Unlock Retail Access to Private Funds

On October 10, 2024, the Ontario Securities Commission (OSC) published a consultation paper proposing new investment options in an effort to unlock retail access to private funds.  This would enable retail investors to participate in long-term, illiquid assets through a new investment fund structure. The paper examines how retail investors, who are typically excluded from such investments, can benefit. It highlights assets like infrastructure, natural resources, real estate, private equity, and venture capital.  These assets, defined as Long-Term Assets (LTAs), typically require extended investment horizons and are characterized by illiquidity and price volatility.

Purpose and Goals

The OSC’s initiative is designed to provide retail investors with access to LTAs, which are often less liquid and harder to value but offer potentially higher returns over extended investment horizons.

The key goals of the consultation paper are:

• Improving Access: Providing retail investors more opportunities to invest in LTAs, which are typically restricted to institutional or accredited investors due to the associated risks and complexities.
• Risk Mitigation:  Developing a regulatory framework that balances the potential rewards of LTAs with their risks, such as illiquidity and price volatility.
• Leveraging Expertise:  Ensuring that these investments are managed by experienced professionals, including registered Investment Fund Managers (IFMs) and Portfolio Managers (PMs), to mitigate complexity and protect investors.
• Co-investing with Institutions:  Allowing retail investors to invest alongside institutional investors such as pension funds, known as “Cornerstone Investors,” who typically bring significant expertise and resources to manage such assets.

The Ontario Long-Term Fund Proposal

The OSC proposes the creation of a new category of investment fund called the Ontario Long-Term Fund (OLTF). The OLTF would be structured to accommodate LTAs, providing retail investors with access to these assets through an investment fund structure. Key features of the OLTF include:

• Investment Focus:  OLTFs would invest primarily in LTAs, with safeguards to manage liquidity, valuation, and concentration risks.
• Co-investment with Institutional Investors: Retail investors invest alongside institutional investors, sharing the management of LTAs with experienced professionals.
• Regulatory Flexibility: OLTFs would be subject to unique regulations that provide more flexibility than existing mutual funds or non-redeemable investment funds.  OLTFs would become reporting issuers in Ontario and only available to Ontario investors.

The Potential Benefits of Long-Term Assets

Long-Term Assets, while illiquid, offer benefits for investors with longer investment horizons. These assets can provide:

• Illiquidity Premium:  A higher return potential as compensation for the inability to quickly sell or trade the asset.
• Diversification:  Many of these assets, such as infrastructure or real estate, tend to have lower correlations with traditional public market investments, helping reduce overall portfolio risk.
• Long-term Gains:  Investors with the ability to “buy and hold” for extended periods can benefit from capital appreciation as these projects or assets mature, leading to potentially higher returns than those found in more liquid markets.

The Potential Risks of Long-Term Assets:

• Liquidity Constraints:  Investors may find it difficult to exit these investments, particularly during market downturns, without incurring losses.
• Volatility:  These assets can be subject to large price swings, especially during periods of economic stress or financial market disruption.
• Concentration Risk:  Over-exposure to illiquid assets can lead to higher risk if the portfolio is not diversified across other types of investments.

Protecting Retail Investors

To address investor protections, the OSC proposes several safeguards:

• Professional Management:  OLTFs would be managed by experienced IFMs and PMs who are qualified to handle the complexities of LTAs.
• Independent Valuations:  OLTFs would be subject to a requirement to obtain independent valuation at least as frequently as at the end of each annual financial reporting period. This will help ensure that the fund’s net asset value (NAV) accurately reflects the prices of illiquid assets.
• Tailored Disclosure:  Clear and detailed information would be provided to investors about the risks, objectives, and redemption policies associated with OLTFs.

Impact on Existing Managers

The proposed OLTF structure could have several impacts on existing, non-registered private fund managers who primarily cater to institutional and accredited investors.

Increased Competition

The introduction of OLTFs, which offer retail investors access to LTAs like private equity, infrastructure, and real estate, may create new competition for private fund managers. Historically, these managers have had an advantage by exclusively offering access to these. investments.

