
With that, lets turn to the world of retail accessible alternative investments
Accessing Alternatives - Managed Accounts
The easiest path to accessing alternative investments, without having to shoulder the additional burden that comes with direct investing, is by using a sophisticated financial advisor. This is unfortunately easier said than done as savvy financial advisors who know how to incorporate alternative investments into client portfolios typically have high minimum investment requirements for clients. According to the Globe & Mail’s Top Wealth Advisors 2021 list, the average minimum requirement of top advisors across the country is close to $1 Million. Having a decade on Bay Street, I can tell you the reality is that getting setup with an investment portfolio with meaningful alternatives exposure will require a much more sizeable account size (think $5 Million+). So for those of you that meet these thresholds, I would encourage you to seek out advisor referrals or speak to your existing advisor about their thoughts on alternative investments and how you can get exposure in your portfolio.
An alternative route to a managed account that includes alternative investments is to use a robo-advisory platform like CI Direct Investing or OneVest. In the case of CI Direct Investing, accredited investors can access investment portfolios that include some alternative investments exposure through a partnership with a Canadian investment manager called Nicola Wealth Management. OneVest’s approach to alternative investments is through the use of publicly listed or liquid securities, which allows broader participation in their portfolios (not limited to accredited investors).
Accessing alternative investments through managed accounts will appeal to retail investors who would prefer to defer the investment decision making to professionals while benefitting from exposure to alternatives. Unfortunately, access to alternatives through managed accounts is limited by high minimum investment requirements, limited use of alternatives (e.g. 10% maximum alternatives exposure) and, in some cases, use of funds/managers that may not be best available. Still, the future is bright for investing in alternatives through managed accounts.
Accessing Alternatives - Do It Yourself (DIY)
The world of DIY alternatives investing is growing and evolving rapidly. Entrepreneurs from across Canada have recognized that retail investors are looking for direct access to non-traditional investments and are busy working on solutions. The platforms in market offer retail, primarily accredited, investors access to alternative investments in asset classes including venture capital, private debt, real estate, natural resources, as well as niche alternative asset classes such as contemporary art investing or fine wine investing. Retail investors also have access to plenty of digital asset (crypto) investing platforms but buyer beware, crypto is extremely risky and should only ever represent a very small portfolio allocation with a recognition that you could lose all your money. Lets get into the platforms, what they’re for, who can invest and risks and benefits of investing:
Venture Capital
FrontFundr, Wealthsimple, Crowdmatrix, Brightspark, Angellist Ventures
What are they: Direct investing platforms through which you can access venture capital investment opportunities either via funds (Wealthsimple, Brightspark) or via individual investment opportunities (FrontFundr, Angelist Ventures, Crowdmatrix, Brightspark, Angellist)
Who can invest: With the exception of FrontFundr, which is technically considered a ‘crowdfunding’ platform, all the other platforms mentioned are limited to accredited investors. FrontFundr can be accessed by anyone but non-accredited investors will be limited to a maximum annual dollar investment amount
Risks and Benefits: Venture capital investments can produce some of the most attractive investment returns of any asset class (average returns are usually in the mid-teens or higher). The challenge is identifying the companies and/or funds that may generate lucrative returns VS. the companies/funds that don’t (most don’t). Depending on your tolerance for risk and your liquidity requirements (most venture investments don’t monetize for several years), venture capital may or may not be appropriate for you. Venture investments can be highly sensitive to interest rates and the venture industry as a whole is currently experiencing a significant correction on the back of a rising interest rate environment
Real Estate & Natural Resources
What are they: Willow is a recently launched real estate investing platform that allows Canadian investors to make a fractional investment in physical real estate such as purpose built multi-residential buildings, mixed-use buildings, commercial buildings and more. Investors earn a yield on their investment and also have the potential to earn capital gains when the property they invest in is sold. FarmTogether is a platform that allows investors to make a fractional investments in US farmland that generate income and the potential for capital gains. Both platforms provide direct exposure to different types of real assets
Who can invest: Willow appears to be open to all Canadian investors although they do put new users through a vetting process. FarmTogether is only accessible by accredited investors
Risks and Benefits: Real assets such as real estate and farmland are age old investment asset classes that don’t deserve to be called alternative investments, yet they are categorized as such. Real estate and farmland are both good investments to protect against inflation, both generate cash flow (income) as well as the possibility of capital appreciation over time. They can also act as risk diversifying exposures when held alongside publicly listed securities. Historically, real estate and farmland have produced high single digit returns with limited variability (volatility) of returns when compared to public equity markets
Private Debt
What are they: gopeer is a peer-to-peer lending platform that connects Canadians looking for loans with Canadians looking for a return on their investment (yield/income). LendingLoop is similar, however, the loans are exclusively made to Canadian small and medium sized businesses and not individual borrowers. In both cases the loans are unsecured (not collateralized) and interest rates dependent on credit ratings assigned and determined by the platforms
Who can invest: Investors who qualify as either ‘Eligible’ investors or ‘Accredited’ investors. The Eligible investor qualification criteria is like a watered down version of the accredited investor criteria i.e. you must have income in excess of $75K yourself or $125K with a spouse or you must have at least $400K in net assets either alone or with a spouse. Eligible investors are limited to how much they can invest on an annual basis while accredited investors are not
Risks and Benefits: For investors seeking higher income producing investment opportunities than a bank GIC, a high interest savings account, a government or corporate bond, etc. However, with the higher interest rate comes higher risk. It’s important to carefully review each lending opportunity and ensure you are insulated from loan defaults by diversifying amongst many lending opportunities. Peer-to-Peer, unsecured lending occupies a niche space in the private debt landscape. Unfortunately, at this time, the core categories of private debt are not directly accessible to retail investors
Niche Alternatives
What are they: Masterworks is a US based contemporary art investing platform that allows retail investors to make fractional investments in curated contemporary art. The art is held for several years before being sold for a higher price and generating a capital gain for investors. Cult Wines is a platform specializing in investing in fine wines. Investors can sign up and purchase one of a few investment plans, which correspond to portfolio of physical wine bottles held in custody by Cult Wines on behalf of each investor. As the wines appreciate in value, investors can earn capital gains.
Who can invest: Masterworks is only accessible to accredited investors whereas Cult Wines appears to be more broadly accessible
Risks and Benefits: Current and historical prices of contemporary art and fine wine are not highly correlated with public markets. Additionally, both art and wine have strong historical track records averaging returns in the high single digits or low double digits. However, in both instances, the averages may not necessarily reflect the specific return of a given piece of art or a given vintage of wine. With that in mind, it would be important to have diversified exposure and to carefully assess respective investment opportunities for risk and return
Accessing Alternatives - Publicly Listed Securities
A third path to accessing alternative investments is through publicly listed companies and securities. Many alternative investment firms have launched listed securities that invest in alternative investments, primarily drawn from the private markets arena. Examples include listed closed-end funds, listed business development companies and listed asset management companies that specialize in alternative investments. No doubt this is the simplest way to gain exposure to potentially diversified alternative investments, however, it comes with added costs and challenges. The added costs that come with listing publicly, the added burden of bearing the overhead of the respective issuer and the potential deviation between the net asset value of the actual investments and the market price of the security are some of the main drawbacks of accessing alternatives in this manner.
To sum it all up, the world of alternative investments is rapidly evolving and access to alternative investments is growing for retail investors. Many challenges remain particularly around broadening access beyond accredited investors as well as bringing high quality private and alternative investment opportunities to the DIY investor market. With that said, the future is bright and you can be sure that access, quality and safety will only increase from here.