Alternative investments can add value to portfolios but top advisors say it pays to do your homework

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Stocks and bonds faced a rough year in 2022 when both plunged simultaneously, leaving some investors wondering if they should stash money into alternative investments too.
Although alternative strategies have been embraced successfully in some cases by pension and endowment funds, three of Canada’s Top Wealth Advisors warn that plenty of due diligence is critical to avoid potential landmines.
“What’s important is that an alternative investment gives diversification and truly can add value,” says Bob Thompson, senior portfolio manager with Thompson Investment Partners at Raymond James Ltd. in Vancouver.
Alternative investments, which are available to higher-net-worth investors and can require long holding periods, run the gamut from hedge funds and private debt to real estate, farmland, and music royalties.
In recent years, liquid alternative (or liquid alt) mutual funds and exchange-traded funds that use similar strategies have been available to retail investors and can be bought and sold daily.
Mr. Thompson, a former hedge-fund strategist at his previous firm, says his clients, who have a minimum account size of $2-million, have about 20 to 25 per cent of their portfolios in alternative investments.
He doesn’t look at hedge funds to shoot the lights out but to achieve a return with lower risk. Hedge funds have “blown up in the past” because of excessive leverage and owning hard-to-sell assets, he says.
“That’s where due diligence comes in,” he says. “You must make sure that the person with all the tools available is capable of using them.”
Among the few hedge funds he favours is Timelo Strategic Opportunities Fund, run by portfolio manager Jean-François Tardif. (His listed JFT Strategies Fund – a closed-end fund – is run similarly.)
The hedge fund, which can go long and short securities, gained 7 per cent in 2022, while the S&P/TSX Composite Index lost 5.8 per cent and the S&P 500 index shed 18.1 per cent when including dividends.
Mr. Thompson also likes Pender Alternative Absolute Return Fund because it’s run by veteran fund manager Justin Jacobsen. This fixed-income offering uses less leverage than its peers and is less volatile than some relevant corporate bond indexes, he adds.
Among liquid alts, he favours Dynamic Premium Yield PLUS Fund. Fund manager Damian Hoang uses options strategies to provide U.S. equity exposure with less volatility and has done “an amazing job.”
Mr. Thompson says he also uses Canadian bank-issued structured notes linked to either an index or industry sector as part of his alternative investment allocation too.
“Given that interest rates are higher today, we’re able to get income-based notes with annual coupons paid monthly that are above 9 per cent with 30-per-cent downside protection,” he says.
“Our clients get 100 per cent of their capital back if the index or sector is not down by more than 30 per cent at the end of a specific term, which is generally five to seven years.”
Rob Tétrault, portfolio manager with Tétrault Wealth Advisory Group at Canaccord Genuity Wealth Management in Winnipeg, says most of his clients have about 30 per cent of their portfolios in alternatives.
He avoids hedge funds but likes certain investments in areas such as real estate and storage, farmland, music royalties, private equity, private real estate, private debt, and infrastructure.
Mr. Tétrault says all of his team’s clients own some multi-family real estate, which could be in a fund, a private pool, or a limited partnership. “That’s something that most people can wrap their heads around.”
Although the S&P/TSX Capped REIT Index lost 17.02 per cent, including distributions, in 2022, private real-estate properties have their valuation done by third-party appraisals, he says.
“That’s usually reflective of cash flow and capitalization rates, so they’re a lot more stable,” he says.
Mr. Tétrault has also invested in storage and farmland through funds run by Avenue Living Asset Management Ltd.
“More Canadians have storage units because we just accumulate stuff as a society,” he says.
“I am also a big fan of farmland,” he adds. It’s a play on the emerging middle class in developing countries wanting to eat more meat, and that requires more grain to feed the animals.
But there’s less arable land every year as it gets converted for housing or other uses, so there will be a supply-and-demand imbalance, he says.
He also invests in music royalties through ICM Crescendo Music Royalty Fund run by ICM Asset Management because he believes people will be streaming more music in the coming years.
Although he does like private-debt funds, he warns that a lot of due diligence is needed.
“You have to make sure the individuals managing this private debt are really doing what they say they are,” he says.
Toronto-based Bridging Finance Inc. is a high-profile example of the collapse of an alternative asset manager. It was put under court-ordered receivership in 2021 following allegations that the private lender used its investor funds to benefit some of its founders and executives.
A big drawback in alternative investments is the longer-term holding period if investors need immediate cash, Mr. Tétrault says.
Investors in the past often had to hold alternative investments for maybe one to five years before being able to sell, he says. “The alternatives we use have 30- or 90-day liquidity.”
However, Ross Ferrier, investment manager with Commerce Valley Financial Group at CIBC Wood Gundy in Thornhill, Ont., says he’s “not an active recommender of alternative products” to his clients.
“I am very cautious,” says Mr. Ferrier, who has been in the business for 25 years. “The more complex and opaque investments become, the harder it is to determine what the outcome will be.”
As a branch manager, he must also approve any alternative investments that the 32 advisors in his office may be considering. The alternatives also require the sign-off by the brokerage firm’s products and regulatory supervisory teams.
“These products require a higher level of due diligence,” he says. “Alternative products is a broad term that can mean a lot of things.”
His higher-net-worth clients have had about 5 per cent, at most, in alternatives in their portfolios. It would have been in the real estate sector with “people or organizations that I would trust,” he says.
“We are not in any now, but clients did put money into condo projects,” he says. “But a lot of these projects have been pushed to the sidelines because the cost of financing is so high now.”
But he acknowledges he has personally invested in Portland Investment Counsel Inc.’s ITM AG Investment Trust. It’s a private equity fund that invests in biotechnology and radiopharmaceutical companies that are developing treatments for cancer.
The fund doesn’t have a sufficient track record to be on CIBC Wood Gundy’s product shelf, but he was given permission by the firm to invest in it.
“Cancer has touched my life personally, so I wanted to see, and be part of anything [to do with it],” he says.
Still, alternative investments don’t have a lot of appeal in the current environment, Mr. Ferrier argues.
“I can buy a [guaranteed investment certificate] and get 5 per cent,” he says.
“That is the risk-free rate of return. Now, you must measure that against alternative investments, which categorically would be put into a higher-risk asset class. …They would be more suitable for people if interest rates were at zero.”
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