Alternative mutual funds and labour-sponsored investment funds (LSIFs) offer alternatives to investing in traditional mutual funds. You should be aware of the different benefits and risks of these investments before you buy.
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What are alternative mutual funds?
Alternative mutual funds are a type of mutual fund. Like a conventional mutual fund, an alternative mutual fund is a collection of investments owned by a group of investors and managed by a professional money manager.
However, alternative mutual funds can invest in non-traditional investment assets or use complex investment strategies in ways that conventional mutual funds cannot. For example, an alternative mutual fund can invest in physical commodities without restrictions, use derivatives, short-sell securities, or borrow cash for investment purposes.
Similar to conventional mutual funds, you will receive a summary document known as Fund Facts at the time of buying the fund if the alternative mutual fund is not listed on an exchange. If the alternative mutual fund is listed on an exchange, you will receive an ETF Facts within two business days after you buy the fund.
Alternative mutual funds also have similarities to hedge funds in some respects. Both can invest in non-traditional assets or use complex strategies like short-selling or use derivatives to meet the funds’ investment objectives. However, not everyone can invest in hedge funds.
Only investors that qualify as accredited investors can invest in hedge funds. On the other hand, everyone can invest in alternative mutual funds.
Comparing traditional mutual funds, alternative mutual funds, and hedge funds
| Conventional Mutual Funds | Alternative Mutual Funds | Hedge Funds | |
|---|---|---|---|
| Invest in non-traditional assets (For example: gold, oil, real estate) | Limited | Yes, although limited to commodities | Yes |
| Complex, high-risk strategies (For example: use of derivatives, short positions) | Limited | Yes, with restrictions | Yes |
| Issuance of prospectus | Yes | Yes | Exempt |
| Issuance of Fund Facts or ETF Facts | Yes | Yes | Exempt |
| Delivery of Fund Facts or ETF Facts | Deliver Fund Facts at the time of buying the fund Deliver ETF Facts within two business days after buying the fund | Not Applicable | |
What should you be aware of before investing in alternative mutual funds?
There are a few things you should consider before investing in alternative mutual funds, including:
1. The fund’s investment objectives
Depending on the fund’s investment objectives, some funds may use complex strategies to beat the market. Other funds may spread the investments across traditional assets such as stocks or bonds and non-traditional assets such as gold or oil to manage risk through diversification. Before choosing an alternative mutual fund, consider whether the fund’s investment objectives meet your investment objectives and needs.
2. The fund’s investment strategies
Alternative mutual funds can use leverage to meet their investment objectives. For example, funds can borrow cash or short-sell securities or use derivative transactions. Use of leverage can increase the riskiness of the investment. Ask your financial representative questions about the fund’s investment strategies and how they could impact the fund’s investment returns.
3. What fees you will be charged
Fees can reduce the return you earn on your investment. Like hedge funds, you are more likely to see alternative mutual funds charging a performance fee in addition to other types of fees. Talk to your financial representative to understand the impact of fees on the fund’s investment returns.
4. How the fund has performed previously
Although past performance cannot tell you exactly how the fund will perform in the future, it is important to review the performance of the fund. If the fund is new and has limited performance history, try to find out as much information as possible from your financial representative about the mutual fund company and the fund manager’s education and experience.
Remember
Financial representatives that sell mutual funds, including alternative mutual funds, are required to be registered with the provincial securities regulators. Check registration through the Ontario Securities Commission or Canadian Securities Administrators.
What are labour-sponsored investment funds (LSIFs)?
The federal and provincial governments introduced labour-sponsored investment funds (LSIFs) in the 1980s to promote economic growth by encouraging Canadians to invest in small- to medium-sized companies. LSIFs invest in companies developing new products or markets. For this reason, these ventures can be risky.
Labour-sponsored investment funds can be purchased from an investment firm or directly from the mutual fund company.
Learn more about Ontario’s LSIF program.
What are the risks of LSIFs?
- Investments are speculative – LSIFs invest in riskier ventures. Many of these companies are small and unproven and are in the early stages of developing new products or markets. There’s a good chance they could lose money or go out of business.
- Your money is locked in for 8 years – If you sell early, you’ll lose any tax credits you claimed. You may also have to pay an early redemption fee.
- Funds can suspend redemptions without notice – You may not be able to get your money out when you need it.
- Performance is difficult to assess – The investments held by LSIFs may be difficult to value, and their valuation may involve significant judgment. Because of this, an LSIF’s performance may be difficult to assess objectively. Some of the fees you pay for an LSIF are based on this performance.
What are the costs associated with LSIFs?
Like many investments, LSIFs have different types of fees.
- Management fees – Like a mutual fund, your costs include fees for managing and operating the fund. This is called the management expense ratio (or MER). Most LSIFs charge a higher MER than mutual funds because they have higher research costs.
- Performance fees – These fees reward LSIF managers for good performance. Different funds use different formulas. Some LSIFs pay a performance fee if the fund’s yearly return is higher than 6%, before costs. Others calculate the return after costs.
- Sales commissions – These fees go to the salespeople who sell the LSIF to investors.
- Early redemption fee – This fee could apply if you sell early.
Remember
Before you invest, read the prospectus to understand the risks and costs of investing in an alternative mutual fund or an LSIF.
Summary
Alternative mutual funds and LSIFs offer an alternative to investing in traditional mutual funds.
- Alternative mutual funds can invest in non-traditional investment assets or use complex investment strategies in ways that conventional mutual funds cannot.
- LSIFs promote economic growth by encouraging Canadians to invest in small- to medium-sized companies developing new products or markets – these ventures can be risky so read the prospectus.
- If you sell your LSIFs early, you’ll lose any tax credits you claimed. You may also have to pay an early redemption fee.
- Review the fund’s prospectus to understand risks and costs.
- Before choosing an alternative mutual fund or an LISF, consider whether the fund’s investment objectives meet your investment objectives and needs.
