The next best thing to true private equity exposure

Mackenzie's Head of Alternative Investments on how pioneering partnership can help Canadian investors experience benefits of PE

The next best thing to true private equity exposure

If Mackenzie Investments wanted to conceal the level of importance alternative investments play in its business strategy, it’s doing a terrible job.

Over the past few years, the company has grown its capabilities and footprint in the space considerably. Beyond managing alternative portfolios for pension funds and U.S.-based institutional investors, the firm recently entered a strategic partnership with Northleaf Capital, expanding its ability to introduce private asset classes into client portfolios.

The firm also has played a trailblazing role on the Canadian liquid-alternatives front, where it staked a decisive claim in May 2018 by launching a multi-strategy fund under the auspices of novel exemptive relief. That was followed several months later with a credit-focused absolute return fund and a global macro fund, which is run by professionals whose investment experience includes working at CPP.

“We took the opportunity to help investors achieve a better risk-return profile using non-directional, absolute-return oriented strategies,” said Michael Schnitman, senior vice president and head of Alternative Investments at Mackenzie. “Those types of strategies generally provide stabilization and ballast when added to a traditional portfolio.”

The company didn’t stop there. Just last June, it introduced an alternative enhanced yield fund that combines leveraged investment in less-risky strategies with high-yielding equity and dividend exposures, generating a consistent 5% fixed rate distribution with little to no return on capital. And less than two weeks ago, it took another step forward by debuting the Mackenzie Private Equity Replication Fund.

“I’m extraordinarily excited about this fund,” Schnitman said. “We have really pioneered in this space.”

As he explained, the strategy was borne out of conversations with Randolph Cohen of Harvard Business School, one of his professors before he graduated in 2002. A focal question of Cohen’s academic research involves how to replicate the favourable return and volatility characteristics of private equity.

As an asset class, PE is nothing new. It’s long had a place in the portfolios of large, institutional investors and endowments, with successful PE managers being distinguished by the returns they get from leveraged access to high-quality, low-multiple companies. With mark-to-model accounting, they’re able to offer smoother volatility profiles than others who use mark-to-market methods of asset valuation. The Mackenzie fund’s resilience against downside volatility is delivered through the use of tail-risk hedging strategies.

“The challenge with true private equity is that you have long lockup periods on the order of 10 years or more where you can't touch your money,” Schnitman said. “They also have very high investment minimums and other limiting liquidity provisions that make them unreachable for everyday investors.”

With the new Mackenzie Private Equity Replication Fund, he said Canadian retail investors can access the next best thing. By marrying the strengths of the firm’s Boston-based global quantitative equity boutique, its Toronto-based multi-asset strategies team, and Cohen’s academic leadership and research, the fund aims to create an investment product that substantially reproduces the benefits of private equity.

In a nutshell, the fund’s portfolio construction process begins with Cohen’s research, which identifies attractive candidates among publicly listed U.S. small- and mid-cap equities – a universe chosen because of how they match the profile of companies PE firms seek for their portfolios. To choose the fund’s investment holdings, Mackenzie takes that information and feeds it into a proprietary investment model; using a private database bought by the firm, the team also determines how PE firms weight their exposures and rebalances the fund accordingly.

“We're basically replicating and providing access to the industries that real private equity selects and allocates toward for their institutional clients, and adding the benefits of daily liquidity, transparency, and low investment minimums,” Schnitman said.

As he explained, traditional portfolio performance could potentially be improved with an allocation to the firm’s new PE replication fund: “Shifting from a balanced global portfolio split (60-40 between equities and fixed income) to a 40-20-40 allocation among global equities, PE replication, and fixed income respectively has the potential to improve total returns, along with improvements in maximum drawdown and Sharpe ratio.”

“We're thrilled to be able to offer the characteristics of private equity to retail investors to add a layer of diversification to their overall portfolios,” Schnitman said. “We believe that through dedicated research and infusion of academic expertise that investors can leverage public markets to achieve a successful risk-return profile as represented by private equity.”

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