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High net worth market opportunities beckon

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Currently there are five key drivers of the booming Canadian investment scene, starting with the general decline in availability of domestic securities.

Currently there are five key drivers of the booming Canadian investment scene, starting with the general decline in availability of domestic securities. With a significant number of local companies having been acquired by foreign entities, a huge amount of cash is now chasing fewer Canadian stocks.

The second element is the huge amount of new wealth being generated through transgenerational transfers, along with the wealth entering Canada as the level of immigration exceeds 250,000 a year, and the wealth effect of soaring real estate values. At the same time, there is a new emphasis on the pursuit of alpha; in a relatively low interest rate environment, people are willing to take on a little more risk in order to obtain better returns. The fourth driving factor is an increase in flows between certain countries because of the removal of limitations on certain types of cross-border investments. A year and a half ago, the government removed restrictions on Canadians investing in foreign securities through their retirement savings plans, and there have been similar changes in other countries such as Australia. Finally, new money continues to come into Canada from investors in other countries who see specific
opportunities, such as in oil and energy investments.

In this environment, institutional investors have been steadily building up their hedge fund expertise. Like their counterparts in other countries, many pension funds now allocate a specific proportion of their total assets to hedge funds, whether through funds of funds or direct investment in singlemanager, single-strategy funds. Canadian hedge funds are also enjoying some success in attracting European investors tapping their expertise in a niche but currently lucrative marketplace.

However, unlike in other markets where high net worth individuals and their family offices blazed the trail in hedge fund investment, in Canada they do not represent a particularly significant part of the investments of high net worth individuals. In the retail market, the sector has suffered from the bad publicity engendered by the collapse of two local hedge funds, Portus and Norshield, and ongoing warnings from abroad such as the Amaranth Investors blow-up.
However, as the memory of these incidents fades, this is likely to change, and hedge fund investment is likely to become more popular not only among high net worth individuals but the mass affluent. Some Canadian hedge fund managers such as Arrow Hedge Partners are already offering closed-ended products that do not carry the high minimum investment requirements imposed on classic hedge funds by Canada’s provincial securities commissions. The Canadian Securities Administrators, a federal forum, has been examining what changes might be necessary to protect individual investors. Regulators such as the Ontario Securities Commission have concluded that regulation of investment management is adequate, although they are proposing to tighten registration requirements. Meanwhile the Investment Dealers Association of Canada, an industry self-regulatory body, is focusing on KYC due diligence and sales practices.
The continuing low interest yields and the recent tax position on income trusts will again in the long term be positive for the hedge fund industry. The Canadian hedge fund sector may currently be driven more by institutional than individual investment, but as the market matures it is likely that more high net worth individuals will be willing to allocate as much as 5 per cent of their assets to hedge funds.

Raj Kothari is a partner and leader of the investment management practice and Chris Pitts is an audit and assurance group partner with PricewaterhouseCoopers  in Toronto

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