Why clients seeking alts diversification have to avoid unnecessary complications
With the war against inflation not quite won and the future of the 60-40 portfolio in question, the case for alternatives exposure is growing among investors in the retail space. But for cross-border clients, getting access to non-traditional assets and strategies – particularly those listed in Canada – may not be so simple.
“Generally speaking, cross-border investors have a slightly limited scope from the alternative options that are available,” says Shiraz Ahmed, senior portfolio manager and senior financial advisor at Sartorial Wealth of Raymond James Ltd.
While there’s no questioning the depth of the U.S. investing space compared to Canada, Ahmed notes that from a product innovation standpoint, the Great White North has in some ways leapt ahead of the land of the free.
Last week, the Wall Street Journal reported U.S. investors are increasingly piling into active ETFs, with 30% of total U.S. ETF flows so far this year going into those products. Still, active ETFs make up less than 6% of the American ETF market – compared to 20% in Canada, where a more favourable regulatory environment has long given managers more confidence to present active strategies to the ETF world.
Canadian regulators allowed the launch of the world’s first-ever spot bitcoin ETF in 2021, but investors in the U.S. have yet to get access to a locally listed equivalent. It’s not for lack of trying on the part of fund providers, either; in late April, Cathie Wood’s ARK Invest and European crypto investment firm 21 shares lodged their third request with the Securities and Exchange Commission to approve a spot Bitcoin exchange-traded fund.
“Even some of our mutual fund structures, with the 81-104 Commodity Pools and whatnot, there are some more, I would say, innovative products north of the border relative to what’s available in the U.S.,” Ahmed says.
On both sides of the 49th parallel, he says the general motivations for alternative investment exposure tend to gravitate around inflation protection, buffering against volatility, and general diversification of portfolios across asset classes. But cross-border clients from the U.S. will find limited opportunity to access an alternative investment strategy that exists within a Canadian structure.
“If the alternative investment is structured as a Canadian product, that would be typically tax-prohibitive for an American investor to own,” he says. “A Canadian mutual fund, an ETF, or even a hedge-fund type structure would typically be not conducive for an American investor because of the reporting requirements involved.”
There are some exceptions to that rule of thumb – for instance, if the investment is held inside a Canadian registered account. But if a cross-border client is looking to invest non-registered monies, Ahmed says it is typically not advisable to put it in Canadian structured products, which would be deemed as passive foreign investment corporations (PFICs) for U.S. tax purposes.
While Ahmed stresses that decisions are made on a case-by-case basis, he says the standard advice in the vast majority of cases is to avoid complications where possible. He and his team try to adhere to that guiding philosophy, though there are situations where there’s a strong reason to do otherwise.
“Typically, it’s a conversation between your financial professional, your tax professional, and yourself to see whether or not the strategy is worth putting money into despite the tax ramifications,” he says. “What I advocate for everybody is you never want tax to drive the bus on your decision-making, but it should definitely sit shotgun.”
Like the vast majority of cross-border investment advisors, Ahmed keeps a lookout for products and strategies that could be a good fit for his clients’ needs. He uses Canada-listed alternatives and U.S.-listed alternatives as appropriate, but isn’t aware of any offering that addresses the specific reporting nuances associated with cross-border investments.
“I haven't necessarily seen people feeling like they're left behind just because they're not participating in a Canadian strategy,” Ahmed says. “I’ve found there are still enough options listed in the US to serve cross-border clients.”