Pressure to Register and Comply with Regulations

Non-registered private fund managers could face pressure to register with regulators if the OLTF model succeeds in attracting retail investment into illiquid assets. The OLTF proposal mandates professional management and significant regulatory oversight, which may create a higher standard for managing these types of assets. Private fund managers might need to consider registration to remain competitive or compliant with potential new industry expectations.

Disruption in Investor Base

If retail investors gain more access to LTAs through OLTFs, private fund managers may struggle to attract new accredited investors. Investors who previously relied on private funds for illiquid investments might shift to OLTFs. This shift could happen due to OLTFs’ lower minimum investment thresholds, improved protections, and the ease of access through a regulated public vehicle.

Higher Scrutiny and Governance Expectations

Since OLTFs follow strict governance, independent valuations, and disclosure requirements, non-registered private fund managers may feel indirect pressure to improve their governance. To stay competitive, they might need to boost transparency, risk management, and reporting. This alignment would bring them closer to the higher standards set by the OLTF regime.

Fundraising Challenges

The OLTF’s proposed structure offers a regulated pathway for retail investors. This may reduce fundraising opportunities for non-registered private fund managers. Retail investors, especially those seeking diversification and illiquid assets, may prefer a regulated OLTF environment over non-registered private funds. Private managers could need to rethink their fundraising strategies. They may focus more on attracting larger institutional investors.

Opportunities for Collaboration

While OLTFs could create competition, they may also provide new collaboration opportunities for non-registered private fund managers. For instance, the proposal would require OLTFs to invest in LTAs through the security of underlying collective investment vehicles (CIVs) . Private fund managers could partner with OLTFs to serve as underlying managers of these CIVs, offering their expertise in managing LTAs while benefiting from access to a broader investor base through the OLTF structure.

Impact on Fees and Cost Structure

Since OLTFs must meet regulatory and governance requirements to protect retail investors, their fee structures may become more transparent. They could also be more competitive than those of non-registered private funds. Private fund managers may need to rethink their fee models, especially if they charge higher fees for exclusive offerings. Investors might seek out lower-fee OLTFs, pushing private fund managers to adjust.

Potential for Increased Regulatory Oversight

The success of OLTFs might prompt regulatory authorities to extend similar oversight and registration requirements to non-registered private fund managers. This could lead to increased compliance costs and administrative burdens for those fund managers who currently operate with less regulatory scrutiny.

Shift in Investor Preferences

OLTFs promote liquidity features, such as limited but regular redemption periods. Retail investors may prefer these semi-liquid structures over traditional private funds, which are fully illiquid and lack regular redemption options.  Non-registered private fund managers may need to adapt by offering more flexible liquidity options to stay competitive.

Feedback

The OSC is actively seeking feedback from stakeholders. It invites input on key areas like balancing retail investor access to illiquid assets. This includes exploring risk mitigation strategies, such as redemption policies, valuation practices, and governance requirements.  We encourage stakeholders to comment on potential investment restrictions and the role of professional managers in overseeing these assets. The feedback collected will guide future regulatory changes. These updates aim to create a balanced framework that protects investors while promoting capital formation and innovation.

The consultation period is open until February 7, 2025. Comments can be sent by email in Microsoft Word format to comments@osc.gov.on.ca.

Conclusion

The OSC’s proposed OLTF)structure is a major step to unlock retail access to private funds. This allows retail investors to participate in long-term, illiquid assets like infrastructure, private equity, real estate, and venture capital. Traditionally, only institutional investors accessed these assets. The OLTF provides opportunities for higher returns and portfolio diversification. However, these opportunities come with risks, including illiquidity and volatility. The OSC addresses these risks through professional management, independent valuations, and enhanced disclosure requirements.

The introduction of OLTFs could create competition for private fund managers while also providing collaboration opportunities, particularly through collective investment vehicles. As the market evolves, non-registered private fund managers may face pressure to align their practices with the governance and transparency standards of the OLTF framework.

Overall, the OSC’s proposal aims to balance the rewards of long-term asset investment with robust investor protection, offering retail investors new ways to grow their portfolios and access previously untapped opportunities.

Pinnacle has extensive experience servicing Private Funds and is strategically positioned to service OLTFs.  If you have any questions about private funds, please contact David Smith at dsmith@pinnaclefundservices.com or 1-604-559-8921.