Asset managers back OSC’s proposal for new ‘long-term’ funds for individual investors

The growth of private credit financing for companies coupled with more issuers staying off the stock market for longer in recent years is potentially cutting into the number of investible opportunities for retail investors – and regulators have taken notice.

Currently, more than 85 per cent of all U.S. firms that generate US$100-million or more in revenue are privately held, according to S&P Global Inc. Experts say the percentage is likely similar in Canada.

Regulators at the Ontario Securities Commission (OSC) and elsewhere are concerned about a diminished pool of public investing opportunities, which could put retirement plans and, more broadly, economic prosperity at risk.

The OSC is now asking for input on a framework to facilitate new vehicles designed to give individual investors access to “long-term asset funds” comprised primarily of non-public assets.

“This is a big opportunity that, until recently, hasn’t been available to everyday investors,” says David Wong, chief investment officer and managing director of total investment solutions at CIBC Asset Management.

“Long-term assets” are illiquid holdings that can’t be disposed of readily, “may be difficult to value, and generally have longer investment time horizons than other assets,” according to the OSC’s consultation paper.

Venture capital, private equity, private debt, mortgages, real estate, infrastructure and natural resource projects represent the bulk of these assets, which have long been a source of elevated returns for big pensions and well-heeled high-net-worth investors who can afford to wait years or longer for such investments to pay off.

Under the proposal, Ontario Long-Term Funds (OLTFs) would be reporting issuers that would require prospectus approval. The structure would be akin to a mutual fund, in which buying or redeeming shares is done directly from the fund itself rather than through an exchange. “OLTFs would not have any securities listed and traded on a marketplace in Canada,” the OSC’s consultation paper states.

The funds would be structured as closed-end or open-ended “evergreen” funds with clearly articulated terms and investment objectives.

While OLTFs wouldn’t be subject to the same illiquid asset restrictions as other investment funds, the OSC paper states, “they would need to address inherent risks associated with long-term assets, such as liquidity, volatility, concentration, duration, and informational asymmetries, by incorporating robust requirements and protections.”

Fund managers such as CIBC Asset Management and CI Global Asset Management already offer accredited investors private market vehicles but would welcome new rules that open products to more customers.

“The proposal is quite pointed on the need for considering tradeoffs within things such as liquidity, the frequency at which redemptions can happen and the right tension between a minimum and a maximum [amount of assets] in long-term investments,” says Marc-André Lewis, president and chief investment officer at CI GAM. “It’s important these funds have, first and foremost, sufficient exposure to these asset classes – hence the minimum. But they also need to be somehow liquid, hence the maximum.”

Here are some of the other issues that may arise in the consultation, which closes Feb. 7.

Cornerstone investors

The OSC says so-called “cornerstone investors” – i.e. larger institutional investors – may be required to participate alongside individual investors in the funds to provide financial heft and the sophisticated oversight smaller holders may lack.

Mr. Lewis says there needs to be more clarity on who qualifies as a cornerstone investor.

“We invest in private equity funds that are, in general, issued by managers that have a significant stake. So, then, the question is, what constitutes a cornerstone investor?” he asks.

Does it have to be a large pension plan, he asks, or could it be a large private market fund operator that’s invested in its own fund?

European efforts

Industry experts point to attempts in recent years by European regulators to create similarly structured long-term asset funds for individual investors. The result has been overregulation that’s deterred firms from offering the funds, says Steve Balaban, chief investment officer of Mink Capital.

“It’s this balance the OSC has to find, which is difficult,” says Mr. Balaban, who trains family offices and financial institutions globally on private markets. “You’re going to open investors who are not ‘sophisticated’ to a ‘sophisticated’ asset class. To do so, you need lots of rules. But lots of rules are now burdensome.”

Mr. Balaban says the inclusion of a large investor such as a pension plan is not a guarantee the funds will be monitored adequately, either.

“We run the risk that if we’re not overregulating these, and the major protection is a cornerstone investor who knows what they’re doing – how do we make sure we know they know what they’re doing?”

Fees and return potential

Mr. Balaban also says adding layers of reporting requirements and other red tape could mean fund managers charge higher fees, eating into the higher return potential private markets are touted to provide.

“The problem is, as you have more rules, it costs more money to get these companies to apply the rules, ultimately leading to more fees for end clients,” he says.

While higher fees are a risk, Mr. Lewis of CI GAM says the pros outweigh that particular con. “Investors are still going to get a good risk-reward ratio in private markets.”

However, Mr. Wong of CIBC AM says many asset managers – especially smaller ones or managers focused on lower costs – could balk and not participate.

“The potential for offering liquidity where the underlying asset itself is not liquid needs to be managed carefully – and it can be,” he says.

“But it’s something [regulators] need to get right. It heightens the amount of advice and care that needs to go into individuals making the decision to invest.”

For more articles on alternative investments, visit Globe Advisor’s Alternative Investments section.