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AIMA and CAIA call for risk rating review for alternative investments in Canada

AIMA and CAIA are proposing a new system to help reduce the complexity of current methods of risk ratings at investment dealer firms.

The Associations have published guidelines on these methods in response to new regulations and consistent feedback from AIMA member firms that retail risk ratings unfairly rate alternative products automatically as high risk.
The final amendments to regulation NI 81-102 will make alternative investment funds available to retail investors. This has the potential to expand the market for alternative investment products that were previously only available to accredited investors. Consequently, some early predictions anticipate the Canadian alternative mutual fund market could grow to CAD20 billion in the next five years.
Existing risk rating methods often result in all alternative funds being rated as high risk in the retail channel. This limits the number of investors who can access these products, and dealer firms often overlay additional risk rating policies on standards outlined by the Canadian Securities Commission (CSA). To facilitate risk-reducing portfolio construction and to give retail investors access to available alternative investment products, the Associations advocate that:
Additional Risk Rating systems at the investment dealer should be re-assessed for all alternative fund strategies, including the new alternative mutual funds, to reflect their true risk;
Any risk rating scale at the investment dealer should include five categories of risk (rather than only three) consistent with prospectus risk ratings;
Fund categories should be separated for alternative fund strategies and alternative mutual funds. They should then also be expanded to include sub-categories so that products can be evaluated adequately and individually against their peers.
The Associations’ proposed new risk rating system is based on the median trailing standard deviation of funds within indices. No alternative mutual funds or alternative strategies will be rated in the ‘low risk’ category.
A new Guidance paper provides specific rationale and considerations on all these points.
Claire Van-Wyk-Allan (pictured), Director and Head of AIMA Canada, says: “To improve access to alternative investments for retail investors, AIMA Canada and the CAIA Association are pleased to propose our risk rating system that more accurately reflects the lower risk that these products provide to a portfolio. Canadian investors deserve a fair opportunity to access the talent and strategies managed at boutique and established investment firms without requiring an unjustly high-risk investing profile to do so.”
Belle Kaura, Chair, AIMA Canada, says: “Alternative investments play a key role in a balanced portfolio, offering diversification, risk reduction and non-correlated returns to investors. It is imperative, especially late in the economic cycle amid a rising rate environment, that Canadian investors are not denied access to the benefits of alternative strategies by simplistic and unfair methods that rate all alternative investments as high risk.”
“AIMA Canada and CAIA’s Risk Rating Guideline seeks to eliminate barriers to distribution by more fairly aligning risk ratings with true risk based on the specific type of alternative strategy and qualitative due diligence on the manager and product. We advocate a review of risk rating systems by investment dealers for all alternative strategies and the use of a five-tier risk scale (rather than only three) for greater flexibility, improved accuracy and consistency with prospectus risk ratings.”
Keith Black, Managing Director of Curriculum and Exams at the CAIA Association, says: “Alternative investments can be complex, in both liquid alternatives and lock-up fund structures. The CAIA Association advocates that all market participants become fully informed regarding the new Canadian fund structure, including the benefits, drawbacks, and complexities. We are pleased to be working with AIMA to further the education of investors, especially those in Canada who choose to embrace the new investment opportunities now available under NI 81-102.”

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