Alternative funds are now offered in the form of exchange-traded funds (ETFs) and mutual funds.

What are alternative funds?

Like a “conventional” mutual fund or ETF, an alternative fund is made up of money pooled by a number of investors and managed on their behalf by a fund manager. The manager invests this money in various securitiesA security is a legal instrument that grants certain privileges and that, as a rule, can be bought or sold. Here are some examples of securities: 
Treasury billGuaranteed Investment Certificate (GIC)Savings bondSharesEtc.
in line with the fund’s investment objectives. However, managers of alternative funds can choose from a broader array of investment strategies than managers of conventional mutual funds and ETFs. By using different strategies, alternative fund managers can help you diversify your portfolio.

As with a conventional mutual fund or ETF, when you invest in an alternative fund, you buy units or shares of the fund.

Comparative table of differences between conventional funds and alternative funds

DifferencesConventional mutual funds and ETFs Alternative funds
ConcentrationMay invest up to 10% of their net asset valueCompany: Liquidation value, or net worth, is the amount obtained on dissolution of a company; in other words, when all its assets are sold and all its liabilities are paid.
Investment funds: The value of the assets of the fund, less the fees, expenses and taxes.
(NAV) in securities of a single issuer.
May invest up to 20% of their NAV in securities of a single issuer. It can be risky when there’s a large concentration of a particular security, because the value of the security could decline substantially.
Physical commodities and precious metals

May invest up to 10% of their NAV indirectly (including through derivatives) in physical commodities: electricity, water, or, in an original or processed state, an agricultural product, forest product, product of the sea, mineral, metal, hydrocarbon fuel product, precious stone or other gem.

May invest 10% of their NAV in permitted precious metals: gold, silver, platinum and palladium.

Total indirect investments in the above physical commodities and precious metals may not exceed 10% of the fund’s NAV.

May invest directly or indirectly, without limit, in physical commodities: electricity, water, or, in an original or processed state, an agricultural product, forest product, product of the sea, mineral, metal, hydrocarbon fuel product, precious stone or other gem.

May invest, without limit, in permitted precious metals: gold, silver, platinum and palladium.

Investments in other investment fundsMay invest up to 100% of their NAV in other conventional mutual funds and ETFs and up to 10% of their NAV in alternative funds and non-redeemable investment fundsA non-redeemable investment fund is an investment company that issues a fixed number of units to investors through a public issue. In rare instances, additional units may be issued.
The fund pools investors’ money to buy shares, bonds or other securities in line with the fund’s objectives. In exchange, investors receive units of the portfolio held by the fund.
Non-redeemable investment fund units are usually registered and traded on an exchange.  
.
May invest up to 100% of their NAV in conventional mutual funds and ETFs, alternative funds and non-redeemable investment fundsA non-redeemable investment fund is an investment company that issues a fixed number of units to investors through a public issue. In rare instances, additional units may be issued.
The fund pools investors’ money to buy shares, bonds or other securities in line with the fund’s objectives. In exchange, investors receive units of the portfolio held by the fund.
Non-redeemable investment fund units are usually registered and traded on an exchange.  
.
BorrowingMay borrow up to 5% of their NAV as a temporary measure to accommodate requests for redemption from investors.

May borrow up to 50% of their NAV to, in particular, accommodate requests for redemption from investors or purchase securities.

Borrowing to invest is risky. If the return on investments is lower than the borrowing rate, the fund’s value will decrease.

Short sellingMay short sellShort selling occurs when you sell a security you do not own.
An investor borrows a security from a dealer or other financial intermediary and sells it immediately on the market. The investor will later have to buy back the security and deliver it to the intermediary.
If the security declines in value, the investor can buy it back (redeem) at a lower price. His profit will be the difference between the selling price and the redemption price.
This investment strategy can be extremely risky. If the value of the security rises, the investor will have to pay back the difference and will therefore suffer a loss. Theoretically, the loss could be unlimited. For sophisticated investors only! 
up to 20% of their NAV, but up to only 5% of their NAV for securities of a single issuer.

May short sell up to 50% of their NAV, but up to 10% of their NAV for securities of a single issuer.

This is a risky strategy. If the value of the security sold short unexpectedly increases, the fund will have to make up the difference, resulting in a lower fund return.

DerivativesMay use derivatives as options to hedge risk. May use derivatives for hedging and speculative purposes. Using derivatives for speculative purposes is risky, as markets don’t always move in the expected direction.

Expected return of alternative funds

Returns are in the form of capital gain (or losses), interest or dividends. Fund performance depends on the success of the strategies used.

Many alternative funds are recent and therefore don’t have a long performance history.

Liquidity of alternative funds

In the case of an alternative mutual fund, investors may redeem their securities upon request to the fund manager. In the case of an alternative ETF, investors may sell their securities on a stock exchange and may sometimes redeem them upon request to the fund manager. For more information, refer to the fund prospectus.

Risks associated with alternative funds

The risks depend on the securities the fund invests in.

The strategies that distinguish alternative funds from conventional funds, particularly greater use of derivatives and short selling, can speed up the rate at which a fund loses value if market conditions sour.

The value of an alternative fund’s units or shares can go up or down. There are no guarantees. You could lose money.

Insight

Take time to read to the sections “How risky is it?” of the fund facts document and “Risk Factors” of the fund prospectusA prospectus is a detailed information document that a company must prepare to be able to sell securities (such as shares) to the public.
It must provide full, true and plain disclosure of all material facts likely to affect the value or market price of the security in question.  
. It contains additional information regarding factors that could affect the fund’s performance. You can also discuss the risks with your representative.

End of the insight

Before investing in an alternative fund

  • Take time to read the Fund Facts. The fund facts document of an alternative fund includes a textbox highlighting how the alternative fund differs from a conventional mutual fund or ETF.
  • Make sure you fully understand the strategies used by and risks associated with the fund, and figure out whether it suits your investor profile.
  • Check the fees that apply to alternative funds. Remember, every dollar in fees is a dollar less in returns. In addition to ETF and mutual fund fees, an alternative fund may charge investors a fee so it can pay an annual performance fee if the fund’s performance exceeded a benchmark. Speak to your representative to find out about alternative fund fees.
  • Contact the AMF Information Centre to make sure the firm or person you’re dealing with is authorized to sell you alternative funds.